PSB Portfolio Update March 2009

| March 17, 2009

March 17, 2009

To say the last month has been a difficult one for the market would be an under-statement.  At one point, the Russell 2000 was down 23% (31% for the year) to levels not seen since early 2003.  The bears were giving the bulls an old fashioned mauling 1929 style.  But, thanks to a five day rally, the small cap index is now down just 12% since our last update.

But don’t break out the champagne just yet.

It’s too early to tell if this is the beginning of a new bull market.  It could just be another head fake conjured up by those clever bears.  A trap to lure unsuspecting bulls back into the market before dropping the hammer for another painful leg down.

There’s still plenty wrong with our economy and financial system.

Unemployment is rising fast and will probably exceed 10% before the year is out. Manufacturing and industrial activity has all but ground to a halt.  Consumer spending is so low that American savings rates are actually rising (they’d been falling since 1980).  Home values continue to fall at a record pace.  And, GDP is declining at the fastest rate seen in more than 25 years.

As if that isn’t enough to worry about, our financial system is on life support.

The Federal Reserve and Congress are pumping trillions of dollars into the system to keep it going.  They’ve got the printing presses running 24/7 (when we get through this crisis we’ll have hyper-inflation to look forward to).  They’ve essentially taken over what used to be the world’s largest bank (Citigroup) and the world’s largest insurance company (AIG).  But they still haven’t figured out what to do about the $50 trillion of “toxic assets” on bank balance sheets.

But there are signs the market has begun the bottoming process.

Retail sales actually rose slightly in January and February if you take out auto sales figures.  This could mean consumers are starting to feel better about opening their wallets again.  Since consumer spending accounts for two-thirds of our economy, it is critical to any meaningful recovery.

Another sign is rising oil and copper prices.  These commodities are widely viewed as a barometer of economic activity.  Rising prices mean demand is increasing which means industrial production is beginning to expand.  (Even so, I still feel strange hoping for oil prices to move higher.)

And finally, consumer confidence may have finally reached desperation levels.  The Consumer Sentiment Index fell to the lowest level on record in February.  It’s a quirk of human psychology that extreme pessimism usually occurs just as the market bottoms.  If we’re not there yet, we must be pretty darn close.

In all likelihood, the market is in the midst of a months long bottoming process.  A deep market decline like this one doesn’t turn on a dime and move straight up.  It usually levels off and moves sideways in a tight range for a while.  Eventually a new bull market begins and we’re off to the races.

When you look at this bear market in the context of a full market cycle, we have a golden opportunity right now.  Good quality penny stocks are available at historically cheap prices.  We’ll have two more for you in the upcoming April issue.

Now on to the updates…

Position Updates

. . . .Hi Tech Pharmacal (HITK) – Buy up to $6.20

We’re off to a good start on this month’s recommendation.  HITK immediately went up 15% going into their earnings announcement.  And, they didn’t disappoint.  Revenue jumped 95% to $29.4 million thanks to heavy sales of new drugs launched in 2008. Earnings per share missed estimates by a penny but skyrocketed 228% to $0.18.  In case you missed it, HITK acquired ECR Pharmaceuticals and its branded prescription drugs for allergies, headaches, and poison ivy.  These drugs generated revenue of $13.2 million in 2008.  HITK remains a buy under $6.20.

. . . .ChinaCast Education (CAST) – Buy up to $3.50

CAST moved lower leading up to its full year 2008 earnings announcement.  But, that trend is about to change.  The company reported strong growth and profitability for the year.  Revenue jumped 64% to $42 million and exceeded analysts’ estimates.  Net income catapulted 48% higher to $12 million.  Earnings per share rose 35% to $0.39 beating estimates by 11%.  Management also provided a strong outlook for 2009.  The shares are trading at a 12% discount to our entry price.  Buy CAST up to $3.50.

. . . .China Security & Surveillance Technology (CSR) – Buy up to $6.60

After a quick 13% pop, CSR moved lower heading into its fourth quarter and full year 2008 earnings release.  The company reported strong quarterly and annual growth, but earnings just missed analysts’ estimates for the quarter (by 2 cents) and the year (by a penny). The stock’s decline is a huge overreaction as estimates had been sharply revised higher all through 2008.  Management has confirmed 2009 guidance for revenue and earnings both of which are above analysts’ estimates.  These shares offer tremendous upside.  They’re trading at just 1.3x 2009 estimates and 1.1x 2010 estimates – incredibly cheap.  We still like CSR under $6.60.

. . . .GigaMedia (GIGM) – Buy up to $7.50

After rocketing 193% off the November lows, GIGM went through a much needed two week correction.  The shares are making a strong upward move again on the back of four consecutive higher closes.  Management announced fourth quarter earnings are in line with market expectations.  The company will report fourth quarter and full year 2008 financial results on Tuesday, March 31st.  We expect the shares to continue moving higher into the earnings release.  GIGM remains a buy under $7.50.

. . . .American Software (AMSWA) – Buy up to $5.88

Despite a very difficult economic environment, AMSWA recorded its 32nd consecutive quarter of profitability.  Unfortunately, they missed analysts’ estimates by a penny.  The good news is AMSWA is in strong financial position to ride out the economic recession. The company has $70 million in cash and no debt.  They also continue to provide shareholder value by buying back shares and paying a quarterly dividend ($0.09 per share payable May 29th).  AMSWA remains a buy under $5.88.

. . . .MFA Financial (MFA) – Buy up to $6.75

MFA is roughly flat since our last update.  But that’s okay.  Remember, we’re earning almost 15% on our money just by collecting the quarterly dividend.  The shares remain a buy under $6.75.

. . . .Alliance One International (AOI) – Buy up to $5.50

AOI is up almost 21% in the last month.  The shares are moving higher along with tobacco stocks in general.  Tobacco stocks are considered to be defensive during bad economic times.  At just 3x fiscal year 2009 earnings, AOI still offers strong upside potential.  Buy AOI under $5.50.

. . . .eResearch Technology (ERES) – Hold

ERES dropped sharply after the company missed revenue and earnings estimates for the fourth quarter and the year.  Management said the shortfalls were due to customers delaying their Thorough QT trials because of the economy.  But, here’s the key, they can only delay the trials for so long.  Remember, these trials have to be completed ultimately within a timetable set by government regulations.  Despite the negative surprise, ERES did have an outstanding 2008.  For the year, revenue jumped 35% to $133 million and earnings per share popped 65% to $0.48.  New bookings increased 35% to a record $187 million and order backlog rose 19% to $166 million.  As you might expect, management has provided conservative guidance for 2009.  We think lowered expectations give ERES an opportunity to produce upside surprises going forward.  And, upside surprises push the stock price higher.

. . . .VAALCO Energy (EGY) – Hold

EGY is scheduled to report fourth quarter and full year 2008 earnings after we go to press. We will review the results in our next update.  The shares have been trending lower along with most oil producers.  The weak economy is keeping downward pressure on oil prices. Nevertheless, the shares are up 20% since we recommended them.  Although the shares are trading slightly below our buy up to price, we maintain our hold recommendation.  We’ll reevaluate the recommendation after we’ve had an opportunity to review the earnings report.

. . . .Questcor (QCOR) – Hold

We were looking for an upside surprise from QCOR and we got one.  They reported fourth quarter earnings of $0.24, beating estimates by 11 cents.  Full year earnings for 2008 were in line with estimates at $0.49 per share.  Unfortunately, the shares didn’t rally on the news.  We found out why the very next day.  The FDA has delayed approval of Acthar for treating infantile spasms.  They’re requiring QCOR to resubmit their application.  QCOR is down almost 35% since our last update as a result.

. . . .TETRA Technologies (TTI) – Sell at market

We’re pulling the plug on TTI following their disastrous fourth quarter.  The company’s financial position is in much worse shape than management led us to believe.  They reported a huge loss of $0.79 per share which missed reduced analyst estimates by a mile. The wider loss was due to asset write downs of $100 million.  The write downs were caused by lower oil prices and hurricane damage (risks management said were contained). The shares plunged on the news and triggered our stop loss.  Sell TTI at market.

. . . .SunOpta (STKL) – Sell at market

We’re giving STKL the boot due to poor earnings visibility.  The company reported record revenue of $1.1 billion and strong adjusted earnings of $0.21 per share for 2008.  However, if you take into account a hefty impairment to goodwill, the company actually lost $0.17 per share.  To make matters worse, management will not provide specific revenue and earnings guidance for 2009.  Not surprisingly, the shares have fallen hard and triggered our stop loss.  If you haven’t already, sell your shares of STKL.

. . . .Obagi Medical Products (OMPI) – Sell at market

OMPI fell off a cliff since our last update and triggered our stop loss.  The bad economy has taken a harsh toll on OMPI’s business.  Fourth quarter earnings dropped 50% and full year earnings fell 17%.  To make matters worse, the company provided weaker than expected guidance for the first quarter of 2009.  And, citing lack of visibility into economic trends, management will only provide guidance on a quarterly basis.  Given these crumbling fundamentals, we recommend you sell OMPI.

Action To Take

•  Sell TETRA Technologies (TTI)
•  Sell SunOpta (STKL)
•  Sell Obagi Medical Products (OMPI)

Category: PSB Portfolio Updates

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