PSB Monthly Issue March 2011

First off, inflation is here. Look around…

Over the last year, prices of commodities are all up.  And up big!

And I’m not just talking about gold or silver.  It takes more and more money to fill up your gas tank.  Your grocery bill is higher.  The cost of clothing is rising.

In addition, the US government has been running a non-stop printing press.

We need to hedge against inflation for our own protection.  And gold is a great way to do it.

So what’s the best way you can profit in gold?

There are many choices.  ETFs, mutual funds, futures, and physical gold are all good ways to get into the game.  But we like one area the best…

Gold mining and exploration penny stocks!

THE GOLD MINING AND EXPLORATION INDUSTRY

The upside of inflation for mining companies is clear.  Miners can pull more and more value out of the ground.  And as long as inflation remains a concern, the value of gold is destined to move higher.

But not all miners are built the same… And buying any ol’ mining stock is foolish. Knowing a company’s business model is critical.

If you didn’t know, the business model for mining companies has three distinct stages.

Exploration comes first.  Companies need to find the metal rich deposits.  Second, a company must develop the land for the mine.  They need to build roads, infrastructure, clear trees, etc… Lastly, a company will begin production in a mine. This is how they start to make money.

I’ve found a company ready to capitalize on a big strike that is also making real money.  And it’s rare to find in a junior miner with income.

Who’s the next big winner?

AURIZON MINES (AZK)

Aurizon Mines is a Canadian based gold-mining company.  They have operations and exploration activities in the Abitibi region of northwestern Quebec.  This area happens to be one of the most prolific gold regions in the world.

AZK is active in all three areas of mining. They don’t just explore for gold, they also develop the mines and put them into production.  And production is what it’s all about.

Let’s start by looking at their production mine first…

THE CASA BERARDI PROJECT

The Casa Berardi is a mine in the heart of northwest Quebec.  Since opening, it has produced over 500,000 ounces of gold. Aurizon took over the Casa Berardi mine in 2006 and has continued to mine gold from this rich resource.

Best of all, they own 100% of this mine.

What’s exciting about Casa Berardi is the reserves.  Recent estimates indicate more than 958,000 ounces of gold still remain.  (At today’s prices of $1,400 per ounce, there’s still $1.3 billion yet to be unearthed.)

Now, the company only pulled 141,000 ounces out of this mine in 2010.  But in 2011 through 2013, AZK advised they expect to mine 160,000 to 170,000 ounces in each of these years.

That’s really impressive stuff for a junior miner!  Now, let’s take a closer look at one of their other projects…

THE JOANNA GOLD PROJECT

The Joanna mine is currently under development.  The best part is Joanna is very close to production.  They might start gold production this year!

The Joanna property comprises 155 claims covering 4,252 hectares.  And again, AZK owns 100% of this property.

Once AZK finalizes a feasibility study, they will be able to start mining this property.

What’s really exciting about this site is the pre-feasibility study.  It shows there are more than 1 million ounces of gold on site!  One million ounces of gold, at the current price of $1,400 an ounce, makes this mine alone worth $1.4 billion!

We are just beginning to scratch the surface of AZK.  The best is yet to come…

EXPLORATION

Exploration is the most exciting part of any gold mining company.  Simply put, a company can stumble upon the largest gold find ever.  Think of it like holding a lottery ticket… Any one mine could be worth tens of billions!

The reality is most junior gold mining companies aren’t actually doing any mining yet. They’ve only gotten as far as exploration and development.  Which means the money is flowing one way… Out!  And that’s a big risk.

But AZK has managed to figure out a way to lower the risk of exploration and development.  You see, Aurizon has partnered with other companies and land owners to explore potential mine sites.  This spreads the cost and the risk.

If a property looks promising, AZK can expand their ownership in the mine by reaching certain spending requirements.  Each property is a little different and they each have separate agreements.  So I won’t get into all those messy details.

But let’s take a look at the projects Aurizon is working on…

Kipawa – Gold/Rare Earth – Early stage exploration with a 6,500 meter drill program recently completed, and results are expected shortly.

Duverny – Gold Mineralization – Early stage exploration with an initial exploration program underway.

Fayolle Property – Gold – Early stage exploration – Joint Venture with Typhoon Exploration.  The initial exploration program is underway to test a new geological model.

Marban Property – Gold – Joint Venture with Niogold Mining Corporation with a $5.8 million exploration program comprising 50,000 meters of drilling started in the third quarter 2010.

Rex South Property – Gold-Silver-Copper-Tungsten – Joint Venture with Azimut Exploration.  Early stage exploration with a recent announcement of a discovery of a major polymetallic porphyry-type mineralization.  AZK may earn up to a 65% stake in this property.

Opinaca Property – Letter of Intent signed with Azimut Exploration and Everton Resources – Early stage exploration

Wildcat Property – Letter of Intent signed with Everton Resources – Early stage exploration

As you can see, there is quite a bit going on.  Let me mention that all of Aurizon’s properties are in Quebec, Canada.  This eliminates many concerns about political unrest and disruption to business.

Now, let’s talk revenue and profits…

THE NUMBERS

Here’s where we separate the winners from the losers.

The company dug up $130 million in the first three quarters of 2010.  And total gold production for all of 2010 came in at 141,000 ounces.

But that’s just the start.  The company estimates a 20% boost in gold production for 2011.  Management expects to unearth 165,000 to 170,000 ounces this year.  Don’t forget the Joanna project comes online later this year and could boost production even higher!

What’s truly remarkable about AZK is that they expect to grow revenue to $230 million in 2011.  Any way you slice it, revenue growth of 33% is fantastic!

Looking at the bottom line, AZK’s performance has been solid.  And for a junior mining company, that says a lot.

Keep in mind every mining company runs into issues now and again.  Gold prices are volatile, costs can swing wildly, and mining may not go as smoothly as planned.

AZK is no different.  Despite their issues, Aurizon has put together some impressive earnings.

Earnings came in at $.20 per share in 2009.  And because of some mining expansion issues during 2010, total earnings are expected to be around $.10 per share.

But don’t let the 2010 hiccup scare you away.  Earnings growth for 2011 is huge!

AZK is expecting 2011 earnings per share to be $.42.  That’s 320% growth from 2010.  Huge growth is exactly the kind of explosive power we want in a penny stock.

Big earnings growth isn’t the only reason I like this company.

AZK has virtually no debt.

Look, for a growing precious metal company, debt is always a concern.  It’s usually how they finance future projects.  But Aurizon has $130 million in cash on hand and no debt.  The big war chest allows them to manage growth for quite some time.

INVESTMENT RISKS

Now, every company has risks and AZK is no different.

A decrease in gold prices will affect profit margins at AZK.  And if the price of gold falls below $825 per ounce, Aurizon might not be profitable.

Also, proven and probable reserves of a mine are at best an estimate.  Aurizon could find more or less gold than initially estimated.

Finally, mine optimization is a major project for every mining company.  Even properly optimized, costs of equipment, labor, and fuel can change… impacting profitability.

POTENTIAL RETURN OF 74% OR MORE

Despite the strong growth outlook, AZK shares are badly misvalued by the market.

At a recent price of $7.18, the shares are trading at just 16.5x the 2011 earnings. Many of the big players in the industry have P/E ratios close to 45.  For AZK to get close to those levels, the stock would need to climb to almost $19 a share.  That’s nearly a 168% gain!

This is an astonishingly low P/E ratio for a company projected to grow earnings by 320% this year.  In fact, at the recent price, AZK has a PEG ratio of just .67.

In other words, the shares are trading at a 33% discount to the projected earnings growth rate.

Based on our analysis, we see the stock trading up to at least $12.50.  Buy AZK now for potential gains of 74% or more.

ACTION RECOMMENDATION

BUY Aurizon Mines (AMEX: AZK) up to $7.90 per share.

Not every company is in a sexy business.  And the company in question today is no exception.  It’s not a biotech or an internet company.  It’s not a company based in China and they don’t mine for rare earth metals.  In fact, the company itself is pretty boring…

But what I found in the company’s financial numbers has me excited.  And I’ll take exciting numbers over an exciting product any day.

What’s this “boring” company do?  They sell life insurance of course.

Here’s the deal…

Eventually, most of us plan for retirement.  Whether we want to or not, we all must face the fact… we’re aging.  We need retirement products in our portfolio to help us meet our goals.

With the growing baby boomer population, retirement needs will continue to expand.

One way for people to meet their long-range financial needs is by using life insurance and annuities.

Simply put, these products fill in the gaps nicely around other investments.  They add layers of needed protection.

Because life insurance fills an important gap, it’s become more and more popular over time.  And the popularity of universal life and annuities has spawned a huge and highly regulated industry.

Let’s take a closer look…

THE LIFE INSURANCE & ANNUITY INDUSTRY

Insurance companies have what appear to be a fairly simple business model.  Most of us see it in very plain terms.  A company will write you a policy, collect money (premiums), and pay out claims.

It seems simple, right?  Not really.  Let me explain…

There’s more to it than just collecting premiums and paying out claims.  Companies need to invest those premiums before they are paid out in claims.

What most people don’t see is the significant investment income that is made by investing the premiums.  It adds up to anywhere from 40% to 70% of a company’s revenue!

Before you get too concerned, not all of the money insurance companies hold can be used in the stock market.  Thankfully, there are legal requirements as to how, when, and how much of this money they can invest.

But things have changed in the past couple of years.  The entire sector has had some difficult times making a profit.

And there’s a reason…

As I’m sure you know, interest rates and returns in the stock market were miserable during 2008 and 2009.  Only in late 2009 and 2010 have we seen the stock market turn around.

But interest rate returns have yet to improve.  And this is an important detail.

Insurance companies are highly regulated.  Regulators tell these companies where they can invest.  There are statutory requirements which demand a level of safety for policyholders.  So a great portion of their holdings are required to be invested and reinvested in fixed interest income assets.

And of course these types of asset values are entirely based on interest rate levels.

Keep in mind, a vast number of policies were sold in a higher interest rate environment.  Now rates are significantly lower.  And losses have been stacked up by all of these companies in recent quarters.

To make matters worse, the recent financial crisis has caused all solid insurance companies to be lumped in with the big “evil” insurance companies, like American International Group (AIG).

But here’s the thing…

Not all insurance companies were involved in the wild investments of derivatives that AIG got into.

Now, life insurance is on track for a big 2011.  And rising interest rates will help the industry even more.  A healthy, focused company could be in great position to have a breakthrough year.

I’ve found a great life insurance company.  They’re mature and have a great turnaround story.

And their upside potential is huge.

Introducing Phoenix Companies, Inc. (NYSE: PNX).

Key Investment Data Name:  Phoenix Companies Ticker Symbol:  PNX Market Cap:  $303 million Recent Price:  $2.55 PSB Rating System 4.7 Stars Raging Revenue:  (4.7 stars) Revenue is expected to climb in 2011.  Higher investment income from rising interest rates and equity prices will drive the increase. Beautiful Books:  (4.8 stars) Earnings are expected to surge over 600% in 2011 to $0.43 per share. And better than expected investment income could drive that estimate even higher.  The balance sheet is solid with $59 million in cash. Stellar Structure:  (4.6 stars) Insider ownership is low at 3% of shares outstanding.  However, institutional ownership is very strong at 61%.  Clearly, the smart money’s confidence is high. Valuation Verification:  (4.7 stars) Despite a robust growth outlook, the stock is nicely undervalued.  Based on our valuation analysis, we think the stock is worth at least $6.00 a share.  That’s upside potential of 135% or more. Meaningful Milestones:  (4.7 stars) The company recently launched their “Plan Right, Retire Right” program. This new campaign will help boost exposure to the company’s retirement income plans and other products and services.

Founded in 1851, Phoenix is a strong insurance company.  They offer a diverse lineup of universal life, whole life, and annuity products.  Annuity products include fixed and variable contracts.

The company uses various networks of independent brokers to sell their products. PNX just launched their own Saybrus Partners retirement arm to assist in education and distribution of products.  Their newest campaign is the “Plan Right, Retire Right” program, which is in place to educate buyers and incentivize sales staff.

Here’s the deal…

The story behind PNX is very much like every other insurance company.  The financial crisis destroyed a portion of Phoenix’s investment portfolio.  It left the investment team in damage control mode.

What’s more, new sales dropped as people had less to invest in life insurance policies and annuities.  And to make matters worse, people were even surrendering their existing policies and “cashing out” at an alarming rate.

The fear factor was spiraling out of control…

The result – the stock price was hit hard… much harder than it deserved.

Remember, PNX wasn’t involved in unrelated and risk derivative contracts like AIG.  They’re a pure life insurance company.

Fortunately, the management team acted quickly.  They’ve been working hard on getting things turned around through expense reduction, improving investments, and retention of current policies.

More importantly, we’re going to see higher interest rates at some point this year.  And that’s great news for PNX’s investment portfolio.

Management has been hard at work improving the company’s bottom line.  Let’s take a closer look at the numbers…

THE NUMBERS

Phoenix is turning the corner with revenue, but still has room to improve.  So, when they get all cylinders firing, they’ll be in great shape to rake in profits.

2010 revenue was flat at around $2 billion.  Actually, this is quite an accomplishment. PNX kept revenue flat despite a decrease in policy sales and a reduction in fee income.

Where the company did see gains was in investment income.  This came in at $845 million, up from $785 million in 2009… a solid 8% increase.

What’s more, PNX vastly improved earnings this year.

2010 saw a loss of just $9.6 million, which is a massive improvement over a loss of $142 million the year prior.  A major reason for the improvement has been in expense control.  Expenses are down 15% compared to 2009.

And 2011 is looking even better.

You see, in their earnings call, the CEO mentioned how the current low interest rate environment hurt earnings.

With interest rates sure to rise sometime soon, we should see even better earnings out of PNX.

Another important point to consider is policy retention.  It’s been a major focus for Phoenix.  In 2010, their surrender activity declined to only 7.6% from 10.3%.  It represents almost a 30% improvement.  Clearly, the lower the surrender rates the better.

Things are clearly looking brighter for PNX in 2011.

INVESTMENT RISKS

Every investment carries risks.  PNX is no different.

An extended low interest rate environment could continue to hamper Phoenix’s returns.  If this were to happen, PNX could struggle growing the bottom line.

New policy sales and growth are important to any company.  If PNX struggles to grow new policies at a high enough rate, then we could see a decrease in revenue.

With any insurance company, there is a unique risk of poor underwriting profits.  Simply put, the company may not be selecting the best candidates for insurance and paying out a much higher percentage of death claims than normal.  This could hurt the bottom line.

POTENTIAL RETURN OF 135% OR MORE

It’s time we take advantage of a significant misvaluation of PNX stock.

At current price levels, PNX is trading at only 6.8x projected earnings.  The entire life insurance industry currently has a P/E of 15.7.  So if PNX were to trade in line with their peers, the shares would jump 131%.

And we think it can go much higher.

What’s more, PNX has a price to book ratio of 0.24.  With a P/B ratio that low, there is little risk of significant devaluation.  Even better, the industry P/B is a significantly higher 1.65.  If we were to value the stock equal to a very reasonable P/B of 1.00, PNX shares would be trading 317% higher!

PNX is in the midst of a strong turnaround.  Management is growing investment income and cutting expenses.  With interest rates sure to rise soon, the company’s investment income can only go higher.

Life insurance isn’t the most exciting product in the world, but this opportunity is plenty exciting.  Don’t let it pass you by.

Based on our analysis, we see the stock trading up to at least $6.00.  Buy PNX now for potential gains of 135% or more.

ACTION RECOMMENDATION

BUY Phoenix Companies (NYSE: PNX) up to $3.00 per share.

Recent price is $2.55.

Use a stop-loss of $1.50 on this position.

Don’t forget your position sizing and stop-loss rules.

Portfolio Update

• The surging tech sector sent two of our companies to new highs.  Web.com(WWWW) climbed to $13.18 for an impressive 189% gain.  Nova MeasuringInstruments (NVMI) hit a high of $11.44… good for a stellar 164% gain.

Category: PSB Monthly Issues