PSB Monthly Issue October 2011

| October 4, 2011

October 2011


In challenging market conditions, investors are constantly looking for an edge.

Let’s face it… it can be difficult to find a company with a strong growth outlook when a recession is looming.  And often times, corporate management is more worried about holding on to their profits than figuring out how to grow them.

That’s why, in times like these, it’s a good idea to look for other ways companies can generate value for their shareholders.  Growth may not always be an option… but that doesn’t mean management is helpless.

And these days, companies are as cash rich as they’ve ever been.

Astute management teams – in any industry – don’t have to sit on their cash just because the economy is slowing.  As a matter of fact, there are multiple ways they can use the cash in the best interests of the shareholders.

Take, for example, companies in the Education & Training industry…

In particular, let’s take a look at the travel-related education industry, such as programs sending students and professionals overseas.  The lion’s share of this industry’s business is based on student travel… and it’s a huge market.

There are nearly 30 million students in the industry’s target age group in the US alone. And roughly 10 million of those students are in the target demographic (income level).

But as you might imagine, poor economic conditions have significantly cut into the budget of would-be world travelers.

So what’s a company to do if they can’t spur growth?

Find other ways to spend their money.

That’s why we’re impressed with Ambassadors Group (NASDAQ: EPAX).  Despite the challenging economy, EPAX’s management is finding a way to provide value to their shareholders.

Key Investment Data

Name:  Ambassadors Group
Ticker Symbol:  EPAX
Market Cap:  $102 million
Recent Price:  $5.53

PSB Rating System 4.6 Stars

Raging Revenue:  (4.0 stars) Last quarter’s revenues dropped a bit due to the challenging global economy. However, the outlook for 2012 is promising with inter-national travel already starting to pick up.

Beautiful Books:  (5.0 stars) The balance sheet is rock solid with $90 million in cash and no debt. Management is using the strong cash position to create value for shareholders by issuing a dividend and buying back shares.

Stellar Structure:  (4.6 stars) Insiders own a reasonable 12% of shares outstanding.  But institutional ownership is an impressive 72%. Institutions are clearly confident in the company’s health and growth prospects.

Valuation Verification:  (4.7 stars) EPAX is significantly undervalued. Based on our valuation analysis, we think the stock is worth at least $11.00 a share.  That’s upside potential of 99%.

Meaningful Milestones:  (4.5 stars) The company’s delegates have surpassed the 500,000 mark.  That’s over half a million who have traveled safely to domestic and foreign locations.


EPAX is a leading provider of educational travel programs for students, athletes, and professionals.  The company’s main source of business comes from students.  This includes programs for students both domestically and internationally.

International programs involve students (or professionals) traveling to foreign destinations to learn about the area’s history, culture, government, and economy. There are also programs which focus on travel to foreign destinations for sporting competitions.  Domestically, the programs are designed to emphasize leadership, community involvement, and government education.

Revenues are generated from one-time enrollment fees.  Foreign programs cost between $5,000 and $7,000.  Domestic programs run $1,700 to $3,000.  To put it in some perspective, in 2010, EPAX had over 26,000 traveling delegates.

Here’s the deal…

It should come as no surprise, travel programs, like the ones offered by EPAX, are seeing significantly less enrollment with the downturn in the global economy.  Simply put, it’s hard to convince customers to drop several thousand dollars on these types of services when most households are struggling to make ends meet.

But this is what I really like…

There’s more than one way to provide value to shareholders.

For instance, EPAX recently declared a quarterly dividend.  And this isn’t just some token payout… we’re talking a yield of over 4%!  More importantly, it’s a good sign management’s optimistic about the company’s future prospects.

And that’s not all…

Management is also aggressively repurchasing shares.  Just this past quarter, the company bought back 60,000 shares.  And they’re authorized to spend another $15 million.  Remember, reducing the share count is another way to boost earnings per share.

That’s not to say we should write off the possibility of growth.  In fact, there’s some hope demand for EPAX’s programs may be once again on the rise.

You see, besides the anemic economy, there are a couple of specific reasons why EPAX’s foreign travel programs saw enrollment declines this year.

For one, travel costs remained high even though the economy was slowing.  That’s because fuel prices stayed elevated due to unrest in the Middle East.  But now, fuel prices have dropped significantly… and travel prices are finally coming down.

What’s more, Japan’s earthquake and subsequent nuclear crisis, along with the Middle Eastern crisis, severely cut into travel to those destinations.  Those situations are mostly behind us now.

Between lower travel costs and more stable global conditions, EPAX could see a demand spike in coming months.

Now let’s take a closer look at the financials…


EPAX’s strength is clearly their balance sheet.  I’ll get back to that in a minute, first let’s take a look at revenues and income.

As you might expect, revenues and profits have suffered somewhat due to challenging economic conditions.  Second quarter revenues dropped 6.7% year over year, while profits declined 11.5% over the same period.  The declines were entirely due to a 1% decrease in traveling delegates.

But here’s the good part…

EPAX’s balance sheet is rock solid.

The company is sitting on a cash hoard of $90 million.  And, they have zero debt. Plus, EPAX is generating nearly $8 million a year in operating cash.  No wonder they can offer a dividend and buy back shares!

And get this…

The $90 million in cash equates to roughly $5.08 of cash per share.  As of this writing, EPAX shares are trading for a mere $5.53.  So the market thinks the rest of the company, including their future growth prospects, should be valued at $0.45 a share?

Something’s amiss here.

Clearly, EPAX is extremely undervalued.

More on the valuation after we cover the investment risks…


As with any investment, EPAX has a few risks.

A more severe global economic slowdown could reduce overall demand for EPAX’s programs.  Lower demand could lead to smaller revenues.

Another risk is a big jump in fuel prices.  Higher travel costs could dissuade some customers from traveling to foreign destinations.

And, if additional global political turmoil occurs, it could also deter potential customers from traveling abroad.


There’s a lot to like about EPAX.  In a period of extreme market volatility and downside risk, it’s great to see the company buying back shares and issuing a dividend.

But the stock isn’t just a good play for risk averse investors.  There’s also growth potential in the picture.  And more importantly, the company is trading at dirt cheap valuations.

Earlier, I talked about the huge portion of the share price made up by the cash position… and how the market is discounting future growth to almost nothing.  What’s so mind-boggling is analysts project EPAX to grow by over 51% next year, and 12.5% per year over the next five years.

Yet, the shares are trading at a very low 11.8x projected earnings.  That’s a low multiple in any industry.

What’s more, the shares are nearly 54% off their 52-week highs, but just 1% above their lows.  Now that’s a low risk entry point if we ever saw one.

Now’s the time to grab this undervalued, dividend paying company at a highly discounted price.

Based on our analysis, we see the stock trading up to at least $11.00.  Grab your shares of EPAX now for potential gains of 99%!


BUY Ambassadors Group (NASDAQ: EPAX) up to $6.10 per share.

Recent price is $5.53.

Use a stop-loss of $4.50 on this position.

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



It’s been a challenging couple of months in the stock market.  Volatility is through the roof.  And share prices have dropped sharply.

What’s going on?

Investors are worried about the ongoing financial crisis in Greece and its potential to spread to other European countries.  Plus, recent economic data is suggesting the US might be slipping back into recession.

As a result, investors have been stampeding out of riskier assets like stocks and commodities for the perceived safety of Treasuries and the US Dollar.  I say “perceived” because low interest rates are actually producing negative real returns on these assets.

Nevertheless, it’s certainly a less than ideal environment for penny stocks.

In this type of market, it pays to focus on penny stocks with more defensive characteristics.  We prefer companies with a recession-proof business, strong brand recognition, and hefty cash flows.

Here’s why…

During periods of economic turmoil, consumers tend to cut back on spending.  They’d rather put money in the bank or use discretionary funds to pay down debt.  The few dollars they do spend are usually focused on buying necessities or cheap luxuries.

Companies that make these kinds of products typically hold up better during economic recessions.

What’s more, consumers are usually more focused during economic downturns on getting the best bang for their buck.  They tend to limit spending to good quality products.  Businesses with well-known brands and reputations for quality often hold up better in tough economic times.

Slower growth environments also tend to spur investor enthusiasm for companies with robust cash flows.  When times are tough, a company that generates cash has a big advantage over the competition.  They can use the funds to expand their business, grab market share, or create value for shareholders.

Now, don’t get me wrong, we’re not saying a European financial crisis is a done deal. European Union countries are working feverishly to prevent a full-blown crisis from happening.

And we’re not ready to forecast a recession for the US just yet.  Second quarter GDP growth was unexpectedly revised higher in recent weeks.  While the rate remains low, a positive number means the economy is growing.

However, given the warning signs, we think it prudent to add a more defensive penny stock to the portfolio.  And we’ve found one that meets our criteria to a tee.

The company is none other than… Krispy Kreme Doughnuts (NYSE: KKD).  I’m sure you’ve enjoyed their world famous doughnuts.  Now it’s time to enjoy solid returns by investing in the company’s stock.

Key Investment Data

Name:  Krispy Kreme Doughnuts
Ticker Symbol:  KKD
Market Cap:  $433 million
Recent Price:  $6.21

PSB Rating System 4.7 Stars

Raging Revenue:  (4.7 stars) Revenues are growing in the low double digits despite the weakening economy.  In fact, revenues are projected to grow in the low double digits to over $400 million in fiscal 2012.

Beautiful Books:  (4.8 stars) Fiscal 2011 was the company’s first profitable year since fiscal 2004.  The trend is expected to continue in fiscal 2012 with projected earnings growth of 82%.

Stellar Structure:  (4.8 stars) Insider ownership of 19% shows insiders love this company.  And with institutional ownership of just 32%, there’s plenty of room for smart money investors to drive these shares higher.

Valuation Verification:  (4.6 stars) Despite a positive outlook, the stock is nicely undervalued.  Based on our valuation analysis, we think the stock is worth at least $10.00 a share.  That’s upside potential of 61% or more.

Meaningful Milestones:  (4.8 stars) After six long years of under-performance, the company is back on track.  Fiscal 2011 marked the company’s first year of profitability since fiscal 2004.


Krispy Kreme is a leading retailer and wholesaler of high-quality doughnuts, complementary beverages, treats, and packaged sweets.  They have over 660 locations in 21 countries around the world.

The company’s main business, which began in 1937, is owning and franchising Krispy Kreme stores.  These stores offer 20 different kinds of doughnuts, including the Original Glazed doughnut, as well as a broad array of coffees and other beverages.

The 1990s and the first decade of the 21st century was a period of rapid growth for Krispy Kreme.  Stores were opening up all over the US and in several countries overseas.  Sales were through the roof at both company stores and franchisee locations.  And the company was experiencing robust earnings growth.

Due to the raging success of the Krispy Kreme brand, the company began buying back locations from domestic franchisees in 2003 and 2004.  But by late 2003, sales were starting to decline and many of the new stores became money losing ventures.

Because Krispy Kreme paid hefty premiums for these stores, earnings were impacted harshly by the slowdown.  In fact, the company was forced to close 240 domestic stores between 2004 and 2009.  As a result, revenues fell off a cliff and the company posted significant losses.

But management had an ace up their sleeve…

While the domestic business was suffering, the company greatly increased their international development.  Since the end of 2004, Krispy Kreme has added a whopping 396 new stores in 16 different countries.

Management sees huge growth potential in the international market.  The sky’s the limit on the number of stores they can open around the world.  Just think of the growth opportunity in big emerging markets like China, India, and Brazil.

In fact, existing franchise agreements provide for the development of over 150 stores outside the US in fiscal 2012 alone.

And now the domestic business is growing again.  For the first time since fiscal 2005, revenues from domestic customers and the total number of domestic stores each increased.  Let’s take a closer look now at the company’s financials.


Fiscal year 2011 (which ended in January 2011) marked the beginning of Krispy Kreme’s financial turnaround.  They reported their first year over year growth in sales and profits since fiscal 2004.

And the trend is continuing so far in fiscal 2012…

In the first quarter, the company reported double-digit top-line growth.  And they recorded their highest quarterly earnings since the fourth quarter of fiscal 2004.

The just ended second quarter produced more of the same.  Revenue jumped 11.4% to $98 million.  Net income quadrupled to $8.8 million.  And earnings soared 300% to $0.12 per share.

A terrific quarter all around… especially considering the challenges of higher agricultural commodity prices, extreme temperatures, and much higher gas prices.

Best of all, management reiterated their positive outlook for the year.  They’re forecasting net income to rise between 189% to 215%.  That’s about triple the prior fiscal year’s profits.

And analysts are climbing on the Krispy Kreme bandwagon as well…

They’re forecasting a 10.8% rise in revenue to just over $400 million.  Plus, they see earnings soaring by 82% to $0.31 per share.

Krispy Kreme’s balance sheet is also improving.

They’re sitting on a hefty cash position of over $32 million.  With total debt of just $27.7 million, the company’s debt to equity ratio is a comfortable 28.5%.  And liquidity is no problem with current assets 1.9x greater than current liabilities.

The best part is the business is generating healthy, positive cash flows.  Over the past 12 months, cash flows from operations are up to $27.8 million.

No question about it, Krispy Kreme’s financials are improving with every passing quarter.  This is great news as better financials will help drive the company’s stock price higher and higher.


Of course, every investment involves some risk and Krispy Kreme is no exception.

The company’s growth depends in part on opening new Krispy Kreme stores both internationally and domestically.  If the pace of new store openings slows, the company’s growth could be impacted.

Another risk is the potential for surging commodity prices.  High commodity prices drive up Krispy Kreme’s raw material costs and could eat into profits.

A third risk is the company’s dependence on off-premises sales for roughly half their revenue.  The loss of one or both of their top two customers could hurt the company’s growth.

Despite these risks, we believe Krispy Kreme is a terrific buy at current prices.  Keep reading for our complete analysis…


Krispy Kreme is in the early stages of a multi-year growth cycle.  After making several important adjustments over the past few years, the company’s positioned to generate higher revenue and profits for many quarters to come.

What’s more, the shares are now trading at a terrific discount.

KKD has pulled back along with the broad market averages in recent weeks.  In fact, the stock’s down 38% from the recent high of $10.08 per share.  This is a golden opportunity to grab our shares at bargain prices.

To see just how misvalued the shares are, all you need to do is look at their price relative to projected growth.  At a recent price of $6.21, KKD is trading at 20x the fiscal 2012 earnings estimate.  That’s higher than the market P/E, but it is well below the company’s projected annual growth rate of 50%.

In fact, at these levels, KKD is trading at a 54% discount to their projected growth rate. This is a huge discrepancy that will not stand as the macro outlook improves.

We have no doubt Krispy Kreme shares will trade up to retest their highs at the $10 level.  That’s a projected 61% gain from the recent price of $6.21.  And if the stock breaks through that resistance level, we’ll see even bigger gains.

And don’t forget, KKD should hold up well through the current market downturn.  The company runs a business that typically thrives in both good times and bad.  Let’s face it, people never stop eating doughnuts… and many eat even more of them during tough economic times.

Based on our analysis, we see Krispy Kreme stock trading up to at least $10.00. Grab your shares of KKD now for potential gains of 61%.


BUY Krispy Kreme Doughnuts (NYSE: KKD) up to $7.00 per share.

Recent price is $6.21.

Use a stop-loss of $3.10 on this position.

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


Portfolio Update

  • Clearly, it’s been a tough market.  Broad based selling has pushed many of our positions in the wrong direction.  However, there’s no reason to panic… or sell when the market is down.  We still believe in the companies we’re holding.  Once the macro fears have subsided, our portfolio will be fine.  Hang on – things will get better soon.


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