Friday, April 27, 2007

FreightCar America Inc. (RAIL)

FreightCar America Inc. is railcar manufacturer based in Chicago, IL. They specialize in coal-carrying railcars which represents most of their business (96% of their deliveries in 2006 and 93% of their deliveries in 2005). They also rebuild and resell used railcars and sell parts for railcars, but that represents a minuscule part of their business.

Industry

Railcar manufacturing is a very cyclical industry. It is very economic sensitive. It follows the economy and does excellent when the economy is doing excellent and does poorly when the economy is not doing so well. So far, a lot of the economic forecasters are forecasting a slowdown in the U.S. economy, just in the 1st quarter 2007, the economy grew at a 1.3% pace compared to a 1.8% pace as forecasted. That does not bode well for the short term. According to the Railway Supply Institute, orders, deliveries, and backlogs all fell in the 1st quarter 2007 compared to the 1st quarter 2006 and compared to 4th quarter 2006. The industry statistics are giving signs of a slowdown in industry as well.

The data below is from the Railway Supply Institute website.



Just in the past quarter, it was the lowest order total since 2003, backlogs went down almost 8% quarter over quarter. This is the biggest decrease in backlogs (in percent) since 2001.

Valuation

This is the most attractive part of the company, they are trading at a trailing twelve month price/earnings ratio of 4.97. They pay a dividend of .24 a year for a yield of .5% at current price of $50 a share. Their balance sheet is very strong with debt almost non existent. Their cash and cash equivalents on hand is over $212 million and about $16.58 per diluted share. They are trading at a forward price/earnings ratio of 11.12 for year end 2007. 18.4% of their float is short.

Positives

Warren Buffett is bullish on the Railroad industry, he just upped his stake and became the number one shareholder of Burlington Northern Santa Fe. Just in January, the Board of Directors authorized a share buyback of up to $50 million, that's almost 8% of their shares outstanding at today's prices.

Negatives

Their railcar backlog dipped from 20,729 to 9,315 from 12/31/2005 to 12/31/2006. There have been cost pressures in the raw materials they use to build their railcars like aluminum and steel. On the bright side, most of cost pressures in raw materials have been passed on to customers. Since railcars are usually ordered in bunches, a big portion of their yearly railcars are tied up into a small number of customers, so if someone cancels or delays there could be a negative effect any given year. FreightCar also relies heavily on one supplier, Amsted Industries Inc, for the purchase of wheels and other railcar components. Just as recently as in 2004 there was a shortage of wheels and that forced them to limit their deliveries.

Technicals

FreightCar America has been in a trading range since around the summer of 2006 of between $45 and $60 a share. The three main moving averages are saying its in a bearish trend with the 50DMA below the 200DMA and the 20DMA is below the 50DMA. MACD and RSI showings are pretty neutral. If it does not go on to break strong resistance at $52.50, this could be the final leg up before it breaks support at $45. Volume has been picking up on negative days the past few weeks as well.



Conclusion

This does not seem like a great buy even though the valuation is superb. The economy has been slowing down and there are signs that the railcar manufacturing industry will follow. I don't know if this is exactly a shorting opportunity due to the extremely low valuation, but this does not seem like a long either. It doesn't look like there will be any growth in the near future so I think it's best to stay away from FreightCar America and come back in a few years when the economy is turning around.

Disclosure: I don't have a position in RAIL.

Thursday, April 26, 2007

RealNetworks Inc. (RNWK)

RealNetworks is a digital media services and software company. They have such products as Rhapsody, RealArcade, and RealPlayer. Their recent downward guidance for the 1st quarter of 2007 has sent the stock down from a $10.50 a share to a more recent trading price of $8 a share. The company predicts that earnings are going to be between 16 and 18 cents for the 1st quarter 2007 and full year 2007 earnings to be between 18 and 23 cents a share.

Issues with the company

The only reason they turned to profitability in 2005 and have been profitable since is because of their windfall in the lawsuit against Microsft. They have received Payments of $478 million in 2005, $221.9 million in 2006, and 61.1 million in January 2007. Over the same time period, their net income in 2005 was $312.3 million and $145.2 million in 2006. The January payment is their last and as you can see, this has been a huge part of their earnings in the past couple of years.

Their main competitors in Music are Microsoft, Apple, and illegal music downloading. Microsoft has been known to be very aggressive with their competitors and has taken aggressive steps against Real Networks. Apple's iPod's dominate the music hardware market and iTunes dominates the legal music downloading market. The iPod line holds a market share of over 70% in U.S according to GfK and NPD. The iTunes music downloads hold a market share of over 85% according to Nielsen Soundscan data. Apple dominates with the quality of their products and Microsft dominates with their size, intimidation, and operating system package advantage. Illegal music downloading has been going on for a long time and still takes a lot of money away from legal competitors. The RIAA has been at it for a while now with no success.

Their SuperPass subscription which deals with media services and software competes with YouTube, which is a free service. It is the number 2 video site on the Internet behind MySpace.

One of their major strategies is acquiring companies for growth, depending on your perspective, this isn't the best way to grow a company because of the different difficulties that occur in mergers and acquisitions.

They have a number of provisions in place to discourage acquisitions and mergers. This will discourage potential acquirers that like their valuation and their wide range of products.

Positives about the Company

They have a superb valuation with cash and short term investments less long term debt of $3.22 per diluted share. This should give them money for acquisitions and a very nice margin of safety for an investment.

Their revenue growth has been superb. As you can see the revenue more than doubled in 5 years.

Some of their revenue has not been through organic growth though, for example, in the fourth quarter of 2006, $26.7 million out of $125.6 million were from the acquisition of WiderThan.

33% of the stock is owned by insiders so that means their interests are aligned with investors. Insiders have also recently stopped selling their shares in RNWK since the stock dropped to $8 a share. As of December 31, 2006, $78.1 million remained authorized to repurchase shares.

They have been spending a consistent 20% of Revenue on Research and Development expenses. This number has to be looked at closely to because an investor wouldn't want the company to forgo R & D expenses to boost short-term earnings.

Technicals

The 20 DMA is below the 50 DMA, and the 50 DMA is below the 200 DMA, so the downtrend is firmly in place. The stock price is basically back to the support of $7.50 it was at before the lawsuit win against Microsoft in 2005. It seems like it has found some support in the $7.50 area and both MACD and the RSI show that it is slightly oversold.



Conclusion

I see a lot of positives in that their Revenue growth has been superb, their insiders own 33% of the shares, they have a wide range of video products, and their valuation is attractive. They also face intense competition from Google, Apple, Microsoft, and illegal music downloads that might stunt their growth. A lot of their products that they charge a fee for face competition that doesn't charge like Google's YouTube and unless there are more laws that restrict the use of illegal music downloading or companies take Google to court over copyright like Viacom recently did, I'm not sure how RealNetworks can succeed in this environment.

Saturday, April 21, 2007

The Long Case for OmniVision Technologies Inc.

OmniVision Technologies is in the semiconductor industry and they sell camera chips that are used in cell phones, digital still and video cameras, personal computer camera applications and interactive video, digital toy cameras, security and surveillance products and analog toy cameras, automotive products and medical imaging devices. Wall Street has not been kind to OVTI recently, it has been downgraded 8 times in the past 8 months, compared to only one upgrade. They have been struggling as of late with earnings and margins falling significantly. OmniVision has been busy clearing out old inventory, which in the FIFO accounting method (OmniVision's accounting method) uses for the technology sector results in lower margins, and continued price pressures because of heavy competition in semiconductors.



Gross Margin has slumped from a high of 45.26% in Q2 of Fiscal year 2005 to a low of 24.93% just in the past quarter.

Here are the Gross Margins for the past 3 fiscal years:

2005 40.34%
2006 36.94%
2007 31.49% (first 9 months)



Earnings have also slipped significantly which is no surprise because of the depressed stock price.

They are currently trading at $13 a share. $6.09 of that is backed by net cash/short term investments per diluted share. So OVTI's operations are only selling for $6.91 per diluted share. The balance sheet is rock solid with almost no debt. They also just authorized a $100 million stock repurchase program. Selling as compared to the Semiconductor Index ($SOX) it is selling at its trough valuation of the past 3 years of the ratio of $SOX:OVTI of 38.

Semiconductors is a tough business, but OVTI won't go anywhere as long as Cell Phones are being sold in millions. I am currently long OVTI.

Friday, April 20, 2007

The Long Case for Optimal Group Inc

The Optimal Group is a payment processing firm that processes credit card payments for small and medium sized companies. They also process online gaming transactions that originate from non-US customers. In October, when the new gambling law was announced by the U.S. congress, this stock took a big hit because 80% of its subsidiary's revenue came from U.S. based gambling internet transactions. The stock received almost a 50% haircut from 14/share to almost 7/share. The gambing transactions segment is the high margin segment averaging 20.4% Profit Margin over the past 3 years, while the payment processing operations just turned a profit for the 1st time in 3 years in 2006.

On the bright side, they still have their payment processing firm, "Optimal Payments." The payment processing operations is turning the corner with having their first profitable year in 3 years in 2006. The gaming operations will just be 20%-25% of the total revenue compared to 50%. There will be considerable less volatility of earnings throughout the year because of the seasonality patterns of gambling transacations in the spring and summer months. The jewel of this situation though, is their net cash of $5.63 per issued and outstanding share. As of today, OPMR was last trading at $9/share, 62.5% of their current stock value is being backed by cash and short term investments. So, you are only paying $3.37 a share for ALL of their operations. This is a rock solid balance sheet as well. The safety of margin in this investment is there. Analysts project on average $121 million of revenue for 2007. They have 25,439,000 outstanding shares, that's $4.76 of revenue per share projected. They also have a 1,100,000 share buyback plan in place.

Technical wise, it just broke out of a descending triangle but I don't think it will just break through really tough resistance at $10 before it will be available at a better price. MACD and RSI have both been trending up while the stock has been moving sideways between $7.50 and $10. At $8.50 is a solid spot with the down trending line and the 50DMA meeting there.

I don't think online payment processing is going anywhere, and the price that their operations are selling for now is too cheap to pass up. I don't currently own a position.