A quick audio recap of last weeks markets and some points to ponder for next week:
Stocks Mentioned:
The Blackstone Group L.P. (BX)
Amedisys, Inc. (AMED)
Almost Family, Inc. (AFAM)
LHC Group, Inc. (LHCG)
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Shares of Intrepid Potash Inc. (IPI) have dropped sharply this week as pressures have mounted in various forms. For starters, the Dow has dropped 8.1% in just the last 5 trading days. It’s tough for any growth stock to avoid losses in that environment. At the same time, the company announced earnings this week. Numbers for the fourth quarter weren’t particularly bad, but there was little reassurance that management could give investors for the coming months. Finally, the potash industry took another blow when Russian miner Uralkali officially cut prices of potash to Brazil by 25%.
Looking closely at the earnings report, it was a bit refreshing to see management acknowledging the tough environment and taking steps to protect shareholders. While earnings were quite high compared to last year’s numbers, the picture for Q1 2009 and following remains cloudy. IPI was able to report sharp profit gains while selling only 94,000 short tons of potash compared to the 215,000 tons it sold in the fourth quarter of 2007. The difference is the realized price of $762 per short ton in 2008 compared to $224 realized in 2007.
In order to maintain financial health in a market with waning demand the company has several options on its plate:
Management made no attempts to assure investors of better days ahead but instead categorized the current market as “erratic and unpredictable.” Much of the production that had been sold to oil and natural gas markets is now being converted for agricultural use. IPI is being forced to adapt to a new environment and appears willing and able to make such transitions.
In 2009, the company intends to spend anywhere from $100 million to $140 million on capex projects. The range is quite wide because the spending depends on exactly how the year progresses. $45 to $65 million of this will be earmarked for sustainability and improvement projects while the remaining $55 to $75 million will be for investments in opportunistic projects. Since the company is sitting on cash of $116.6 million (as of 12/31), no debt, and has access to a $125 million line of credit, the budget should be adequately funded.
With consensus earnings expectations of $2.54 per share in 2009, and $2.84 in 2010, the shares appear to be a good value near $15. The ZachStocks Growth Model has a position in IPI and while obviously I wish we had waited until today to make that investment, the long-term potential for this stock remains attractive. I remain optimistic that this position will realize gains over the coming 6 to 12 months.
FD: Long position in ZachStocks Model – no personal Position
IPI Notes
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Additional Reading:
Trader Mark: Potash Stocks Under Pressure
Big Picture: China – Better Days Ahead?
AECOM Technology Corporation (ACM) saw its shares drop significantly early this week after the company announced a public stock offering. Morgan Stanley was retained to manage the books on this deal and appears to have done a stellar job.
The original announcement was for a sale of 3.5 million shares. The current market environment has made it difficult for any company to raise funds – even a strong cash-flow positive business like ACM. However, Morgan Stanley was able to get the deal done on a larger scale than originally announced. At the end of the day, a full 4 million shares had been sold at $20.20 netting AECOM $80.8 million (less fees and expenses).
According to the press release, the company intends to use the proceeds for general corporate purposes and to fund future strategic acquisitions. I expect that management has its eye on a few specific acquisitions and is preparing its balance sheet to be able to make the transaction. After all, the current environment has many companies trading at historically low multiples. Private acquisitions are also a strong possibility with many small businesses finding it difficult to get adequate funding for their day-to-day business.
ACM already boasts a strong balance sheet and a healthy business model. Earnings are expected to grow 19% in the current fiscal year (ending September 30) and an additional 20% in fiscal 2010. These earnings figures are relatively conservative as the company enjoys a healthy backlog of business. Large projects managed by AECOM are not totally immune to the current economic decline, but are usually a bit more resistant. After all, if you are managing a several hundred million dollar project, you will likely find a way to finish once you have spent the first hundred million. And since ACM can work on projects for multiple quarters if not years, the cash flow is more predictable than many other construction businesses.
Currently, the stock is trading at a PE of 12.4 considering this year’s earnings, and 10.3 compared to 2010 expectations. The stock is also trading solidly above the deal price of $20.20 which likely indicates healthy demand. We are certainly seeing volatility with the equity markets in flux, but It appears ACM is positioning itself to be a strong contender in the months to come. The ZachStocks Growth Model currently holds the stock and I expect to see a sharp rebound in conjunction with any market strength.
FD: Author does not have a position in ACM
ACM Notes
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Trader Mark: Water Infrastructure Play
NYT: Stimulus Spurs Road Projects
Healthcare stocks took it on the chin last week following Obama’s budget submission. The new budget calls for a National Health Insurance Program and sweeping changes to the current Medicare process.
While the entire budget will likely be cut up, twisted, reformatted and then put back together by congress, the uncertainty had a profound effect on the markets. Drug makers, managed care providers, medical technology companies and insurance firms all fell in lock step. Investors obviously fear that a widespread change in government reimbursements and other programs could severely crimp future profits.
In particular, Obama plans to establish a $630 billion dollar “reserve fund” which will be used to fund the national health insurance program. This program would likely require much more capital to be “fully operational,” but the move is still groundbreaking and has the potential to significantly change how Americans receive medical care.
This year I have actually been quite active in the healthcare sector. In the publication Taipan’s New Growth Investor that I write for, we have two long positions (A diagnostic company as well as a managed care firm). At the same time, my trading service Death Cross Trader has benefited from shorting or buying puts on a few over hyped, high multiple medical technology companies. The new budget has certainly had a profound effect on all of these positions.
Efficiency as the Goal
It’s a bit ironic coming from the government, but the big push for this budget centers around efficiency. I say ironic, because it is pretty rare that you actually see the government operating efficiently. But with a new Universal Healthcare system beginning to take form, the government wants to keep a lid on medical costs.
Looking at “for-profit” companies in the industry, this can be pretty bad news. If regulators look in and see companies accepting medicare payments and making wide profit margins, the payments will likely be reduced. That’s why we are seeing stocks of profitable healthcare companies trading sharply lower. For instance, Gilead Sciences, Inc. (GILD) dropped 9.6% in just 2 days following the release of the budget. The company develops treatments for many viral diseases.
Most of Gilead’s products have very high profit margins because they own the patent on vaccines and medicines. We’ve been short GILD in Death Cross Trader because investors got too confident that these profits would continue to grow. Now, investors begin to question whether these wide profit margins will stick around. After all, what if the government requires Gilead to offer treatments at substantially lower prices? I don’t think this is an impossibility anymore.
This is a pretty sobering event for free-markets. Part of the reason Gilead’s products are so expensive is because of the huge research expense to develop a product. Typical drug companies may spend tens or hundreds of millions to develop, test, and get products approved.
Once the process is complete, the actual cost to manufacture each pill can be very low. But companies charge a high price to make up for the development expenses along the way. If medical companies can’t charge enough to make a profit on top of these costs, there is a pretty good argument that the advances in medical technology could be pressured.
Aside from the social and moral concerns, we as investors and traders have to do the best we can to protect our capital in this environment. And that means even profiting from declines like we’re seeing in the medical stocks right now. For instance, last week I suggested DCT traders buy puts on Immucor, Inc. (BLUD). The stock had broken sharply below a support level and was vulnerable due to a high earnings multiple (among other things).
Today, just over a week later, those puts are more than 200% higher. The movement in stocks like Gilead and Immucor goes to show that healthcare is a recession resistant sector, but certainly not recession proof.
Attractive Opportunities Still Exist
While investors quickly sold every healthcare company that had a pulse (pardon the pun), there are a few key areas that still appear to be good investments. To be quite honest, the healthcare sector can actually be quite bi-polar when it comes to the profitability of individual companies. So from and investing standpoint, there are several sub-sectors to consider when looking at healthcare stocks.
Some of my most recent recommendations have been for home healthcare companies with relatively attractive profit margins. These firms usually have a significant reliance on Medicare which reimburses the company for much of the care given.
On the surface, this may sound like a losing combination. After all, if Medicare payments are going to be reduced to firms making strong profits, doesn’t that mean home healthcare companies will be in the crosshairs for Medicare cuts?
But looking deeper into the dynamics, I believe home healthcare solutions will actually be PART of the plan to increase efficiency. You see, when a patient gets discharged from the hospital, or needs to have watchful care, home health companies step in and provide care at a much lower cost than if the patient were hospitalized. So in actuality, these firms ALLOW Medicare to be MORE efficient and cost conscious.
Obama has stated the goal of reducing re-admission to hospitals. They simply don’t want to see patients released and then have these same patients returning to the hospital. That’s more costly for everyone. But since many home care firms specialize in taking care of acute patients, there should be even more business coming their way.
So I expect while profits per patient may decrease a bit, companies in this sub-sector will get more than enough new business to make up for it.
FD: Author does not have a position in stocks mentioned
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Additional Reading:
Forbes: What Obama’s Healthcare Budget Means For You
Big Picture: Time For A New Deal
MetroPCS Communications, Inc. (PCS) entered the year looking a bit vulnerable. In an early January post on PCS, I recommended readers consider shorting the stock as the multiple was quite high and it appeared the company would likely face stiffer competition.
As it turns out, the stock is a bit lower than where it was trading in early January, but I am feeling less comfortable with a short position in this name. Despite a market that is now down more than 20% on the year, PCS has traded in a wide, but relatively flat pattern. This out-performance could eventually lead to a sharp move higher if the market begins to show more strength.
Last week the company announced earnings for the fourth quarter and the results were actually quite impressive. Total revenues were $724 mil which is an increase of 22% over last year. The company added another 520,000 subscribers during the quarter ending the year with 5.4 million subscribers. More importantly, the company is successfully launching in new cities with Philadelphia and Las Vegas coming on board in late 2008, and New York City and Boston fresh out of the gate February 4th.
Management sounded very optimistic on industry trends as they noted “Voice continues to go wireless and wire-line replacement trends continue to accelerate.” PCS was able to capitalize on this trend and lower their cost per gross addition to $119.82. This is $21.60 lower than the fourth quarter of 2007 and shows that the company is now reaching a point where their overhead marketing expenses are efficiently reaching a broader audience.
Looking to 2009 the company expects to add another 1.4 to 1.7 million subscribers and report EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) of $900 mil to $1.1 billion. The company will continue its aggressive spending on its technology rollout and expects Capital Expenditures in the $700 million to $900 million dollar range. This is a bit surprising, given the economic climate, but may pay off if the bigger picture becomes more attractive.
One of my main concerns when I covered PCS in January, was that the competition could launch similar “unlimited” programs to PCS and take their competitive edge away. To date, we have not seen any moves by Sprint (S), Verizon (VZ) or AT&T (T) to match the plan. I believe this is a mistake by the big firms because they are now likely to begin losing market share to the likes of Leap Wireless (LEAP) and MetroPCS. For this reason I’m still not recommending a long position in PCS. The risk is just too great with the economy in such a difficult spot and with PCS trading at such a rich valuation.
But to avoid the risk of a rebounding market sending this stock sharply higher, I would recommend closing short positions in PCS for the time being. The company has laid out an aggressive plan and to this point the plan has been executed flawlessly.
FD: Author does not have a position in PCS
PCS Notes
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Additional Reading:
Barrons: Wireless Sector Price War?
Last week Continental Resources (CLR) reported earnings. The figures were a bit disappointing as the company essentially broke even for the quarter. Management blamed falling commodity prices for the earnings miss which is no surprise given the steep drop in oil and natural gas prices.
But despite the lackluster performance, the stock actually traded higher after the report. Apparently traders were pleased with the fiscal discipline management is employing to ensure the company remains healthy throughout these challenging times.
The company has actually taken drastic steps to reduce production growth for the time being. In October there were 32 rigs in action drilling for resources. As of last week, this number was reduced to 7. And management stated that during the coming year, they will average only 5 rigs in operation. This significantly reduces the amount of capital being spent on drilling projects and management said they would not increase activity until they see meaningful recovery in the price of oil and natural gas.
Despite drilling less, Continental has actually increased its proven reserves. This essentially means that the company has been successful in its remaining drilling projects and the proven level of resources continues to climb. This is certainly good news at a time when competitors are having trouble replacing reserves that are actually produced (pulled out of the ground for consumption). It appears the conservative approach that management is taking will pay off.
For 2009, the management expects production growth of 8%. However, according to a Raymond James report that digs into the production statistics for current wells in the regions CLR is drilling, these numbers are likely to be overly conservative. It probably works to the company’s best interest to under-promise and then over-deliver. That way if commodity weakness continues, they can back off drilling programs even further to save capital.
Speaking of capital spending, the budget for 2009 is set up to spend $275 million. This is sharply lower than the 2008 budget of $609 million. Of this $275, the company will use $211 for drilling, $58 million for land and seismic tests, and the remaining $6 mil for general purposes. With only $5.2 mil in cash and 198.1 available under a credit facility, the company will rely on sales of resources to fund much of the budget. But even at the current low prices, this should be more than adequate.
So in a time when economic pressures are hampering growth, Continental has taken the wise step of retreating from unstable growth. The company should remain in a strong position to capitalize on increases in prices for years to come. The recovery will take time, but investors might be wise to begin building positions now.
CLR Notes
FD: Author does not have a position in CLR
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Additional Reading:
Ritholtz: Words From The Investment Wise
TPG: What To Do With Your Money Now
