PSB Monthly Issue March 2009

| March 3, 2009

March 2009


Are you one of the 160 million Americans taking a prescription drug?

If you are, then you know how expensive they can be.  If not, consider yourself lucky. You not only have a healthy body, but a healthier bank account as well.

Prescription drug prices are increasing twice as fast as prices for other goods and services.  As a result, the average cost of a prescription has almost doubled in just the past decade.

These rising costs are pushing many Americans into financial hardship and even bankruptcy.  Patients with low incomes, chronic conditions, multiple medications and no health insurance are suffering the worst.  To save money, many patients are no longer taking their medications at all.

Even if you have insurance, you’re probably paying more for your prescriptions.

Employers and insurers are shifting more of these costs to consumers through higher premiums and drug copayments.  This shift is particularly severe for patients needing expensive brand-name drugs.

What’s pushing drug prices higher and higher?

Quite simply, it’s more patients buying more prescriptions.  Prescription drug purchases are up more than 72% in the last ten years.  This is due mostly to the increasing average age of our population.  Older folks take many more prescriptions than younger people.

This trend is not about to change anytime soon.  Our population is going to keep growing older because of a powerful demographic trend.  The aging of the ‘Baby Boomer’ generation.  This means more prescriptions and ever increasing prescription drug costs.

As you might have guessed, I’ve found a way to profit from this otherwise harmful trend.  A certain industry actually benefits from higher prescription drug prices.

This industry is just beginning a multi-year boom in sales and earnings.  It’s growing faster than both the pharmaceutical and biotech industries.  And, it’s expected to grow at double-digit rates through 2011 to more than $69 billion.

I’m talking about the generic drug industry.

Soaring name-brand drug prices are forcing more Americans to choose generic drugs. Two out of every three prescriptions today are for generics.  The reason is generics cost 30% to 80% less than their name-brand counterparts.  Americans are saving about $8 to $10 billion a year buying generic drugs.

Other trends are also driving growth in this industry.

One trend is patent expirations.  $70 billion worth of name-brand drugs will lose their patent protection between now and 2012.  Many of these are blockbuster drugs with annual sales of several billion dollars each.  Generic drug companies are chomping at the bit to develop generic equivalents for these cash cows.

Another potential trend is generic biotech drugs.  Congress may soon allow generic versions of these expensive drugs.  Several biotech drugs with combined annual sales of $20 billion would immediately become fair game for generic drug makers.

A number of stocks in the generic drug industry are poised for huge gains over the next few years.  But, one microcap generic drug maker stands out from all the rest.

This company’s revenues and earnings are growing faster than industry averages. They market a number of profitable generic drugs and healthcare products.  They also have a strong pipeline of new drugs in development.  And, its stock has huge upside potential.

The company I’m talking about is Hi-Tech Pharmacal (HITK).

Key Investment Data

Name:  Hi Tech Pharmacal
Ticker Symbol:  HITK
Market Cap:  $58 Million
Recent Price:  $5.17

PSB Rating System 4.7 Stars

Raging Revenue: (4.8 stars) Revenue growth is on fire.  Last quarter revenue popped 58%.  This quarter revenue is expected to double the year ago period.

Beautiful Books: (4.8 stars) Current quarterly earnings are expected to skyrocket by 283%. With $12.9 million in cash and no debt, the balance sheet is strong.

Stellar Structure: (4.8 stars) Insider ownership is very strong at 35%.  Institutions own a substantial 59%, but there’s room to grow. When institutional ownership expands it will drive the stock price higher.

Valuation Verification: (4.5 stars) HITK is selling for less than book value.  It also trades at a 50% discount to its projected growth rate.  The shares offer huge upside gains of 122% or more.

Meaningful Milestones: (4.5 stars) Five new products launched in 2008 are boosting revenue and earnings growth.  HITK has 13 new products awaiting FDA approval and 20 other products in active development.


HITK’s main business is developing generic prescription drugs.  They also market over the counter medications and nutritional products.  Founded in 1982, the company offers over 100 generic and branded products to about 100 different customers.

Their customers are mainly chain drug stores, drug wholesalers, managed care organizations, and federal government agencies.  Major customers include premier drug wholesalers like McKesson Corporation, AmerisourceBergen, and Cardinal Health.

Generic drugs make up about 80% of HITK’s total revenue.

The company actively markets 37 approved generic drugs.  They target diseases like asthma, allergies, bronchial disorders, skin disorders, neurological disorders and others. (You might be taking one of these generics and not even know it.)  Revenue from generic drug sales for fiscal year 2009 (ending in April) is on pace to hit a record $80 million.

Profits are soaring on five new generic drugs launched in 2008.

The most recent was the generic equivalent of Merck’s glaucoma drug, Cosopt Ophthalmic solution.  This is a major new drug for HITK.  In its first quarter on the market, this drug produced more than $5 million in revenue.

A number of new drugs are poised to hit the market.

HITK has 13 different generic drugs currently awaiting approval from the FDA.  They’re targeting generic and branded drugs with sales of over half a billion dollars a year.  The company’s also developing 20 other drugs targeting brands with annual sales of more than $2 billion.

A strong research and development program should sustain growth for years to come.

HITK’s identified a number of attractive candidates for future development.  These name-brand drugs produce more than $9 billion in revenue every year.  Most have patents expiring in the next five years.  The rest have patents HITK can successfully challenge.

Generic drugs aren’t this company’s only business.

HITK also operates a growing health care products line.  This business accounts for about 20% of total revenue.  Most of these products are over the counter, nutritional, and prescription products for people with diabetes.


HITK’s revenue and earnings are rocketing higher thanks to the flurry of new products.

The company’s second fiscal quarter was impressive to say the least.  Revenue jumped 58% from the prior year period to a record $25.1 million.  Net income turned positive to $1.1 million or $0.09 per share compared to a loss of $1.0 million or ($0.08) per share a year earlier.

The current quarter should be even better.

HITK will announce fiscal third quarter results on March 9th.  They’re expected to report record revenue of $30.2 million.  More than double the year ago quarter’s revenue.

Earnings per share are expected to leap up to $0.25.  Hang on to your hat… that’s a whopping 283% higher.

But, that’s not all.

HITK also sports a clean balance sheet.  They have $12.9 million in cash with virtually no debt.  This puts them in a strong position to weather any downturn caused by the global economic recession.

Of course an investment in HITK is not without some risks.


The company’s future growth depends on new products receiving FDA approval.  They can’t market them to the public without it.  With more than 37 products approved, HITK knows how to navigate the FDA approval process.

Even if approved, a new product may not be accepted in the marketplace. Acceptance depends on competing product availability, pricing, and quality.

A third risk is HITK’s ability to comply with FDA regulations for its manufacturing facilities and processes.  Failure to comply can result in the FDA delaying or withholding product approval.


HITK is capable of making big moves in a hurry.  In December, the shares rocketed up 95% in just four trading days.  The shares spiked higher on expectations for strong quarterly financial results.

A similar opportunity is shaping up right now.  HITK is poised to report strong quarterly results next week.  We could certainly see the shares spike higher leading up to their earnings announcement.

Even if this short-term trade doesn’t develop, the shares offer huge long-term upside potential.  The stock has pulled back recently following Obama’s proposed healthcare reforms.  This provides a golden opportunity to establish lower risk long-term positions.

The market is clearly ignoring HITK’s strong fundamentals and capacity for growth.  A comparison with two leading generic drug makers shows just how misvalued HITK’s stock really is.

A conservative price to book analysis shows HITK is worth more than its recent stock price.  Watson Pharmaceuticals (WPI) and Mylan (MYL) have P/B ratios of approximately 1.40x.  HITK’s book value per share is $6.93.  Applying a P/B of 1.40x, HITK’s shares are worth $9.70 (a potential gain of nearly 88%).

On a PEG ratio basis, HITK’s stock is worth even more.

HITK’s earnings are expected to grow much faster than MYL’s and WPI’s.  But, its stock trades at a much lower price relative to its projected earnings growth.  Given its higher growth rate, HITK deserves a higher P/E multiple.

With a conservative PEG Ratio of 1.0, HITK’s P/E would be 25x.  Assuming HITK’s fiscal 2009 earnings meet estimates of $0.41 per share, a P/E of 25x implies a share price of $10.25 (a potential gain of 98%).

HITK reports fiscal year 2009 earnings in April.  It won’t be long before the market begins discounting fiscal year 2010 earnings into its stock price.  Given its earnings estimate of $0.55, a P/E of 25x suggests a share price of $13.75 (a potential gain of almost 166%).

Management believes HITK is worth a lot more than its recent price.  They recently had the company repurchase 94,000 shares at an average price of $7 per share. When companies repurchase their stock, management usually believes the stock is headed higher.

Fair value for HITK is somewhere between $9.70 and $13.75.  We believe the shares are worth at least $11.49 – for a potential gain of 122% or more.


BUY Hi Tech Pharmacal (HITK) up to $6.20.

Recent price is $5.17.

Use a stop-loss of $2.58 on this position.

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



Last month we told you now’s the time to buy quality microcap Chinese stocks.  Our opinion hasn’t changed.  We’re continuing with our theme in this month’s issue.

Let’s quickly review the reasons for jumping back into Chinese stocks.

The Chinese government’s moving quickly to boost economic growth.  They’ve lowered interest rates and implemented an unprecedented $586 billion stimulus plan.  And don’t forget, even in recession, China’s still the fastest growing economy in the world.

Chinese investors are betting the economy will start recovering in the second half of 2009.  They’ve pushed the Shanghai Composite Index up 21% this year and 29% since the stimulus plan was introduced in November.  It’s the best performing index in the world this year.

Here’s why…

China’s newly affluent middle class.

This group of some 300 million is seeing their incomes rise dramatically.  With more money in their pockets, middle class Chinese are spending more on domestic goods and services.  As you can imagine, Chinese domestic consumption is rising long term.

One industry really benefits from this trend.  For-profit, post-secondary education services.  It’s gone from relative obscurity to one of the fastest growing industries in China.  What’s really exciting is the industry’s phenomenal long term growth potential.

The industry’s target market is absolutely massive.

Over 600 million Chinese are in the prime age group for higher education services.  In addition, 750 million Chinese workers need to upgrade their job skills to survive in a services based economy.  Any way you slice it, this market is more than twice the size of the entire U.S. population.

But a huge market isn’t worth much without a catalyst to spur demand.

Trust me these consumers have a huge incentive to seek out higher education.  During the economic boom, many of them saw their better educated neighbors make a lot more money.  They learned their ticket to a higher income and a better life is a college degree.

Don’t believe me?  Take a look at enrollment growth.

Enrollment in post-secondary degree programs has increased five-fold since 1998 to over 26 million students.  That’s a whopping compound annual growth rate of 23%. Compare that to the U.S. market where enrollment growth is an anemic 2% per year.

But this is just the beginning…

China’s for-profit education services industry is still in its infancy.  Right now only 22% of the target market utilizes these services.  In the U.S., market penetration is almost four times greater at 82%.  A similar level in China translates into a mind boggling 500 million students.

Still not convinced?

Take a look at the number of college degrees.  25% of all Americans or 75 million people have some kind of college degree.  In China, just 5% of the population (65 million) has one.  At U.S. levels, the number of college educated Chinese would number an amazing 325 million people.

If this industry’s growth potential doesn’t get your heart pumping, you’d better check your pulse.  Half a billion students make for a steadily rising, recurring revenue stream for decades.

I know what you’re thinking.  Even if all these people wanted to go to college, how could they afford it?

Subsidies and loans from the Chinese government.

Government spending on education has doubled since 2005 to over $400 billion annually.  More important, the government has pledged to bring annual spending levels up to 4% of GDP by 2010 (close to the 5% levels of developed countries).  All this spending makes education services available to more people.

Okay.  This all sounds great.  A huge target market.  Motivated consumers. Phenomenal growth potential.  And government funding.  How do we grab our share of this coming boom?

Look no further than ChinaCast Education (CAST).

Key Investment Data

Name:  ChinaCast Education
Ticker Symbol:  CAST
Market Cap:  $100 Million
Recent Price:  $2.81

PSB Rating System 4.6 Stars

Raging Revenue: (4.8 stars) Revenue growth over the last three years is red hot at 33% per year. Demographic trends and government spending should drive revenue growth for years to come.

Beautiful Books: (4.8 stars) Earnings growth over the last three years is phenomenal at 96% annually.  A large cash position and virtually no debt put CAST in strong financial position.

Stellar Structure: (4.2 stars) Insiders are confident about the future with ownership of 28%. Institutional ownership is somewhat low at just 38%.  When institutions begin increasing their holdings look for the stock to take off.

Valuation Verification: (4.8 stars) CAST offers huge upside potential of 180% or more from its recent price. The stock’s recent price ignores CAST’s strong future growth potential.

Meaningful Milestones: (4.5 stars) CAST plans on expanding its e-learning services to over 200,000 students and acquiring 3 or 4 traditional universities in the next two years.


CAST is one of the leading for-profit, post-secondary education and e-learning service providers in China.  They provide education services through two lines of business.

CAST provides traditional post-secondary education services through its Foreign Trade and Business College (FTBC) of Chongqing Normal University.

FTBC offers career-oriented bachelor’s degree and diploma programs in business, economics, trade, tourism management, advertising, language, information technology, and music.  All of these programs are accredited by China’s Ministry of Education.

FTBC is working to grow enrollment levels more than 50% by 2011.

They’re adding courses in more areas of study to attract a wider base of students. They’re exploring joint-venture degree programs with foreign education institutions to increase foreign student enrollments.  And, they’re cross-marketing to hundreds of thousands of students in their e-learning program.

CAST is the market leader in e-learning.

They provide interactive distance learning services to over 131,000 students at 15 different universities.  They also provide training services for government ministries and corporate enterprises.  And, they provide teacher training content to over 6,500 K-12 schools.

CAST has a major advantage over the competition in this business.

They can provide e-learning services anywhere in China through their nationwide satellite broadband network.  Most of their competitors rely on earth bound networks. These networks have much smaller coverage areas especially in less-developed rural China.

But, management’s not content to rest on their laurels.

They have an aggressive two-pronged growth strategy for the next two years.  First, they’re going to acquire 3 to 4 career-oriented universities.  Second, they’re going to expand e-learning services enrollments to over 200,000 students.  Their goal is to be the first in China with both physical campuses and online education services nationwide.

This is a great story, but what about their financial condition?


CAST operates a high margin, cash generative business with highly visible recurring income.  For my money, there’s no better kind of business.

The company’s results from last quarter illustrate exactly what I mean.

CAST reported strong growth across the board.  Revenue jumped almost 59% to $10.7 million.  Gross profit rocketed 62% higher to $6.2 million on margins of 58%.  Operating income rose 59% to $3.7 million on margins of 34%.  And net income rose 17.7% to $2.9 million.

These are stellar financial results.  Top line growth is very strong.  Profit margins are high and expanding.  And the bottom line grew despite higher cost of sales from an acquisition.

I expect more of the same when the company reports fourth quarter and full year 2008 results in March.

For the year, revenue is expected to grow 66% to almost $41 million.  Earnings are slated to jump 25% to $0.35 per share.  This is outstanding growth in one of the worst global financial meltdowns in history.  You aren’t going to find too many companies right now growing at all, let alone as fast as CAST.

Despite China’s slowing economy, CAST should post more solid growth in 2009.

Revenue is expected to rise 20% to $49.3 million.  An earnings increase of 29% to $0.45 per share is also projected.  This estimate could move higher as it was just raised in the last week.

A strong balance sheet completes the picture.

CAST is in a strong financial position to weather any downturn caused by the global financial crisis.  The company has $73 million in cash, $13 million in short-term debt, and no long-term debt.  With such high liquidity, CAST has no problem meeting its short-term obligations.

That’s not to say an investment in CAST is completely without risk.


One risk CAST faces is a cut in government funding for education, distance learning services, or job retraining.  Government spending in these areas is one of the main growth drivers of CAST’s business.

Another risk is a worsening of China’s economic downturn.  If China’s $586 billion stimulus package fails to boost growth, consumer spending might decline sufficiently to hurt CAST’s business.

A third risk is fluctuations in currency exchange rates.  CAST does most of its business in Chinese Remnibi, but it also does business in some foreign currencies. Unfavorable currency exchange rates could hurt CAST’s bottom line.

We think the huge potential upside in CAST outweighs the potential downside risks.


The time is now to back up the truck and fill it with shares of CAST.

Over 1 billion Chinese students and workers are candidates for higher education and job retraining.  Annual increases in government spending will make higher education available to more people.  And, more Chinese are recognizing the path to a higher income goes through college.

If stocks of U.S. education companies are any guide, CAST shareholders stand to reap huge gains going forward.  Take a look at the returns of three U.S. education stocks over just the past ten years.

Strayer Education (STRA) up 616%.
Apollo Group (APOL) up 747%.
ITT Educational Services (ESI) up an amazing 1,597%.

Right now the market’s not factoring CAST’s huge growth potential into its stock price.  A comparison with two leading U.S. education service companies shows how misvalued CAST really is.

CAST’s revenue is growing faster than APOL’s and ESI’s, but its P/S ratio is quite a bit lower.  With a similar P/S ratio of 4x, CAST’s stock would be worth $5.32.  About 89% higher than its recent price.

CAST’s forward P/E ratio is ridiculously low at just 6x.  With faster growing earnings, you’d expect CAST’s forward P/E to be at least as high as its competitors.  A forward P/E of 15x puts CAST’s stock price at $6.75.  A potential gain of 140% from recent levels.

With a PEG ratio of just 0.23, CAST is trading at a huge discount to its higher earnings growth rate.  A conservative PEG Ratio of 1.0 implies a P/E of 29x.  Using this multiple on 2009 estimated earnings of $0.45 per share, CAST is really worth $13.05.  About 364% higher than its recent price.

My analysis puts CAST at $7.88 – that’s about 180% higher than its recent price.


BUY ChinaCast Education (CAST) up to $3.50.

Recent price is $2.81.

Use a stop loss of $1.41 on this position.

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


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