PSB Portfolio Update May 2010

May 18, 2010

The Market’s Correcting… What To Do Now

It’s been a crazy month in the market to say the least.

The European debt crisis sparked the market correction we were expecting.  British Petroleum’s oil rig went up in flames leaving the worst environmental disaster in history. And we saw the biggest ever one-day point drop on the Dow… 1,000 points in 15 minutes (phew!).

Right now the debt crisis in Europe is exerting the biggest impact on the market.

Investors are worried about whether the European Union can survive the crisis.  This fear is leading many investors to pull money out of “higher risk” assets and move into “safe” assets like U.S. Treasuries.

As a result, we’re seeing money flow out of small cap stocks.  Small company stocks are considered to be higher risk assets.  This is causing weakness in small caps across the board.

It’s not clear how long this trend will last.

As I said last month, we need to stick to our discipline.  Our stock selection strategy by design gets us into higher quality penny stocks.  So, there’s no need to panic and sell everything.

And don’t forget to keep investing in the new recommendations.  With the market down, we have an opportunity to get into some stocks at bargain prices.

Now, let’s see how our positions are doing…

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

. . . . Health Grades (NASDAQ: HGRD) – Sell Half and Hold Half

HGRD is on fire.  The shares recently traded up to a new high of $7.89.  That gave usa big 82% gain.

The shares are soaring on strong first quarter 2010 earnings.

Revenue jumped 20% to $14.9 million.  Strong growth in the Internet Business Group drove the increase.  Net income increased 19% to $1.9 million.  And earnings surged 20% to $0.06 per share.

HealthGrades.com is continuing to drive the company’s growth.  During the quarter, unique visitors to the website jumped 38% to 57.4 million.  Remember, an increasing number of unique visitors means higher revenue and earnings for HGRD.

HGRD has hit our price target of $7.00.

Let’s go ahead and sell half the position for gains of 60% or more!  But hang on to the remaining shares for potentially bigger profits.

I’m raising the price target to $9.00, or 23x the 2011 estimate of $0.39 per share.  Given the strong growth at HGRD, I can see the market giving the shares a P/E closer to the long term growth rate of 25%.

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

Get ready for huge gains in LLEN.  These shares are poised for a major upward move this year. How come?

The company’s growing like wildfire.

Fiscal year 2010 (ending in April) results are now expected to exceed recent guidance. Management says revenue will top their already lofty target of $108.1 million.

Here’s why.

Coal prices in China have surged to $115 per ton.  And demand for coal in China continues to outstrip supply.

But that’s not all…

Management has also issued extremely positive guidance for fiscal year 2011.

They’re forecasting revenue growth of 102% to $218 million.  They’re expecting net income to jump 66% to $47 million.  And they’re calling for earnings to surge 41% to $1.33 per share.

Based on this outlook, we’re moving our price target up to $16.00 or 12x the 2011 estimate.  From LLEN’s recent price of $9.94, that’s potential upside of over 60%! Continue holding LLEN for greater gains.

. . . . LJ International (NASDAQ: JADE) – Buy up to $2.93

JADE is showing remarkable strength in a weak market.  The shares jumped on strong earnings and rallied to a high of $2.98.  That gave us a nice 12% gain in just our first week.

Here’s a quick recap of JADE’s first quarter 2010 earnings.

Revenue jumped 18% to $26.9 million.  A stabilizing global economy and pent-up demand within JADE’s Chinese middle-class clientele drove the revenue gain.

Sales at the company’s ENZO retail stores were very strong increasing 38% year over year.  And a smaller decline in wholesale revenue points to future growth in this important market.

More importantly, JADE had huge gains in profitability.

Net income increased from just $0.1 million a year ago to $1.9 million.  And earnings jumped from $0.01 to $0.07 a share.

The second quarter outlook is for more of the same.

Management’s expecting a 30% rise in revenue to $29 million.  And they’re forecasting net income of $1.9 million or $0.08 per share compared to $0.1 million or $0.01 per share a year ago.

I’m expecting the shares to move significantly higher from current levels.  Right now JADE is trading just below our buy up to price.  If you haven’t yet, grab your shares before they trade out of our buy range.

. . . . ZST Digital Networks (NASDAQ: ZSTN) – Buy up to $7.44

This pick from the May Issue is off to a slow start due to unfortunate timing.  We recommended ZSTN on the very day the market correction began.  The good news is you’re all getting into the shares at a nice discount.

Another positive is the company’s strong first quarter earnings.

A big increase in GPS tracking product sales nearly offset lower sales of IPTV set top boxes.  Although revenue fell by 4%, I’m not too concerned.  This is the company’s seasonally slowest quarter.

Despite lower sales, ZSTN reported a huge jump in profitability.  Net income surged 58% to $2 million.  And earnings increased by a penny to $0.17 a share.

Both revenue and net income exceeded management’s guidance for the quarter.

I see a couple of things driving growth going forward.

First, sales of the company’s new GPS products are growing rapidly.  These higher margin products are spurring nice increases in profitability.

Second, ZSTN’s new standard definition IPTV set top box opens up a huge new market. I’m expecting strong sales of this lower priced unit outside the larger cities in Henan province.

Take advantage of the market correction and grab your shares of ZSTN at a nice discount.  ZSTN remains a buy up to $7.44.

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

KLIC is pulling back with the broader market.  But this is just a temporary decline.  If you missed the shares earlier, here’s your chance to get in.

The company’s second quarter 2010 number show KLIC is still in high-growth mode.

Revenue surged 510% year over year and 20% over the first quarter’s figure.  Growth is clearly accelerating quarter by quarter.  And according to KLIC’s CEO, the company’s seeing “unprecedented demand” from customers across the board.

Earnings were great as well.

Net income increased 34% from the first quarter to $21.2 million.  And earnings jumped 33% to $0.28 per share.

Next quarter is looking even stronger.

Remember, management raised revenue guidance to $205 million.  That’s better than analyst estimates of $143 million.  And, it’s a whopping 34% increase over second quarter revenue.

With KLIC now trading below our buy up to price, we’re moving it from Hold to Buy.  Don’t miss your chance to grab shares of this fast growing chip equipment maker.

. . . . Winner Medical Group (NASDAQ: WWIN) – Buy up to $8.55

WWIN is moving higher on strong second quarter results.  The shares are up more than 21% off the late April low.  And the 200-day moving average is providing strong support.

Here’s a quick earnings recap.

Revenue jumped 26% to $26.1 million.  Surging sales in China of the company’s Winner brand medical products and PurCotton products drove the increase.  The company also saw improved sales in North and South America.

Higher sales drove huge growth in profitability.

Net income rose 63% to $2.7 million.  And earnings soared 71% to $0.12 per share.

Despite this strong growth, WWIN shares are significantly mispriced.

At a recent price of $6.50, the shares have a PEG ratio of just 0.22.  That’s a 78% discount to the company’s growth rate.

Don’t miss your chance to get into WWIN.  The shares offer huge growth potential over the next year.  Go ahead and buy them up to $8.55 a share.

. . . . SkyPeople Fruit Juice (NASDAQ: GFRE) – Buy up to $6.20

SPU has pulled back since our last update.  But the shares are now surging higher on record quarterly earnings.  SPU is up 18% from the May 7th lows.

Here’s a recap of their second quarter 2010 results.

Revenue increased a whopping 164% to $17.7 million.  A sharp recovery in overseas markets and continued strong growth in the Chinese market drove the increase.

Net income jumped 54% to $2 million.  And earnings soared 157% to $0.18 per share.

SPU is clearly building upon 2009’s record results.

With the shares now trading below our buy up to price, we’re moving SPU from Hold to Buy.  Go ahead and buy SPU up to $6.20 a share.

. . . . Taseko Mines (AMEX: TGB) – Hold

Big news out of TGB.

First, the company has secured 45% of the financing needed to develop the Prosperity Mine.  Best of all, they sold just 6% of the mine’s total gross metal revenue to get it.

Here’s a quick summary of the deal.

Franco-Nevada has agreed to purchase gold equal to 22% of the life of mine gold to be produced from Prosperity.  TGB will receive $350 million during mine construction.  And they’ll get an additional $400 for every ounce of gold delivered to Franco-Nevada.

This is a great deal for TGB.

Combined with cash on hand and expected cash flow from Gibraltar, the company has Prosperity 80% funded without any debt.

The other big news is strong first quarter 2010 earnings.

Operating profit soared 400% to $33.1 million.  A combination of greater production at Gibraltar, higher copper prices, and the unwinding of copper hedges drove results.

Things are looking very good at TGB.  However, the shares still don’t fully reflect the value of Prosperity.  We fully expect this to change as the company continues taking risk out of the project.  Continue holding TGB for greater gains.

. . . . China Marine Food Group (AMEX: CMFO) – Buy up to $7.50

CMFO reported strong first quarter 2010 earnings.

Revenue jumped 19% to $19.7 million.  Strong sales of the company’s seafood snack products drove the increase.  And the company got a strong contribution from sales of newly acquired “Hi-Power” beverages.

Management believes the company is on track to hit their revenue goal of $100 million by year’s end.

Net income jumped 40% to $4.5 million.  And earnings increased 29% to $0.18 per share. That beat analyst estimates by 28%!

Best of all, our fears over the company’s accounts receivable were put to rest. Accounts receivable declined a whopping 48% to just $9.7 million.  Clearly the company is having no trouble collecting payment from customers.

The outlook for the rest of the year remains strong.

Management reaffirmed their guidance.  They continue to expect $100 million in revenue and $21.5 million in net income.

Despite this strong growth and outlook, CMFO remains grossly mispriced.

At a recent price of $6.13, the stock’s trading at just 8.4x the 2010 estimate of $0.73 per share.  That’s a 76% discount to the company’s projected growth rate.

CMFO remains a buy all the way up to $7.50 per share.

. . . . Gulf Resources (NASDAQ: GFRE) – Hold

GFRE continues to knock the cover off the ball on a quarterly basis.  The company just reported solid first quarter earnings.

Revenue jumped 26% to $29.7 million.  Higher bromine prices and strong demand for the company’s environmentally friendly chemicals drove the increase.

Net income jumped 22% to $8 million.  But earnings were flat at $0.23 per share.  This was due to a larger number of shares outstanding in the latest quarter.

The outlook for the next couple of quarters is good.

Management expects bromine demand to continue exceeding supply and prices to remain firm.  They also expect to increase production levels now that the weather has improved.

Higher revenue and earnings should drive the share price higher going forward.  Continue holding GFRE for greater gains.

. . . . Ceva (NASDAQ: CEVA) – Hold

CEVA reported record first quarter 2010 results.

Revenue increased 11% to $10.6 million.  The company’s seeing strong growth in both licensing and royalty revenue.

Net income surged 51% to $2.1 million.  And earnings jumped 29% to $0.09 per share.

All in all, a great quarter.

CEVA continues to grow steadily quarter by quarter.  Continue holding for greater gains.

. . . . MFA Financial (NYSE: MFA) – Hold

MFA is continuing to navigate its way successfully through the volatile mortgage backed security market.  The company just reported another quarter of stellar growth.

Here’s a quick recap of their first quarter results.

Profits surged 56% to $80.6 million.  Higher net interest income and gains on the sale of mortgage backed securities drove the increase.  Earnings jumped 26% to $0.29 per share. And they beat analysts’ estimates handily.

Despite the strong quarter, the stock has been moving lower.

We think this is just a temporary situation.

You see the company said their second quarter results will be reduced temporarily.  Fannie Mae and Freddie Mac are planning on buying back a number of delinquent loans.  This activity will cause a temporary decline in MFA’s earnings.

However, the company expects earnings to rebound in the third quarter.  In the meantime, we continue to collect a hefty quarterly dividend.  Continue holding MFA for greater gains.

. . . . China Gengsheng Minerals (AMEX: CHGS) – Buy up to $2.60

CHGS is continuing to struggle.  The company has not yet seen the expected recovery in demand overseas.  And this has impacted another quarter’s results.

Here’s a quick recap of first quarter 2010 numbers.

Revenue declined 4% to $11.9 million.  A drop in exports of fracture proppants is mostly to blame.  Net income fell from $1 million to $0.4 million.  And earnings dropped from $0.03 to $0.02 per share.

Nevertheless, management is confident the global economic recovery will spur demand for the company’s products.  The company’s CEO recently said, “we expect that our primary target markets of steel, oil, and solar will rebound and are confident that we are well positioned to capitalize [on] the anticipated increase in market demand as growth resumes.”

We need to remain patient with this stock.  Let’s go ahead and give CHGS more time to develop.  With the drop in share price, we’re moving CHGS from Hold to Buy.

. . . . China Natural Gas (NASDAQ: CHNG) – Buy up to $11.00

CHNG is off to a slow start in 2010.  The company’s first quarter earnings came in below the year ago quarter’s numbers.  Higher operating expenses due to larger procurement costs are to blame.

The shares are down as a result.  However, I see this as just a temporary setback.

Management’s forecasting very strong growth for full year 2010.

They’re expecting a 20% to 25% surge in revenue to between $97.3 and $101.3 million. And they’re forecasting a 17% to 22% jump in net income to between $22 and $23 million.

Here’s why…

The company is continuing to add more CNG fueling stations (2 more added in the first quarter.)  And they’re signing up lots of new pipeline gas customers (12% increase in first quarter).  Remember, these two lines of business generate 80% of the company’s revenue.

More importantly, CHNG is poised to enter the lucrative LNG business.

Construction of the company’s new LNG facility is on track for completion by June 30th. When finished, the new facility will have production capacity of 500,000 cubic meters per day.  (That’s a whopping 150 million cubic meters annually!)

Completion of the LNG facility should be a big catalyst for the shares.

I see the current weakness in CHNG as a great buying opportunity.  Go ahead and buy CHNG all the way up to $11.00 per share.

Action To Take

• Sell Half of Health Grades (NASDAQ: HGRD) and Hold the rest
• Move Kulicke & Soffa (NASDAQ: KLIC) from Hold to Buy
• Move SkyPeople Fruit Juice (NASDAQ: SPU) from Hold to Buy
• Move China Gengsheng Minerals (AMEX: CHGS) from Hold to Buy

Category: PSB Portfolio Updates