PSB Portfolio Update July 2010

| July 20, 2010

July 20, 2010

Weak Economic Data Trumps Good Earnings

Going into earnings season, I was optimistic earnings would get the market trending higher again.  I was expecting companies to report very strong second quarter numbers.  And I believed many bellwether firms would provide strong outlooks for the second half.

We got off to a strong start.

Companies like Alcoa (AA), Intel (INTC), and JPMorgan Chase (JPM) all posted big upside surprises.  In fact, 75% of companies reporting as of last Friday had beaten analysts’ estimates.

So, why is the market moving lower?

I think investors are worrying about the recent slew of weak economic data.  GDP estimates are being revised lower.  New home construction levels are anemic.  June retail sales missed estimates.  Manufacturing levels are sinking.  And consumer sentiment is falling sharply.

And that’s just in the U.S.

Don’t forget other areas of the world are also showing signs of slower economic growth. Many believe Europe is sliding into a double dip recession.  China’s slight cooling off is being viewed (inaccurately in my opinion) as the beginning of a recession.

Investors around the world are very skittish right now.

In this type of environment, weak economic data trumps good earnings.

This is making it very difficult for penny stocks.  When investors are worried, they move money out of higher risk investments.  That includes penny stocks.  As a result, we’re seeing most of our stocks moving sideways or down.

I don’t think this is the beginning of a bear market.  It’s more likely were experiencing a cyclical correction after the huge rally off the March 2009 lows.

The big question is what do we do?

We need to remain patient and stick to our trading discipline.  There’s no need to panic and sell out of every position.  If we do that, we’ll miss the next upward move.

We have good quality penny stocks.  When the market starts moving higher again, our penny stocks should make some big gains in a hurry.

Now, let’s take a look at the position updates…

Position Updates

Please Note:  We don’t necessarily update every open position each month.  We focus on the positions experiencing significant news, notable price movement, or a change in recommendation.  Please refer to the Performance page on our website for our current buy, sell, or hold recommendation for any positions not mentioned in the Update.

. . . . China Pharma Holdings (AMEX: CPHI) – Sell

It’s time to exit our position in CPHI.

The company’s earnings growth is slowing down.  Earnings estimates are heading lower. And, we’re not hearing anything about new products being launched.

With the shares rallying in recent days, I see this as a good opportunity to close this position with a nice gain.  Sell your shares of CPHI and book profits of 25% or more!

. . . . OMNOVA Solutions (NYSE: OMN) – Hold

OMN traded up to a new high of $8.69.  That gave us a nice 23% gain.  Strong second quarter earnings propelled the shares higher.

Here’s a quick recap…

Revenue jumped 40% year over year to $65.1 million.  Strong demand for chemicals and higher prices drove the increase.

Net income soared 196% to $15.1 million.  Earnings nearly tripled to a record $0.33 per share.  And earnings blew away analysts’ estimates.

The company is clearly reaping the benefits of last year’s restructuring.  They’ve introduced new products, penetrated new markets, increased productivity, and aggressively cut costs.

The outlook going forward is getting better and better…

Analysts recently raised earnings estimates by quite a bit.  They’re now expecting $1.01 for 2010.  That’s 20% higher than just 30 days ago!

This is great for us.

Upside earnings surprises and rising estimates usually drive shares higher.  We should see OMN move higher in the months ahead.  Continue holding OMN for greater gains.

. . . . Information Services Group (NASDAQ: III) – Buy up to $2.28

We got off to a good start with our most recent pick.  III shot up to a high of $2.29right off the bat.  That gave us a nice 16% gain in just our first two weeks.

Now the shares are pulling back with the market.  But I don’t expect this downturn to last very long.  If III can deliver on analysts’ high growth estimates, the shares should provide big gains over the next year.

If you haven’t bought III yet, you still have an opportunity to grab your shares at a nice discount.  III is a buy up to $2.28 per share.

. . . . SMART Modular Technologies (NASDAQ: SMOD) – Buy up to $6.88

We were looking for strong third quarter earnings.  And we got them.  The strong results sent SMOD to a new high of $7.22.  That gave us a terrific 18% gain.

Here’s a quick earnings recap…

Revenue surged to just over $201 million.  That’s an increase of 26% over the second quarter.  And it’s a whopping 120% increase year over year.

Rising sales are a good sign demand for SMOD’s products is still growing.

Earnings were very strong at $17.3 million or $0.26 per share.  That’s a 13% jump over the second quarter and a 2,200% increase over last year’s quarter.  Enhanced operating efficiencies helped drive these outstanding profits.

More importantly, both revenue and earnings crushed analysts’ estimates.  Analysts were expecting revenue of $180 million and earnings of $0.18 per share.  By beating estimates, SMOD has shown business is recovering faster than anyone expected.

But, here’s the best part…

Management provided a very strong outlook for the fourth quarter.

They’re expecting revenue of $200 to $210 million.  And they’re forecasting earnings of $0.22 to $0.24 per share.  Both estimates were much higher than analysts’ projections.

As a result, analysts are jacking up their earnings estimates.  They’re now expecting $0.81 for 2010 and $0.93 for 2011… increases of 29% and 19% respectively.

This is great for us.

Remember, nothing drives a stock price up like positive earnings surprises and rising estimates.  SMOD will inevitably climb to a price in these higher expectations.

Right now, SMOD is trading at a discount to our buy price.  Grab your shares now while they’re significantly misvalued.  SMOD is a buy up to $6.88 a share.

. . . . GT Solar International (NASDAQ: SOLR) – Buy up to $6.00

SOLR is moving higher in a nice uptrend.  The shares are up about 20% since early June. Not too shabby.

What’s driving the stock higher?

An improved outlook for the solar industry.

Germany may not kill solar growth after all.  The country is still cutting solar subsidies… but by a smaller amount.  The revised cuts should impact industry growth less than many feared.

At the same time, solar demand is growing rapidly in other markets.  The Czech Republic, Italy, China, and the U.S. are all spending more on solar capacity.

As a result, IMS Research is forecasting solar capacity will increase a whopping 95% in 2010.

This all bodes very well for SOLR.

With solar demand strong and growing, solar companies need to increase production capacity.  This means they’re going to buy more manufacturing equipment from SOLR.  As a result, SOLR should see revenue and earnings surge higher in coming quarters.

SOLR is trading just below our buy up to price.  If you don’t own these shares, here’s your chance to grab them.  Buy SOLR up to $6.00 per share.

. . . . China Natural Gas (NASDAQ: CHNG) – Buy up to $8.00

Good things are happening at CHNG.

The company completed construction of their liquefied natural gas plant on schedule. It’s the only plant in Shaanxi province and one of the largest in China.  Management expects it to contribute significantly to revenue and earnings by the end of 2010.

In addition, CHNG purchased a compressed natural gas (CNG) compressor station in Hubei province.  This facility will support the company’s expansion into Hubei.  CHNG already has government approval to build CNG stations in the province.

Finally, Rodman & Renshaw has initiated coverage of CHNG with a market outperform rating.  This is great for us.  A positive rating should help attract investors to the shares.

CHNG has pulled back some since our last update.  If you don’t own the shares, you can pick them up now at a nice discount.  CHNG is a buy up to $8.00 per share.

. . . . Kulicke & Soffa (NASDAQ: KLIC) – Buy up to $7.95

KLIC is providing another terrific buying opportunity.  Investors have sent the shares down 22% in just three days.  They’ve been selling KLIC because some orders were pushed out.

I think they’re overreacting.

Demand for semiconductors is growing rapidly.  Leading chip makers, Intel (INTC) andAdvanced Micro Devices (AMD) just reported very strong quarters.  They both beat analysts’ top and bottom line estimates.

And this is translating into strong demand for chip equipment.  Novellus Systems(NVLS) and ASML Holdings (ASML) both reported better than expected quarterly numbers.  And KLA Tencor (KLAC) just boosted their dividend by 66%.

As a result, revenue and earnings estimates for chip equipment makers are rising across the board.  This includes KLIC.  In just the past week, analysts have boosted estimates for both 2010 and 2011.

Despite the optimistic outlook, KLIC is trading at a huge discount.

At a recent price of $6.89, the shares are trading at just 4.2x the 2010 estimate of $1.65. That’s well below the industry average of 15x.  And it’s a huge discount to KLIC’s projected earnings growth rate of 14.7%.

If you don’t own KLIC, grab your shares now while they’re down.  The shares could rise going into earnings on August 5th.  And if the company provides strong guidance, the shares could jump on the results.

. . . . L&L Energy (NASDAQ: LLEN) – Hold

China is supposed to be slowing down.  But you wouldn’t know it by looking at LLEN’s numbers.  This amazing company is red hot.

Check out their record results for fiscal year 2010…

Revenue increased a whopping 166% to $109 million.  Strong organic growth and a slew of acquisitions boosted production capacity.

Net income was out of this world… tripling to $30 million.  And earnings soared 154% to $1.17 per share.  Now that’s what I call a fantastic year!

And LLEN is not expected to cool off much in 2011.

Management’s forecasting a revenue increase of 100% to $218 million.  And they’re expecting a 56% jump in earnings to $1.61.

For now, I’m sticking with my $16.00 price target.  That’s a very reasonable 10x the FY 2011 estimate.  And it offers potential upside of more than 66% from recent prices! Continue holding LLEN for greater gains.

. . . . China Marine Food Group (AMEX: CMFO) – Buy up to $5.00

CMFO shareholders got a big vote of confidence from an important source.  The company’s CEO, Pengfei Liu, recently bought 245,500 shares of CMFO on the open market. SEC documents show he paid between $3.91 and $4.34 a share.

That’s around $1 million in open market purchases!

Liu said he is “very confident in the long-term growth of [CMFO] and firmly believes that [CMFO’s] shares are always an excellent investment.”  And I believe him.  With over 40% ownership of CMFO, he’s certainly putting his money where his mouth is.

Liu also had other good reasons to buy more shares.

He thinks the seafood snack food business will grow 30% this year.  And he expects meaningful revenue and earnings contributions from the Hi-Power beverage.

Open market share purchases by insiders are often a good indication a stock is misvalued. Insiders usually buy their company’s shares at good discounts.

Moreover, the CEO’s purchases should help restore confidence in CMFO.

The shares had been declining due to scare tactics by short sellers.  They accused the company of defrauding shareholders by overpaying for the Hi-Power beverage business.  (I think the short sellers were just trying to profit by driving CMFO down.)

However, the CEO’s purchases appear to have put in a bottom.

As a result, I’m moving CMFO from a Hold to a Buy.  I’ve also lowered the buy up to price to $5.00.  These shares are very speculative and are appropriate only for investors with the most aggressive risk tolerance.

Action To Take

  • Sell China Pharma Holdings (AMEX: CPHI)
  • Move China Marine Food Group (AMEX: CMFO) from Hold to Buy

Category: PSB Portfolio Updates

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