Tuesday, May 29, 2007

Stay Away from this Magic Formula Stock (ALOY)

Alloy Inc is a media and marketing services company. There are three main segments of the company:

Promotion – helps clients reach promotional goals with their target customer through event and field marketing, sampling, onsite promotions, and customer acquisition programs
Media – Provides advertising solutions for young adults, both online and offline, through such sources as Display Media Boards, websites, books and print sources
Placement – provides placement solutions for targeted customers in college, multi-cultural and military markets

They mostly target 10-24 year olds, but they do reach consumers outside of that group.

Their revenue growth has been very slow but their operating income has reached positive level this past year for the first time since 2003. On an aggregate basis, their last positive earnings per share was in 2002. In December 2005, Alloy spun off its subsidiary, dELiA’s, which was a specialty retailer operation.

Industry

This is a very competitive market, key competitors include MTV, MySpace.com, and Facebook.com. There is a lot of competition for the attention of this target market. This industry will suffer if there is a downturn in the economy since the companies that advertise with Alloy largely depend on discretionary consumer spending. It is also regulated by the government. The 2nd half of the year is where a majority of the income and revenue is earned due to the back-to-school and holiday shopping seasons.

Company

There are a lot of issues with Alloy. They place a big emphasis on acquisitions which they have been unsuccessful in. Their pace of dilution is too fast, there were 10,652,000 shares outstanding in 2004, and as of the close of 2006, there were 12,541,000 shares outstanding. That’s a dilution rate of over 8% a year.

They have been in business since 1996. 10.3% of the company is owned by insiders. The two founders, Matthew C. Diamond and James K. Johnson Jr., have been with the company since 1996 and both are executives with the company.

Valuation

They are trading at a forward price/earnings ratio of 13.89 for Fiscal Year 2007. They have almost $28 million in cash and cash equivalents and marketable securities on hand and almost no debt. They have lots of goodwill on their balance sheet. They are trading at a Price/Book ratio of .95 and Price/Sales of .79. Their Cash flow from operations has been positive the past 2 years. Alloy made it on the top 25 Magic Formula Companies with a minimum market cap of $100 million as of 5/29/2007.

Technicals

It is currently trading in the midpoint of its range over the past year at around $11 a share. RSI is close to being oversold. MACD is showing negative momentum. ALOY is currently trading below its three major moving averages. Recent volume has been very high on down days which signals that near-term momentum is down. They are in a long-term down trend.



Conclusion

There is really nothing to like about Alloy. They have had continuing losses for the better part of the new millennium, their acquisition strategy has not been very successful, and their stock price has mostly moved south. They do have valuable assets that could be profitable if they are used properly. A lot of their book value stems from Goodwill, their trailing price/earnings ratio is not applicable due to negative earnings, and I would not be too confident their earnings are going to turn positive all of the sudden as analysts seem to predict.

Sunday, May 27, 2007

Color on American Eagle Earnings (AEO)

American Eagle just reported earnings last Tuesday, May 22nd. The earnings came in at what the analysts expected at $.35 a share, but the outlook for the 2nd quarter came in below expectations, that sent the shares down 4%. Margins looked good, no signs of them decreasing.

They also authorized a 23 million shares repurchase program, they already had 4.2 million shares outstanding in their current repurchase program. Their policy on share repurchases was to offset dilution related to stock options. Could this mean that their growth is slowing down and they have to make up for it in other ways?

Tuesday, May 22, 2007

Finish Line Turnaround Coming? (FINL)

Finish Line Inc. is a mall-based specialty retailer which specializes in apparel and footwear. They have three different stores:

Finish Line – sells brand name footwear and soft goods, currently 693 stores
Man Alive – street fashion retailer, currently 87 open stores
Paiva – new store concept for active women, currently 15 open stores

While Man Alive and Paiva are recent growth strategies, the Finish Line stores have been open for business since 1976. Their biggest supplier is Nike, which accounted for over 50% of their total purchases the last 2 years. They have had some recent struggles. For Fiscal year 2007, their earnings were $.68 per diluted share compared to $1.23 per diluted share in Fiscal year 2006. This was due to a 5.7% decline in comparable store net sales. SG&A increased 10% year over year, that put further pressured earnings. Sales only increased 2.5% year over year, but 1.87% of that growth was aided by the additional week in the Fiscal 2007 year. That has led to a depressed stock price, it is currently trading around $12 a share.

Industry

Shoe retailers face a lot of competition. One aspect that they cannot compete on is price, the big retailers like JCPenney and Walmart will take market share away in a blink of an eye. Finish Line’s main competitor is Foot Locker, and they have had recent struggles of their own. Just earlier this month they issued a downside revision to their 1st quarter outlook. Foot Locker said that their USA stores suffered a big decline, which is the only market where Finish Line operates. There currently seems to be obvious issues in specialty athletic shoe retailers. An obvious question would be: are there major issues in specialty athletic shoe retailers or just a normal business cycle?

Company

The company has invested in an impressive inventory management system that should help them become more efficient. Most of their senior management has been with the company at least a decade, besides their President and the Chief Merchandising Officer. Their two founders are still with the company in senior management positions. Their new Chief Merchandiser Officer, Sam Sato from Nordstrom, is very experienced in this area and management is very excited about having him come aboard. Man Alive comparable store net sales were up 4.4% compared to the 4th quarter of the previous year, there is a bright spot. They are also currently working on a partnership with Nike that should be rolled out later this year.

Valuation

They are currently trading at a trailing price/earnings of 18.09 and a forward price/earnings ratio for Fiscal 2009 of 12.89. The trailing P/E seems a bit high for a company having so many short-term problems. They also pay a dividend of $.10 a year which is a yield of 0.8%. Their Price/Book ratio is 1.28 and Price/Sales is 0.44, which are both great valuations. They have a solid balance sheet with almost $63 million in cash and no debt. Their cash flows from operations is solid, but most of that cash is going towards capital expenditures on new stores, therefore, free cash flow is suspect. Return on Equity has been low, 7.2% last year and 14.1% the year before.

Technicals

Weekly Chart

The picture is not pretty. The long-term trend is down, it’s been in a long-term trading channel since 2005 and still has not broken that trend. There was some strength in FINL at the end of last year, but since 2007 it’s been trending down. It has not found support at the 50 Weekly Moving Average and it is acting as resistance. Short-term, it has been beat down because of the Foot Locker warning.



Daily Chart

FINL just recently crossed below the three major moving averages. RSI is showing almost oversold levels and MACD is showing negative momentum. Ever since the late November high, there have been lower lows and lower highs. It looks like it will be heading down to its late summer levels of $10-$11 a share.



Personal Experience

I worked at Finish Line as a sales associate a few years ago while I was still in high school. It wasn’t one of my favorite jobs as a teenager. I wanted to work there because I was a Michael Jordan fan and wanted to get to know more about his line of sneakers and sneakers in general. The pay was pretty close to the minimum level. Management concentrated a lot on the apparel. A lot of people visited Finish Line just to see the new authentic jerseys they have in stock. There was also a lot of pressure to sell something with the sneakers, either a pair of socks, shoe cleaner, shoe laces, etc. to average up the items per transaction.

As a customer, I sometimes wander in their stores when I am at the mall. They usually have the newest footwear and apparel in stock. Their prices are definitely higher compared to JCPenney or other major retailers. Prices are similar to Foot Locker. Foot Locker’s and Finish Line’s store setups are generally alike. They are very antsy to try to sell something, as soon as I walk in there, usually there is a Sales Associate next to me immediately.

Conclusion

Finish Line is currently going through some tough times and this will continue for at least the near future. They have made some changes inside the company, that hopefully will start paying dividends in the near future, but the Finish Line stores are struggling and it will take a little bit longer to turn them around. Hopefully, the Nike partnership will quicken the turn around of the Finish Line stores. I would stay away from FINL in the near future, management said that the second half results of Fiscal Year 2008 are key and they could give some hints to future performance, positive or negative. Waiting until later this year, before making any decisions, would be a prudent move on an investor’s part.

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

Sunday, May 20, 2007

K-Swiss: More Downside in the Short-Term

K-Swiss is a shoe company which designs, develops, and markets sneakers for athletic and casual purposes. K-Swiss has been in business since 1966. They have two main product strategies, one is their “classic” line of sneakers, they are the sneakers which were the company’s first product. They have longer product cycles than normal sneakers and long product cycles reduce the markdowns on a sneaker. This makes it more attractive to retailers. K-Swiss keeps a large inventory of classics in their warehouse. Their other product strategy is based on current consumer fashion trends. They do not keep a large inventory for these. Their goal is to take advantage of current fashion trends in the marketplace while minimizing risk. K-Swiss’ primary goal is to become the “retailers’ most profitable vendor,” meaning that through longer product cycle, they can maximize the effect of market expenditures and minimize retailers’ markdowns.

Industry


They operate in the athletic footwear industry, which is very competitive. Their biggest competitors are Nike and adidas. Investment gurus who are bullish on Nike, and by extension the footwear industry, include Warren Buffett, Bill Miller, and Glenn Greenberg. There are some issues with the economics though, people are worried consumers will slow their spending, due do them being overextended in debt and gas prices that are rising. To some degree though, a recession cannot destroy the footwear industry because it meets one of the 3 basic needs of people, clothing.

Recent Developments

Their 1st quarter 2007 report was a mild disaster. Although they managed to beat Wall Street earnings estimates by one penny, they lowered full-year estimates due to significant obstacles in the domestic environment. They lowered their range from $1.20 to $1.50 a share for fiscal 2007 to $1.20 to $1.35 for fiscal 2007. Revenue guidance was also lowered slightly. Domestic revenues decreased 39.7% year over year. Future orders (backlogs) also decreased significantly year over year. International revenues increased 29.2%. On the bright side, they do not see Gross Margin shrinking, they expect it to be between 46% to 47%, consistent with their recent results. They stated in their conference call that they will not clear out their inventories at any price, this will keep margins up but pressure sales down. This also will not damage brand reputation.

Their domestic business has been in a decline for the past few years though, this is a concern because it accounts for the majority of their total revenues. Domestic revenue has fallen 20% over the past 2 years. Management said during the last conference call that inventories at domestic retailers have been going down and so retailers will have to order more K-Swiss footwear in the near future. On the bright side, foreign sales have been growing rapidly going from over $80 million in 2004 to almost $170 million in 2006.

They have recently put in significant resources into developing new products. Their target date for new products is the 1st quarter of 2008. K-Swiss is also currently working on opening retail locations. Their most recent openings have been in Asia. Their other big investments have been in Royal Elastics and Apparel which are planned to be key future growth drivers. Near-term trends do not seem to be positive with backlogs significantly down year over year.

Recently, Anna Kournikova has signed on to be the new spokesman of K-Swiss. The thinking behind hiring her as the new spokesman is because she is a tennis star and K-Swiss is a tennis shoe company. It makes sense, but she is more of a celebrity than a tennis star. It will definitely give K-Swiss more publicity, but will people looking for tennis sneakers more likely buy K-Swiss tennis footwear just because Kournikova is their spokesman? I highly doubt it.

Valuation

They are trading at a trailing price/earnings ratio of 14.74. Their Earnings Yield is 11%. They have $264 million of cash on their books. There is no debt. They are trading at a forward price/earnings ratio for Fiscal Year 2008 of 17.22. They are a great cash generator, cash flows from operations as a percentage of total revenue has been 14.4%, 18.5%, and 17.7% in the years 2006, 2005, and 2004 respectively. Their return on equity has been very strong, averaging over 25% over the past 5 years. They also pay a dividend of $.20 per year or a dividend yield of 0.7% per year.

Regarding their cash position, they are very conservative with the use of their cash. Acquisitions are not a priority for them, unless the acquisition is an attractive candidate. A deal to do a deal is not something that interests them. They plan on doing more future share repurchases. A good indicator of when to start buying K-Swiss stock will be when they start buying back their shares in bunches, during their 1st quarter 2007 conference call, CEO Steven Nichols said that once they have a clearer picture of what 2008 will look like, and if it will be positive, they will aggressively start repurchasing their shares.

Management

Management is fiscally conservative and seems to be on the right path of expanding the company with their new investments. They also have been using their cash wisely by buying back K-Swiss outstanding shares. Their management is very shareholder friendly. Their bonuses are based on Economic Value Added (EVA), which better aligns their interests better with shareholders instead of regular bonuses based on EPS. Their CEO, Steven Nichols, has been with the company since 1987. George Powlick, who is their CFO and COO, has been with the company since 1988. Steven Nichols basically controls where the company goes because he, through a Family Trust, controls 92.4% of the Class B shares. Each Class B share is worth 10 votes compared to each Class A share.

Technicals

KSWS has been in a trading range the past few years mostly between $26 and $36 a share. The medium-term trend is down and the short-term trend is neutral. RSI and MACD are both neutral. KSWS is currently above the 50DMA but below both the 20DMA and the 200DMA. On the bright side, the 20DMA just crossed over the 50DMA, which could be a signal of a change of the trend. Recent volume has been mixed.



Conclusion


K-Swiss was growing rapidly until they starting experiencing issues in the United States. That has thrown their growth curve way off and currently domestic sales are still trending down. There are definitely short-term issues with K-Swiss, but I think management has taken steps to correct this downtrend in domestic sales with new products in the pipeline. Also, the retail stores, the apparel rollout and the Royal Elastic subsidiary should provide growth. Buying right now would not be terrible, but since their outlook for the rest of 2007 is not bright, there should be more downside on the way in the near-term. Once their domestic sales start to stabilize, and management starts to repurchase shares in big quantities, that could be a good entry point knowing that 2008 is the year management is planning for the big turn around.

Disclosure: I don’t have a position in KSWS.

Thursday, May 17, 2007

Pre-Paid Legal Services: Great Business Model and Great Valuation (PPD)

Pre-Paid Legal Services is a company that sells exactly what its name states, they sell pre-paid legal services. This is how it works, a customer signs up and agrees to pay $20 per month. The customer receives a certain amount of legal services from local lawyers that are part of Pre-Paid’s provider law firms for the time they are a member. Some of the lawyer services that are provided for the standard fee are: “standard plan benefits include preventive legal services, motor vehicle legal defense services, trial defense services, IRS audit services and a 25% discount off legal services not specifically covered by the Membership.”

Industry

Their main competition consists of Hyatt Legal Plans, ARAG(R) North America, and National Legal Plan and Legal Services Plan of America but most of their competition markets to bigger employers compared to PPD. According to Pre-Paid, their target market consists of around 100 million households, and they currently have 1.5 million households as subscribers. This is a big opportunity. Litigation in the United States is a constant, I don’t see how this market can shrink if the population of the United States does not shrink and grows at the steady pace it has been growing. If there becomes a Democrat majority in the government, this can also potentially grow PPD’s member base in the short term since Democrats are more apt for litigation.

Company


Their revenue has been growing very steadily at a rate of 6.1% over the past 5 years. The total of memberships, using the end of the year count, has been also growing steadily, growing at a rate of 2.7% per annum over the past 5 years. They have expanded from their basic legal service into a few other products, with the Identity Theft Shield being the most important.

The Identity Theft Shield (IDT) is provided by Kroll, which is a part of Marsh & McLennan Companies, Inc. What IDT does is help monitor a customer’s credit information and offers identity theft restoration services. IDT has been a great product, there are as of last quarter, 73,525 stand alone IDT memberships, meaning that that is the only product these customers purchase, they do not have any legal service plans. There are 562,075 add-on IDT memberships, meaning they have another service besides IDT. Pre-paid only started this service in late 2003 and already has about 1/3 of all their members with legal plans with the IDT service. IDT has been their main growth driver over the past 3 years. They also recently entered into a new agreement with Kroll to extend their agreement and negotiated a significant reduction in payments to Kroll per customer per month of IDT service from $4.25 to $3.75 as of April 1st 2007, to $3.50 in 2008 to $3.25 in 2009 to $3.00 in 2010.

They sell their products through a Multi-Level Marketing program. Members only make commissions when a membership is sold, not when they recruit members to develop their sales organizations. The company is still fun by its founder, Harland C. Stonecipher, who founded the company in 1972.

They also recently started to roll out their “ADRS” program which provides businesses and their employees a way to reduce identity theft risk. The associates, which have to pass required training, give presentations about Pre-Paid’s products and provide opportunities for the businesses and their employees to purchase their identity theft solutions and legal plans.

Valuation

They are trading at a trailing P/E of 16.94 and an Earnings Yield based on EBIT of 10%. 38.83% of the float is short. 33.5% of the share outstanding are owned by insiders. They have been very busy in the past 5 years returning money to shareholders. Their diluted shares outstanding decreased from 19.8 million shares in 2002 to 13.6 million shares as of last quarter. Also, in 2005 and 2004 they paid dividends of $.60 and $.50 a share respectively. The balance sheet does not look exceptional, they have about $80 million of cash and investments and debt of around $100 million. Their Cash flows from operations has been strong, it was $47.3 million, $50.1 million, and $54.4 million in the years 2004, 2005, and 2006 respectively. PPD is a great cash generator. It is a top 25 Magic Formula Stock of over $100 million market cap as of 5/16/2007.

Technicals

Just in April it broke through overheard resistance and old highs of about $52 a share to its all time highs of over $64 a share. In 2006 it formed a rounding bottom chart pattern. Both of the big advances in the past 2 months were confirmed by large volume. All of the trends are up. It is trading above all 3 of its main moving averages and all of them are trending higher. The first major support is around its old highs of around $52 a share. The stock is currently borderline oversold with RSI and MACD at very high levels.



Conclusion

Pre-Paid has a great product and they have their own position in the industry with not a lot of competition. There are a lot of opportunities out there with how they can expand their business. One avenue of expansion can be through the traditional forms of advertisements. PPD’s management has stated that they will continue to buy back their shares with their excess cash. They have had and are still having issues with associate recruitment. The Balance Sheet is not the best looking one either, the debt is not something to be too worried about considering they are such a cash generator. Also, they have taken out two loans to build a beautiful headquarters and buy an aircraft, I’m not sure how wise that was. To conclude, they have a great business model with not a lot of competitors, there are avenues for further growth with new offerings, like the IDT, and new ways to market them, like the ADRS. And they have a great valuation, being on the Magic Formula top 25 list of companies over $100 million market cap. Technically I would wait and see if a pull back occurs, there has been a big run up of more than 50% in the past 2 months. The 50DMA or old support at $52 would be great buy points.

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

Saturday, May 12, 2007

American Eagle Outfitters Inc. (AEO)

American Eagle is a casual clothing retailer mostly designed to target 15 to 25 year olds. They concentrate on value offerings. They are currently in the process of expanding to target the 25 to 40 year olds with their MARTIN + OSA brand and are working on expanding their aerie line which sells dormwear and intimates for females between the ages of 15 to 25 years old. They also operate AE.com which sells their American Eagle and aerie clothing lines. AE.com has also been a major growth driver. In 2006, sales at AE.com rose 48%. They have been operating American Eagle retail stores since 1977. They have been growing at a very brisk pace, their revenue has grown from $406 million in 1998 to almost $2.8 billion in 2006.

Industry

This is a very competitive industry. Fashions can come and go without notice. Clothing is one of the three basic needs for humanity so that is a plus. Also, their clothing is mid priced so economic trends should not affect American Eagle significantly. The industry is also very sensitive to weather trends, which can affect results. American Eagle products are significantly cheaper than Abercrombie & Fitch and a bit more expensive than Aeropostale. Compared to Aeropostale, the quality of AE's clothing is significantly better.

Company

American Eagle has been growing very steadily. Their sales have been growing at a spectacular rate as I have stated earlier. They are currently testing out their aerie and MARTIN + OSA in experimental markets. Their American Eagle line is slowly saturating, so MARTIN + OSA and aerie will be their main future growth drivers. The key metrics AE measures their stores by is sales per square foot and comparable store sales, both of these metrics have been showing positive signs recently. Since they have been selling clothes over 3 decades with great success, they have showed that they have a good knowledge of trends in the clothing industry.

Valuation

They have over a $1 billion in cash, short-term investments, and long-term investments on their balance sheet. There is no long-term debt. They are trading at a trailing Price/Earnings ratio of 17.18. According to Yahoo's Apparel Stores industry, the average trailing P/E is 18.4. They pay a dividend of $.30 a year which is a yield of about 1%. American Eagle has been buying back stock, but there is nothing to be excited about. During their 4th quarter conference call (courtesy of www.seekingalpha.com), Joan Hilson, who is their Executive Vice President and Chief Financial Officer, said that

The philosophy that we have on our stock repurchase program is we offset a dilution related to stock option exercise.


Their return on equity has been very strong, averaging 27.83% over the past 10 years. According to Yahoo's Apparel Stores industry, the average return on equity is 19.7% Their EBITDA is $717.1 million and they are trading at around 7.5x Enterprise Value/EBITDA ratio.

Technicals

Their uptrend that started in late 2005 has been broken and they have been in a trading range from 28 to 34 in the past 7 months. RSI and MACD has been both trending down since October of 2006. The 20 and the 50 day moving averages have been trending down since early March and the 20DMA has crossed below the 50DMA in February for the first time since December of 2005. The three moving averages are right next to each other currently, and AEO is trading below all of them. It is also below its 200DMA for the first time since February of 2006. AEO's first major support is at $28 a share, which from the current trends does not seem like it will hold. The next major support is around the $24 area. It looks like its slowly breaking down.



Conclusion

American Eagle seems to be fairly priced or just a bit undervalued at these prices using Price/Earnings as a metric. The industry is trading at an average trailing P/E just a bit higher than AEO's. There is not much room for error if there is a slowdown in their growth. Management has shown they can perform and beat expectations, but their 15% yearly earnings growth will be harder to reach as a mid cap compared to when they were a small cap. The stock price will continue to go up as long as management can reach growth expecations set by themselves and analysts, but if there is a slowdown in their growth, the stock will tumble. Also, keep in mind the technicals are changing so that could be a hint of what is coming in the future.

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

Sunday, May 6, 2007

Vector Group Ltd. (VGR)

The Vector Group is a holding company consisting of 3 main businesses:

Liggett Group – manufacture and sell cigarettes
Vector Tobacco Inc – specialize in developing low-risk cigarettes like nicotine-free QUEST
New Valley LLC. – real estate business

Liggett Group primarily specializes in discount cigarettes, in 2005 and 2006 all of their sales were of the discount variety. Their market share of the overall discount cigarette industry has been growing, 7.4% in 2004, 7.5% in 2005 and 8.7% in 2006 according to the Management Science Associates. Their best seller is the Liggett Select brand. All of their sales are in the United States, they have no foreign operations. They also have a cost advantage compared to their bigger competitors like the Altria Group and Reynolds American Inc. due to the Master Settlement Agreement, which states that the three biggest cigarette manufacturers must make payments to states based on how much many cigarettes they sell annually, Liggett only has to pay if their market share is above 1.65% of the U.S. cigarette market. In the past 3 years, their market share of the overall U.S. cigarette market has averaged 2.3%. They are the fifth largest manufacturer of cigarettes in the United States based on sales volume. There are roughly 135 litigation cases pending where the Liggett Group is named the defendant or one of the defendants.

Vector Tobacco is a small part of the Vector Group holding company. Their goal is to continue developing low-nicotine and nicotine free cigarettes and to continue working on the development of low-risk cigarettes. Their sales as a percentage of total sales in the holding company in 2004, 2005, 2006 have been 2.8%, 2.0%, and 1.3% respectively. Vector Tobacco has not been profitable in the past 3 years. They also benefit from the Master Settlement Agreement, they will only have to pay if their market shares is above .28% of the U.S. cigarette market.

New Valley LLC consists of real estate operations all across the United States. They own a 50% interest in the biggest residential brokerage in metropolitan New York City, the Douglas Elliman Realty, LLC. They also hold interest in properties in Hawaii, Washington D.C., and in Florida.

The Vector Group has been very aggressive in cutting costs in its two tobacco operations, they are constantly eliminating jobs and trying to improve operating efficiency. This has been a big staple of Altria’s success over the years and this has greatly contributed to Vector’s success as well.

Cigarette Industry

The total domestic cigarette industry has been declining and will continue to decline. In 2006 it declined 2.4% according to the Management Science Associates. In the domestic market, the three largest cigarette manufacturers based on sales volume accounted for a total of 86.8%. Liggett Group faces competition on two fronts, the three major distributors and other small manufacturers similar to Liggett in size that do not have to pay in the Master Settlement Agreement since their market share is so small. In the past, there have been considerable barriers to entry in the industry, but recently the smaller companies have been able to enter the market since they are not influenced by the Master Settlement Agreement and due to the surplus manufacturing capacity in the industry. Litigation has been a constant in the industry since 1954.

Valuation

They are trading at a trailing twelve month price/earnings ratio of 25.7, that’s not great, but when you look at Joel Greenblatt’s pre-tax earnings yield, which removes the effect of the financing and taxes, they are at 10%. They also have a high Pre-Tax Return on Capital. 24.5% of the outstanding shares are owned by insiders. There is a bit over $103 million of long-term debt on the books with almost $147 million in cash and cash equivalents. There is also approximately $57 million in long-term investments Icahn Partners LP and in the Jeffries Buckeye Fund LLC. They also own about $29 million worth of LTS stock. Two investment gurus that are invested in the Vector Group are Carl Icahn and David Dreman. They also pay a dividend of $1.60 a year which equates to a dividend yield of 8.7% at today’s prices. They have a strong dividend history, raising it from $.213204 a share in 1998 to the current dividend of $1.60 a share. Their gross margin in the year 2004, 2005, and 2006 has been 34.7%, 40.3%, and 37.7% respectively. This stock appeared on the top 25 Joel Greenblatt’s Magic Formula stocks over $100 million market cap on 5/6/2007 which is based on Pre-Tax Earnings Yield and Pre-Tax Return on Capital.

Technicals

VGR has been on a tear this past year, like most tobacco stocks. It is currently trading near its high of the year. The uptrend is still in tact, the 20DMA is greater than the 50DMA which is greater than the 200DMA, but the 20DMA is moving dangerously close to the 50DMA, and if it cross it could be a big momentum shift. Momentum has been slowing already though; MACD and RSI are both diverging with the stock trend. There seems like there will be support along the 17 area, followed by the 15 area.



Conclusion

The tobacco industry is obviously in decline, but that still has not stopped tobacco stocks from outperforming the market. There is a lot to like about the Vector Group besides the 8.7% yield, they use their capital wisely, have a high earnings yield, are owned by Carl Icahn and David Dreman, and 24.5% is owned by insiders. Also, their performance will not suffer in an economic slowdown due to the nature of their product. One issue with the company that I have encountered is that the lawsuits that are currently pending against them, but this is the nature of the business. All the other cigarette producers are experiencing the same issue. I will be looking to add this to my portfolio once the stock pulls back to the $15-$17 a share range.

Disclosure: I don’t have a position in VRG.

Saturday, May 5, 2007

USANA a Fraud? (USNA)

USANA is a health and beauty company. They produce, research, and sell health and beauty products mostly through a Multi-Level Marketing operation (direct selling). Their growth has been phenomenal and they have been a publicly traded since 1992. Their stock has appreciated from $.60 a share in 2002 to a high of over $60 a share just within the past few months. In the past few months all sorts of negative news has come out, the biggest is which ex-convict Barry Minkow has published a 500 page negative report on USANA basically saying they are a fraud, and the SEC has opened up an investigation into USANA. There were also new class action lawsuits announced late last month.

Addressing the Multi-Level Marketing Scheme Accusation
When I read about and watched a YouTube video of how USANA has supposedly lied to new associates about the money they can make, I just thought to myself of all the same schemes or businesses my friends/associates throughout the years have offered me. Some lie, some just only talk about the positives, no one ever talks about the negative aspects and how tough it actually is to make it as an associate and make a lot of money (for Usana, the top 3% of distributors make 70% of the commissions). When I did ask a question about the risk involved, there is a change of topic or some how the question is not answered. If the new associate/distributor does their own research or actually think about what they are being told, there would be a lot less people signing up. I have never been involved in a MLM operation, but I would guess there are specific directions they follow when answering questions regarding risk. There obviously is an issue with USANA's MLM, but I think it will pass, it is just temporary negativity.

Here is an interview with an actual USANA Distributor or “Victim” as Barry Minkow calls her:

Barry Minkow interviews actual USANA Distributor / Victims

Regarding the Product Problems
I am more worried about the product issues. Barry Minkow said in his report that some of the products fall short of the claims made on the labels for ingredients. This is from Barry Minkow’s report for the Usana’s product Essential Mega Antioxidant:

o Folate (as folic acid) claimed 500 pgs per serving and only tested for 390
pgs per serving.
o Vitamin B-12 (as cyanocobalamin) fell significantly short from the claimed
100 pgs per serving and only tested for 63.8 pgs per serving.
o Alpha Lipoic Acid fell short by 8% from the claimed potency on the box.
o By far the most serious and significant shortage resulted from the mega
antioxidant ingredient Coenzyme Q-10, which scored only 14% of the
“guaranteed potency.”

The other issue with the products is that, according to Barry Minkow, the prices are extremely high compared to similar products. One example is USANA HealthPak 100, taken from Barry Minkow’s report:

The Usana product has a regular wholesale price of $118.89 for a 28 day supply, while
the Animal Pak product has a price of $18.50 for a 22 day supply.
Usana 28 day supply @ $ 118.89 = $ 4.25 daily cost
Animal 22 day supply @ $ 18.50 = $ 0.84 daily cost
As you can see, the Usana daily cost of $4.25 is $3.41 more per day than the Animal Pak,
or 406% more expensive.


There are a significant amount of other products that laboratories compared and the USANA product was clearly more expensive when the potency of the two products were similar. There were also issues where the potency did not match the label claims.

Valuation
Their trailing price/earnings ratio is 17.07 and their forward price/earnings ratio for fiscal year 2008 is 13.32. Both great numbers for a company growing as fast as USANA, the PEG Ratio is .86. Their gross margins for the past 3 years have increased from 75.2% to 76.1%, most of their costs are associate incentives/commissions and SG&A expenses. Their operating earnings have been 16.6%, 18.1%, and 16.6% for the past 3 years. They have a very strong balance sheet with over $32 million of cash and cash equivalents on their books and no debt. Their growth has been phenomenal with sales going from just over $133 million in 2002 to just over $374 million in 2006, that is over 29% per year. Just recently on April 10th, they announced an increase in their stock buyback program to $65 million.

Technicals
To put it mildly, it’s been trending down in the past few months. Volume has been big in distribution days, all of the momentum is down. This is not the place to buy. On the bright side, RSI and MACD are both showing over sold, but they have been both showing over sold for the past few months. USNA is close to support from last summer at around $37.50 a share, which is a good level to keep an eye on it. The down trend is not confirmed yet by the moving averages, but the 50DMA is getting ready to cross the 200DMA this week and that will be the confirmation.



Conclusion
The negativity this company is currently experiencing is tremendous. The stock price is definitely displaying it, some of it is definitely unwarranted. The issues I am worried about are their products, some of which do not support their claims and being much more expensive than comparable products for other brands. If what Barry Minkow said in his report about their products is true, I expect to see margin pressures from USANA trying to increase their product potency's to match the claims on the products and from price pressure since comparable products are so much cheaper. (Their 1st quarter results had no signs of these pressures as gross margins increased by 220 basis points compared to their 1st quarter results in 2006.) I would avoid this stock for now and wait to see what happens to their sales, earnings, and margins in a full quarter after the accusations. The technical picture does not look great at this point either.

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

Thursday, May 3, 2007

True Religion Apparel Inc. (TRLG)

True Religion Apparel is an upscale Apparel Clothing company. They are best known for their denim apparel. Their target customers are fashion-conscious consumers. Just recently they started expanding their operations by opening Retail Stores to sell their apparel, but it is still just a small part of the company, with just over 3.5% of net sales coming from their retail segment. They also sell their clothing through such upscale retailers such as Nordstrom, Neiman Marcus, and Saks Fifth Avenue.

Bullish Case

1) This is a classic growth slow down stock. They are still growing fast but they are not growing as fast as they were in 2004. Sales are projected to grow just over 20% for fiscal year 2007.

2) Their retail stores are showing good signs, this is one of their main strategies of growth. The gross margin for their retail operations was 46.5%.

3) There are no signs that their apparel is going out of fashion. Sales are at an all time high. Their denim apparel has been a hit all over the world.

4) Their valuation is excellent. Their trailing twelve months price/earnings ratio is just 14.64 and their forward price to earnings ratio for fiscal year 2008 is just under 10. PEG ratio is just .54.

5) Their growth has been phenomenal. Their revenue has grown from $27.7 million in 2004 to $139.0 in 2006 and expected to grow to $167.1 million in 2007 by analysts.

6) Their balance sheet is strong with almost $45 million of cash on their books and no debt.

7) Company wide gross margin increased 166 basis points in 2006 compared to 2005.

8) Great inventory management. Sales increased by over 35% and inventory shrunk by over 6%. Inventory Turnover increased to 14.79 in 2006 compared to 10.2 in 2005.

Bearish Case

1) Upscale clothing is one of the first casualties in the downturn of the economy, people will slow their buying of luxury goods.

2) There have been a lot of clothing fads over the years where styles have come and gone and their companies with them, will TRLG still be around in a decade?

3) TRLG has been in business for not even 5 years. What will happened to them when the current fashion changes, will they adjust on the fly or will they struggle? Are their management and designers talented enough to adapt to the fast changing fashion trends?

4) Their auditor has found some issues with their accounting recently. There could be issues with internal control over financial reporting.

Technicals

TRLG has been trading in a range for the past 18 months between $15 and $24 a share. Currently it is trading around $15 a share. It is pretty much sitting on 18 month support, a good spot to buy in. $12 looks like the next solid support. The down trend is firmly in place, the 200DMA is above the 50DMA which is above the 20DMA. The 20DMA has been acting as recent resistance. MACD and RSI are pretty neutral right now but they have been showing a bullish divergence.



Volume has been positive. The up days have been on heavy volume and volume on down days has generally been pretty light.



Conclusion

I can't seem to make up my mind on this stock. Both, the bear and the bull cases seem to make sense. My primary concern is TRLG has not been in business long enough to see how it adjust to different trends in fashion. Yes, growth so far is excellent but how will they adapt to a new trend? Their valuations are excellent and they seem to be making the right decisions about expanding their company with the new retail segment and licensing deals they have signed. They have also expanded their distribution. There is no doubt that their denim product that they have been putting out is excellent, but for me there is not enough operating history to start a long position.

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

RAIL Earnings

Yesterday morning RAIL earnings came out, they were $1.80 per diluted share on sales of $322.5 million. Analysts were expecting earnings of $1.67 per diluted share. More importantly, as I noted in my last week's post, orders for new railcars continue to dip. This is from their Press Release:

"Orders for new railcars totaled 768 units in the first quarter of 2007, compared with 2,199 units ordered in the fourth quarter of 2006 and 1,031 units ordered in the first quarter of 2006. The backlog of unfilled orders was 6,006 units at March 31, 2007, compared with 9,315 units at December 31, 2006, and 17,794 units at March 31, 2006."


Also there was a significant jump in Accounts Receivable (6x) quarter over quarter but that could be a seasonality issue since there was almost a 4x jump in Accounts Receivable in the same quarter last year quarter over quarter.

RealNetworks Update (RNWK)

Last week I wrote about RealNetworks' inability to turn a profit without the help of Microsofts' lawsuit, earnings came out after market yesterday and that pattern continues. Earnings came in at $0.22 per diluted share on Revenue of $129.5 million. More importantly, Operating Income came in at $53,743,000, the last payment from the Microsoft lawsuit was $60,747,000. If not for the Microsoft lawsuit, Operating Income would have been negative. For the 9 months ending 12/31/2007, they expect earnings to be $.01 to $.03 per diluted share.

On the bright side, they authorized an additional $100 million to repurchase outstanding shares. Their cash and short-term investments position is still very positive.

Tuesday, May 1, 2007

JAKKS Pacific Inc. (JAKK)

JAKKS Pacific Inc. is a toy manufacturer that also designs and markets their product. Some of their most popular products are action figures such as WWE, Dragon Ball, and Pokemon characters. Their toy business breaks down into four segments:

1) Traditional toys
2) Craft, Activity and Writing Products
3) Seasonal/Outdoor Products
4) Pet Products

Of these four, traditional toys is by for the biggest representing over 86% of their Total Net Sales. They are also in a joint venture to produce video games featuring the World Wrestling Entertainment and its wrestlers.

Industry

The traditional toy industry is mature, very competitive, and stable. Toys are a consumer product so as long as JAKKS Pacific's toys are not extremely expensive, which they are not, they will still sell in the economic down times. According to the Toy Industry Association, the Total Traditional Toy Industry was $22.4 billion in 2004, $22.2 billion in 2005, and $22.3 billion in 2006. So, there is no growth. The Total Video Games market has been growing though, and that is the opportunity that lies ahead of JAKKS Pacific. According to the Toy Industry Association, the Total Video Games industry was $9.9 billion in 2004, $10.5 billion in 2005, and $12.5 billion in 2006.

Valuation

JAKK is selling for a trailing twelve months price/earnings ratio of 10.31. They have over $192 million of cash and debt only of $98 million. They are trading at a forward price/earnings ratio of 10.14 for fiscal year 2008. Their main competitors, Hasbro Inc. and Mattel Inc., are selling at price/earnings ratios of 21.8 and 19.0 respectively. But unlike JAKK, they do pay a dividend of 2.3% for Mattel and 2.0% for Hasbro Inc. Here is the comparison between JAKKS Pacific and its two biggest competitors, Mattel Inc. and Hasbro Inc:



What also jumps out in the comparison is that their P/E is half of what their bigger competitors P/E is. It is not the best run company in the toy industry, as the ROE compared to Hasbro and Mattel indicates, but it does not seem like they deserve the extremely low valuation they are receiving. Unfortunately, this has been the average valuation they have traded for in the past 5 years. Part of the reason their is such a discrepancy in price/earnings ratio is because Hasbro and Mattel both pay a healthy dividend of at least 2%, while JAKKS Pacific does not pay a dividend.

Positives

They have been a solid performer in the past few years in the toy industry. Their revenue growth rate excluding acquisitions almost matched Mattel's of 3.7%. They have a great variety of products. Their 2005 acquisition of Pet Pal Corp. was a great extension to their line of toy products because it has allowed them to use their core competency of developing and marketing toy products and extend it to another product line.

Negatives

Their Cash Flow from operating activities has been in a downward slope since 2004, from over $131 million in 2004 to almost $64 million in 2006 while earnings have been growing steady from $1.49 per diluted share in 2004 to $2.30 per diluted share in 2006. That is a major red flag. It seems like their earnings are of low quality. The competition they face is fierce, and it does not seem like this will ease up in the near future due to the consolidation going on in the industry.

Technicals

I decided to include both the 1 year and the 3 year view to show the longer term trading range.

Daily Graph

JAKK is really close to its high of the year. The three daily moving averages align consecutively with the 20DMA above the 50DMA, and the 50DMA which is above the 200DMA. The daily moving averages are showing that JAKK is in a bullish trend. There is a troubling sign though, it just broke below its 20DMA on high volume. RSI is showing neutral and MACD is showing a slightly overbought condition. It is currently trading right at its 50DMA.



Weekly Graph

On the weekly graph you can see that the stock has been in a trading range for the past 3 years, mostly it has been trading between $15 and $26 a share. Currently it is trading in the top end of its range.



From the two graphs, it does not seem like this is the right place to open a position.

Conclusion

JAKKS Pacific looks significantly undervalued compared to its peers Hasbro and Mattel. The question is, does JAKK deserve the higher valuation its competitors have? While JAKK on average has traded for a P/E ratio for 10 in the past 5 years, Hasbro and Mattel have had an average valuation in the upper teens. Using a rough valuation, taking out the dividend effect on the P/E ratio of mature, slow growing companies like Mattel and Hasbro, the valuation does not look as great as before. It seems like JAKKS Pacific does deserve a higher valuation, but not high enough to merit an investment. I am not sold on JAKKS Pacific at these prices, but if it does come back to recent long term support to around $16 a share I would definitely be interested in initiating a long position as long as the story does not change. There just does not seem to be a significant margin of safety for me to be bullish on JAKK at these prices.

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