PSB Portfolio Update May 2009

| May 19, 2009

May 19, 2009

IMPORTANT NOTE:  We sent out a Sell Alert by email on May 13th recommending you sell your shares of Primedia (PRM).  We wanted to capture our 356% gains on the position.  If you missed the email, you’ll find a summary of the sell recommendation in the Position Update section below.

The Rally Continues… For Now

In our last update, we said the fate of the market rally hinged on the bank stress tests.  It looks like we were right.  Investors viewed the results as net positive for the banks and are continuing to push the market higher.

The Dow’s rallied 28% off the low set in March.  The S&P 500 is up 32%.  And, small cap stocks are continuing their historic run.  The Russell 2000 is now a mind-boggling 49% higher.

But, the rally may be starting to lose steam.

Last week, all of the major market indexes went into full retreat.  The Russell 2000 posted its first weekly decline in ten weeks – it dropped 7%.

What happened?

Investors had been content to push stock prices higher on reports the economy is getting less bad.  Now, they’re starting to demand more.  They want to see signs the economy is actually starting to improve.

Last week’s action is a good example.  April retail sales fell more than expected.  And, weekly unemployment claims rose unexpectedly.  Many investors used the bad news as an opportunity to take profits.

If profit taking on disappointing news becomes the new trend, the markets will probably drift lower for a period of time.

It’s going to be tougher for the market to move significantly higher from here.  Investors will want to see signs corporate earnings are growing again.  Stock prices have probably risen as far as they can on relief the economy and financial system didn’t completely melt down.

The question is what will drive earnings higher?

In the past, it’s been spending by consumers.  Unfortunately, most consumers aren’t ready to open their wallets just yet.  They’re still concerned about job losses, falling home values, and smaller investment portfolios.

We’re probably going to see the market pause for a while until consumers are ready to spend again.  All eyes will be focused on unemployment reports, retail sales figures, and other consumer spending data for signs of the recovery.

Now on to the 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.

Position Updates

. . . . Primedia (PRM) – Sell

In case you missed our email alert, we’re recommending you sell Primedia.  We decided the time is right to book our 356% gains on the position.

The shares are pulling back after setting a new high over $4 a share (514% peak gain!). The company’s first quarter earnings were less than impressive.  And, we got a bearish crossover on the 5- and 20-day moving averages.

All signs point to a lower share price near term.  If you haven’t already, sell Primedia to lock in your substantial profits.  Congratulations on a great trade!

. . . . ChinaCast Education (CAST) – Hold

CAST is firing on all cylinders.  The shares hit a new high of $5.50 ahead of their first quarter earnings release.  (That’s a 96% gain for us.)  And, the company didn’t disappoint.

The Chinese for-profit education company reported a blow-out quarter.  Revenue jumped 33%.  Net income rocketed 146%.  And, earnings per share beat estimates by a penny.

After rallying 25% since our last update, the stock’s trading well above our buy up to price.  CAST remains a Hold at these levels.

. . . . Hi Tech Pharmacal (HITK) – Hold

HITK is continuing its upward climb along the 5-day moving average.  The shares hit anew high of $8.40 for a gain of 62%.  Hang on to this stock for greater gains.

. . . . Overhill Farms (OFI) – Buy up to $4.86

As we predicted, OFI’s pullback last month was just a temporary pause.  The shares are still moving higher in an upward trend along the 20-day moving average.

Going into earnings, the shares hit a new high of $5.29.  Good for a gain of more than 35%.  The stock’s stumbling a bit now after OFI’s weaker than expected results.

Not to worry though.

After a sluggish January and February, sales made a nice upturn in March.  Management believes revenue will normalize over the course of the year.  OFI remains a buy at $4.86 or lower.

. . . . GigaMedia (GIGM) – Hold

GIGM is drifting lower since management provided its cautious outlook for the first quarter of 2009.

Management expects strong revenue growth in Asian Online Games (+30%) to offset weakness in Online Gaming Software (-10%).  And, they’re implementing cost cutting measures to protect profitability.  We’ll get a look at their progress when earnings come out later today.

In other news, the company’s Chairman, Daniel Wu, resigned for personal and family obligations.  Board member, Michael Ding, is replacing Wu as Chairman.  Ding looks like a worthy successor having led several prominent finance and investment banking firms. We’re keeping GIGM at a Hold for now.

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

CSR is rising and falling like the nastiest roller coaster in the amusement park.  The stock rocketed up to a new high of $8.99 after the company’s first quarter earnings.  Amind-boggling 75% gain since our last update.

And, it’s easy to understand why.  Revenue jumped 34% year over year.  Adjusted earnings per share beat estimates by a penny.  And, management reaffirmed revenue and earnings projections for 2009.

The stock sold off sharply as investors took some hefty short-term profits.  Now, it’s rising again as investors find the extremely low valuation too tempting to resist.  We’re moving CSR from a Hold to a Buy now that it’s trading below our buy up to price.

. . . . China Information Security Technology (CPBY) – Buy up to $5.00

CPBY shot out of the gate.  The shares spiked up 42% in just four days.  The shares were rising in anticipation of a stellar earnings report.  Unfortunately, management threw a wet blanket on all the enthusiasm.

They reported China’s stimulus plan is hurting business rather than helping it.  Local governments are diverting funds from CPBY’s projects to fund other initiatives. Management revised 2009 revenue and earnings guidance lower as a result.

Nevertheless, we still think CPBY is a buy at these prices.  Earnings are expected to grow 12% this year and 14% next year.  Yet, the stock trades at a P/E of just 4.7x and a forward P/E of just 3.9x.  We see the stock doubling if not tripling from here.

. . . . CECO Environmental (CECE) – Buy up to $5.00

CECE is also off to a fast start.  The shares jumped 25% heading into earnings.  But, they gave it all back after CECE reported mixed first quarter results.

Net income swung from a loss last year to a profit that beat estimates.  But, revenue fell 15%.  As a result, analysts revised their quarterly and annual estimates slightly lower.

But, don’t despair.  We view these downward revisions as a good thing.  Lowered expectations increase the chances for upside surprises.  And, upside surprises drive big rallies in stocks.

Stay patient with this one.  Remember, CECE is a cyclical stock.  We need the economy to show signs of further recovery to really drive the shares higher.  It’s just a matter of time now.  Buy CECE all the way up to $5.00.

. . . . CEVA (CEVA) – Buy up to $9.00

We got the upside surprise we were expecting from CEVA.  Earnings of $0.07 per share beat estimates by a whopping 133%.  But, overall weakness in the semiconductor industry is keeping a lid on the stock.

The company is executing very well.  They signed nine new licensing agreements – four with leading companies.  And, improved efficiency led to record high operating margins. CEVA is in good position to rally when their customers’ end markets begin recovering.

. . . . VAALCO Energy (EGY) – Buy up to $5.25

EGY is moving lower after disappointing first quarter results.  The company posted a loss of $0.22 per share on a 50% decline in revenue.  Sharply lower oil prices and higher costs from two unsuccessful exploratory wells are to blame.

We think the stock will eventually move higher for two reasons.

First, production levels are rising.  The company added two new development wells in Ebouri.  And, they achieved a new production record for the Etame Marin block in April. The second reason is oil prices should rise substantially as the economy recovers.

Greater production and higher average selling prices will boost revenue and earnings down the road.  We think EGY offers huge upside potential from its recent price near the November low.  The shares remain a Buy at $5.25 or less.

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

MFA is up 17% after reporting strong first quarter results.  The company earned $51.6 million, or $0.23 per share, for a solid return on equity of 16%.  This is a terrific ROE, especially in a period of economic stress.

MFA should continue to generate a double digit ROE going forward.  Most of their portfolio is in higher yielding securities that carry a low risk of early prepayment.  And, MFA’s portfolio spread (the difference between the interest-earning asset portfolio and its cost of funds) is expanding nicely.

MFA’s balance sheet is also getting stronger.  The Fed’s program to buy $1.25 trillion of Agency MBS is boosting the value of MFA’s portfolio.  Debt to equity levels are declining. Liquidity is improving.  And, book value per share is rising.

All signs point to a higher stock price going forward.  (And, don’t forget about the 14% annual dividend yield.)  MFA is getting close to our buy up to price.  Establish a position soon if you haven’t already.

. . . . ERT (ERES) – Hold

As noted in our May Issue, we’ve moved ERES from a Buy to a Hold.  The company’s first quarter earnings met the company’s previously downward revised estimates.

But, business continues to worsen.

As a result, management guided 2009 revenue and earnings lower.  We want to hold on to our shares.  The business should recover quickly as the economy improves.

. . . . Questcor Pharmaceutical (QCOR) – Buy up to $6.50

QCOR gave us a scare last week when it dropped 12% in a single trading day.  The stock fell on news the FDA is requesting more data on QCOR’s drug for treating infantile spasms. The stock has since recovered to prior levels.

We think QCOR is a good buy at these depressed levels.

But remember, our investment thesis is based on QCOR getting FDA approval for the infantile spasm treatment.  If they don’t get it, the stock could drop substantially.  Of course, if they get approval, the stock should soar.

Action To Take

  • Move Primedia (PRM) from Hold to Sell
  • Move China Security & Surveillance Technology (CSR) from Hold to Buy


Category: PSB Portfolio Updates

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