PSB Monthly Issue November 2010
November 2010
INTO YOUR PORTFOLIO
Have you ever stared in awe at the paychecks investment bankers get? The average guys often pull down half a million or more a year…
And the really good ones often take home year-end bonus checks with seven digits!
If investment bank “employees” are making this kind of cash, what does that say about how the companies are doing?
Let me tell you, investment banking is an extremely lucrative industry.
These outfits regularly post big revenues and huge profits. They’re just the sort of stock you’d love to own!
Let’s look a little closer at the industry…
Investment banks offer a broad range of products and services. They are most widely known for underwriting and issuing securities, such as taking a company public through an IPO.
But that just scratches the surface.
Investment banks also advise companies on mergers and acquisitions, structure derivatives, trade securities for their clients, and run their own proprietary trading groups. All of these activities have one thing in common…
They generate big money.
Take 2007 for example. It was the best year on record for investment banks worldwide. Global revenues reached an eye popping $84 billion.
Now that’s some serious coin!
After a challenging 2009, investment banking activity is finally recovering… and so are revenues. 2010 revenues probably won’t reach 2007 levels due to economic conditions, but they’re certainly headed in the right direction.
And one area in particular is growing like crazy…
One of the fastest growing segments of investment banking is private investment in public equities, often called PIPEs. Basically, PIPEs are publically traded shares sold in a private transaction to hedge funds and wealthy individuals.
Here’s the interesting part…
Demand for PIPEs is going through the roof.
Small and medium sized companies use PIPEs to access financing normally not available to them. You see, PIPEs are a lot easier to get done than standard public offerings or debt financings. And they provide quick and cheap access to capital.
In a typical year, there are well over 1,000 PIPE transactions taking place. And these deals can add up to more than $100 billion. That’s a ton of money no matter how you slice it.
And that’s not all…
2011 is looking more and more like a comeback year for investment banking.
Financing deals in general pick up quite a bit when the financial markets are doing well. There’s more money to be made when markets are going up. And markets have rebounded from their 2010 lows and look to be in good shape to move higher.
What’s more, a new calendar year always brings a flurry of activity. Many companies like to start the new year off with a bang… and a bunch of cash.
As you can see, now’s the ideal time to add an investment bank to our portfolio. And it just so happens there’s a quality penny-sized investment bank available.
Rodman and Renshaw Capital (NASDAQ: RODM) is that company. Let’s take a closer look at them now.
Name: Rodman & Renshaw Ticker Symbol: RODM Market Cap: $99 million Recent Price: $2.87 PSB Rating System 4.8 Stars Raging Revenue: (4.7 stars) The company is looking at $100 million in revenue for 2010. Revenues are expected to jump 47% in 2011. And there’s upside to these numbers with market conditions improving. Beautiful Books: (4.7 stars) Earnings are expected to surge an amazing 130% in 2011. And they could easily beat estimates if market conditions keep improving. Plus, the company’s sitting on a ton of cash and no long term debt. Stellar Structure: (4.8 stars) Insiders are clearly confident with ownership of 57% of shares outstanding. And, institutional ownership of 15% shows the smart money is already starting to buy. Valuation Verification: (5.0 stars) The stock is badly mispriced by the market. Based on our valuation analysis, we think the stock is worth at least $6.60 a share. That’s upside potential of 130% or more. Meaningful Milestones: (4.8 stars) The company is #1 in PIPE deal volume for the 5th year in a row. Sagient Research reports RODM completed an impressive 50 deals in the first 3 quarters of 2010. |
THE INVESTMENT BANKING BUSINESS
RODM is an investment bank working with companies in the U.S. and China. They specialize in multiple sectors including life sciences, healthcare, mining & metals, financial services, energy, and cleantech. RODM offers the full range of investment banking services, though their specialty is in financing alternatives, such as PIPEs.
Lately, the company’s heavily focusing in on three areas… China, metals & mining, and oil & gas. All three of these areas have been growing like crazy. And each has a ton of upside potential.
Here’s the best part…
RODM is the clear market leader in PIPEs. According to Sagient Research, RODM has already completed 50 PIPE transactions this year for a total of $643 million.What’s more, the company has been the largest PIPE dealer for the last five years in a row.
That bodes well for the coming year.
You see, the PIPE market is going to explode as the economy improves. And, there’ll be a huge number of deals to do once 2011 begins. Remember, there’s always a flurry of new deals at the beginning of the year.
Now let’s take a closer look at the company’s financials.
THE NUMBERS
Despite challenging market conditions, RODM is putting up solid numbers.
The company’s pulled in $54.3 million in first-half 2010 revenues, compared to $35.6 million in the year ago period. That’s a stellar 53% rise. Driving results was a significant increase in deal flow.
As a matter of fact, the company completed 66 transactions for $1.4 billion. Much better than the 32 transactions for $519 million in the first half last year. That’s an enormous jump and a great sign of things to come.
First-half 2010 income didn’t look too great. But income is heavily impacted by economic conditions. And with the economy looking much stronger, we should see a big jump in income levels in coming quarters.
Bigger and better deals tend to come with improving markets. In fact, RODM’s earnings outlook is excellent going forward.
In 2010, the company’s earnings are projected to be $0.19 per share on $100 million in revenues. For 2011, those numbers skyrocket to an expected $0.44 a share on $147 million in revenues.
That’s an astonishing 130% increase in earnings! Clearly there’s reason to be optimistic about RODM’s future.
What’s more, the company has an outstanding balance sheet.
RODM is sitting on a cash hoard of almost $60 million. The company also has no long-term debt… very impressive. And, current assets are a robust 3.4x current liabilities. Management obviously knows how to run a healthy company.
INVESTMENT RISKS
As you know, no investment is without risks, and RODM is no exception.
The company’s growth depends on the market for banking deals improving. If the equity markets experience a major selloff, it could cut down the number and size of deals RODM makes.
Also, financial regulations are in the process of change. Certain regulations which have yet to be defined could negatively impact the PIPE industry and RODM.
Finally, bigger investment banks could decide they want a piece of the PIPE market. The big firms might be looking for new ways to earn money and enter the alternative financing markets.
POTENTIAL RETURNS OF 130% OR MORE
Despite RODM’s bright future, the shares are badly mispriced.
At a recent price of $2.87, RODM shares are trading at just 4.9x earnings. Meanwhile, the industry average is 21.4x earnings. If RODM simply trades at the industry average P/E, the share price would go up over 220%.
RODM has an expected long-term growth rate of 15%. So, the industry average P/E is certainly a reasonable multiple. But let’s use a more conservative 15x the 2011 estimate to determine a price target.
That would work out to over $6.60 a share, or an incredible 130% return.
From the chart below, you can see how at the beginning of 2010, RODM shares traded over $5.50. With the market rallying and the potential New Year bump coming, there’s no reason to believe RODM can’t match that climb. And it certainly could go much higher.
Based on our analysis, we see the stock trading up to at least $6.60. Buy RODM now for potential gains of 130% or more.
ACTION RECOMMENDATION
BUY Rodman & Renshaw (NASDAQ: RODM) up to $3.21 per share.
Recent price is $2.87.
Use a stop-loss of $1.43 on this position.
Don’t forget your position sizing and stop-loss rules.
JUST IN TIME FOR THE HOLIDAYS
In the past few weeks, two of my colleagues have had beautiful baby girls. As a father of two girls myself, I know what a special time this is in my friends’ lives.
As you might imagine, I’ve heard a lot of talk about how expensive newborn babies are. Everyone’s shocked at how much money they’re shelling out for clothes, cribs, strollers, high chairs, car seats, and toys.
Of course, I just chuckle and say… “You ain’t seen nothin’ yet!”
However, all the talk about spending on newborns got me thinking. Perhaps there’s an investment opportunity here?
So I started doing a little research…
And what I found was very interesting indeed.
The global market for juvenile products is huge. More than $12 billion is spent on these items every year. And it’s a remarkably stable area of spending. With at least 4 million babies born in the U.S. every year, the annual birth rate creates solid baseline demand.
What’s more, the industry has a couple of important growth drivers…
First, sales per child are increasing. As more parents wait to have children later in life, they have greater disposable incomes than prior generations. And they’re willing to spend more on items with greater quality, safety, innovation, and style.
Second, retailers are more committed today to expanding shelf space for these products. More shelf space translates into greater sales for manufacturers of juvenile products.
But here’s the best part…
The juvenile products industry is largely immune to economic downturns.Parents typically spend money on products that promote the health and wellness of their babies no matter how bad the economy gets. And it’s one of the last spending areas to get cut back.
Clearly, the juvenile products industry is an attractive sector for investment.
But are there any opportunities for penny stock investors?
You better believe it! After a bit of digging, I found a sensational penny-sized juvenile products company. I’m pleased to introduce, Summer Infant (NASDAQ: SUMR).
Let’s take a look under the hood…
Name: Summer Infant Ticker Symbol: SUMR Market Cap: $107 million Recent Price: $6.98 PSB Rating System 4.7 Stars Raging Revenue: (4.8 stars) Revenue is expected to jump 24% in 2010 and 16% in 2011. However, a stronger economy could boost the 2011 increase even higher. Beautiful Books: (4.9 stars) Earnings are expected to surge 35% in 2010 and another 20% in 2011. The balance sheet shows an appropriate use of leverage for sustaining robust growth. Stellar Structure: (4.7 stars) Insider ownership of 29% shows management’s confident in the company’s future. And solid institutional ownership of 49% indicates the smart money likes the shares too. Valuation Verification: (4.5 stars) The stock is mispriced by the market. Based on our valuation analysis, we think the stock is worth at least $10.92 a share. That’s upside potential of 56% or more. Meaningful Milestones: (4.7 stars) The company is celebrating their 25th anniversary this year. Since 1985, they’ve been dedicated to delivering “The Best Time Of Your Life” to parents and babies worldwide. |
THE JUVENILE PRODUCTS BUSINESS
SUMR is one of the few public company pure plays in the juvenile products industry. They make a variety of products for infants including monitors, safety gates, baths, cribs, bedding, and booster seats to name a few. And their customers are leading U.S. retailers like Babies R Us, Target, Kmart, and Wal-Mart.
To say the company’s growing rapidly is an understatement.
Since 2004, revenues have exploded more than seven-fold from $21 million to a dazzling $153 million. And earnings growth is even more impressive. Since 2005, earnings have mushroomed an eye-popping 800%!
And the company’s just getting started…
Management has a surefire strategy for growing the company. Their growth strategy includes selling more products at existing stores, selling products at more stores within each retail chain, introducing new products, expanding into new distribution channels, and going international. Plus, they’re looking to expand through strategic acquisitions.
What’s more, management has the chops to achieve their goals. The company’s three senior executives each have 20 years experience in the industry. And they’ve all worked for leading companies in the field, including Safety First, Hasbro, and Little Kids.
To see management flawlessly executing the company’s growth strategy, you don’t have to look any further than the latest financials.
THE NUMBERS
Despite a tough retail environment, SUMR knocked the ball out of the park in the second quarter of 2010.
Revenue jumped an impressive 29% to a record $49.5 million. Net income surged 38% to a record $2.2 million. And earnings increased a hefty 18% to $0.13 per share.
Three things drove this amazing growth.
First, the company expanded their product offerings at customers’ stores. Second, they penetrated into more stores within their customers’ chains. And third, stringent cost reductions boosted profit margins.
A fantastic quarter any way you slice it!
Third quarter numbers looked even better…
Revenue was a solid $49.8 million. That’s up over 21% from the year ago quarter. And net income increased to $2.1 million or $0.13 per share. Again, expanded product offerings at existing stores and penetration into more stores within customer chains drove growth.
What’s more, the outlook for full year 2010 and 2011 is simply terrific.
Revenue is expected to jump 24% this year to $190 million and then ratchet up 16% next year to $220 million. Even better, earnings are forecast to increase a stunning 35% this year to $0.50 per share and then pop another 20% next year to $0.60.
But here’s the kicker…
Management’s guidance for 2011 is intentionally conservative. They’re clearly trying to manage analyst expectations lower. That’s great news for us because potential upside surprises are now built in for coming quarters.
In addition to strong growth, the company also boasts a sound balance sheet.
You’ll notice SUMR carries more debt than many of our past recommendations. This is not necessarily a bad thing. The truth is the company needs leverage to sustain its high growth rates.
You see, SUMR must borrow funds in order to purchase inventory from vendors in China. The good news is the amount of leverage used is not excessive. In fact, it’s equal to the industry average.
In addition, the company’s debt to equity level is less than the industry average. Current assets are a comfortable two times current liabilities. And receivable turnover is better than the industry average.
These indicators show the company’s using just the right amount of leverage to grow sales and earnings. Just what we want to see from a rapidly expanding retail business.
INVESTMENT RISKS
However, like any investment, SUMR does carry some risk.
As a retail business, the company depends on market acceptance of their products. If consumers stop buying these products, SUMR could lose market share.
Another risk is the company’s dependence on a few large retail customers for more than half their revenue. Without these customers, the business could suffer.
A third risk is the company’s strategy to grow through acquisitions. If SUMR is unable to successfully integrate new acquisitions, their growth could slow.
POTENTIAL RETURNS OF 56% OR MORE
SUMR is poised for huge gains over the next year.
Management’s flawlessly executing their growth strategy. And this is driving strong revenue and earnings growth quarter after quarter. Remember, nothing attracts investors like consistent, red-hot growth.
Now, you’ll note the stock dropped today…
The company announced third quarter results this morning. Revenue missed the estimate by a mere $1 million and earnings missed by just a penny. Not huge misses by any measure, but investors are still sending the shares lower.
However, it’s really not that bad…
You see, revenue missed only because $3 million in orders were pushed into the fourth quarter. It’s not like the orders disappeared… they simply moved into the next quarter due to timing of the sales.
And management’s slightly lower guidance is nothing to worry about either.
They’re using the oldest trick in the book… jawboning analysts’ estimates lower. By lowering expectations, they take some of the pressure off the company and themselves. Plus, they make it easier to manufacture upside earnings surprises going forward.
And you know what investors do to stocks that beat estimates… they send them surging higher!
Clearly, the “bad news” has created a great buying opportunity for us.
Right now SUMR’s trading at just 14x the 2010 earnings estimate of $0.50 per share. That’s an awfully low P/E for a company projected to grow earnings 27% a year over the next five years. In fact, it leads to a PEG ratio of a mere 0.52.
That means SUMR is trading at a 48% discount to their projected growth rate.
A more appropriate P/E under current market conditions is 16.8x earnings (a 40% discount to the long term growth estimate). If we apply this multiple to management’s 2011 estimate of $0.60, we get a share price of $10.08.
That’s upside potential of 44%!
But remember, management’s sandbagging on guidance. Their 2011 estimate is intentionally lower than what the company could earn. Using a more realistic estimate of $0.65 and the P/E of 16.8x, we get a price target of $10.92.
That’s a potential profit of 56%!
Based on our analysis, we see SUMR trading up to at least $10.92. Buy shares now for prospective gains of 56% or more.
Important Note: Because of the late breaking earnings news, we’ve updated all the stock prices and other figures as of this morning. Also, the shares could drift lower in coming days, so be patient with your buy orders. You might be able to get even better prices.
ACTION RECOMMENDATION
BUY Summer Infant (NASDAQ: SUMR) up to $7.68 per share.
Recent price is $6.98.
Use a stop-loss of $3.49 on this position.
Don’t forget your position sizing and stop-loss rules.
Portfolio Update
- We adjusted our buy price for MFA Financial (MFA) to reflect a dividend of $0.225 per share paid at the end of October.
- In case you missed it, we said to Sell Kulicke & Soffa (KLIC) and Taseko Mines (TGB) in our last Portfolio Update. If you’re still holding these stocks, go ahead and sell them now. We’re cutting our losses short on KLIC, but you can still book profits of 50% or more on TGB.
- Move Ultra Clean Technologies (UCTT) and PLX Technology (PLXT) from Buy to Hold. Both companies’ third quarter numbers missed estimates. And they both lowered guidance for next quarter. However, we think they’re sandbagging in order to lower analyst expectations. This sets up potential upside surprises in coming quarters. Hang on tight for a potential recovery rally.
Category: PSB Monthly Issues
