Tesla a Bright Spot in Still Dim, but Improving Electric Car Industry

Photo of Nissan Leaf S courtesy of evworld.com

Photo of Nissan Leaf S courtesy of evworld.com

Anyone watching the still slow but improving progress of the electric car industry may have seen the Bloomberg Businessweek story on the “Tale of Two Electric Car Makers: Tesla Soars, Fisker Flops” (http://www.businessweek.com/articles/2013-05-08/a-tale-of-two-electric-car-makers-tesla-soars-fisker-flops). Tesla Motors not only produced a profit in the first quarter, as advertized, but also increased its guidance on sales for the year, from 20,000 to 21,000 cars. TSLA revenues were up 83 percent year-over-year to $562 million and the stock is soaring (see below).

While the article outlines supply chain and battery issues and other “kinks in its processes” Tesla needs to iron out, their stock is soaring and the outlook looks good. The contrast was provided by Anaheim, CA-based Fisker Automotive, which is laying off employees and hiring bankruptcy consultants, the article reports. Another electric car maker, Los Angeles-based CODA Automotive, recently filed for bankruptcy protection and announced it was “focusing its business strategy on the growing energy storage market,” according to a company filing.

For more positive electric car news, the BBC posted an article this week on the Nissan Leaf (http://www.bbc.com/autos/story/20130509-leaf-charges-into-mid-life) as it “charges through mid-life.” The Leaf, billed as “the first truly global mass-produced electric vehicle,” now includes the Leaf S, a lower cost model “designed to lower the barrier of entry to EV ownership.” One of the cost cutting moves was to move its assembly line from Japan to another Nissan factory in Smyrna, TE.

The BBC put the Leaf through its paces and managed to get 75 miles from a full charge, right about in line with Nissan estimates. Competitors mentioned in the article include the Toyota Prius PH-V and Ford C-Max Energi, both plug-in hybrids.

If anyone out there is charged up about the electric vehicle market, and knows of a small cap stock play in this market, please let us know. Meanwhile, we’ve been following a few small caps, plus Tesla to see how their stock is moving. We’ve also added a new company, Car Charging Group, to our list.

Palo Alto, CA-based Tesla Motors (Nasdaq: TSLA, http://www.teslamotors.com/) manufactures the Tesla Roadster, the Model S and other electric vehicles and electric powertrain  components. It’s way too large for our small cap blog focus, but just as a reference, the last time we looked at Tesla last February 20 it was trading at $38.90 with a market cap of $4.4 billion. As we mentioned, TSLA stock has been on a huge roll. It closed May 15 at $84.84, up $1.60 for the day. Its 52-week trading range is now $25.52-$97.12.

Santa Rosa, CA-based ZAP (OTC: ZAAP.OB, http://www.zapworld.com/) makes a variety of all-electric vehicles including trucks, motorcycles, shuttle buses and sedans and was formerly known as ZAPWORLD.COM. When we last checked on Feb. 20 its stock closed at $0.08 with a market cap of $24. ZAAP closed May 15 at $0.14, up 3 cents for the day, with a market cap of $42 million. Its 52-week trading range is $0.06-$0.27.

San Diego-based Maxwell Technologies Inc. (Nasdaq: MXWL, http://www.maxwell.com/) was formerly known as Maxwell Laboratories. The company manufactures ultracapacitors that are energy storage devices and power delivery systems for use in transportation, automotive, IT and industrial electronics.  MXWL closed back on Feb. 20 at $10.01 with a market cap of $292 million. It closed May 15 at $6.36, up 11 cents for the day, with a market cap of $185 million. Its 52-week trading range is now $4.90-$11.08.

Miami Beach-based Car Charging Group (OTCQB: CCGI, http://www.carcharging.com/) caught our eye with the announcement March 12 that it was acquiring EVPass, a company building destination charging networks for EV charging. CCGI  is also in the business of building charging station networks and has been busy making more acquisitions. Earlier this month, CCGI announced it had acquired 350Green LLC. CCGI closed May 15 at $1.34, up 4 cents for the day, with a market cap of $70.8 million. Its 52-week trading range is $0.60-$2.

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This Big, Bad, 949-Horsepower, Million Dollar-Monster Is a Hybrid

If you are a fan of electric and particularly hybrid vehicles, and more people apparently are every day, you have to like the spectacular news coming out of Ferrari and the recent report from Autodata Corp., a research firm.

Photo courtesy of automonthly.blogspot.pt

Photo courtesy of automonthly.blogspot.pt

Let’s start with Ferrari, which unveiled its La Ferrari supercar in Geneva in March. Yes, Ferrari’s “biggest and baddest” car these days is a hybrid, according to the Los Angeles Times (http://www.latimes.com/business/autos/la-fi-hy-autos-hybrid-20130330,0,2070748.story). It’s a V-12, “949-horsepower, million-dollar monster” that also has two electric motors and recharges its batteries with regenerative braking and the engine’s excess torque.

Who knows how many La Ferraris will actually sell, but the good news from Autodata is that hybrids are certainly selling faster than ever. Hybrid sales in the first two months of 2013 are up 32 percent over the same period last year, according to the Times report.

While overall marketshare is still low, about 4 percent, the fact that Ferrari is now in the hybrid market underscores the fact that that hybrid technology “is being taken seriously by virtually all the automakers,” noted analysts in the Times, including Nissan which introduced a new hybrid version of the Pathfinder at the New York Auto Show in February after dropping out of the hybrid market a few years ago. Overall, hybrids deliver 40 percent better fuel economy than conventional gasoline-powered cousins of the same model.

As we have noted earlier, the Prius is now the best-selling car in California, the nation’s largest auto market, and they’re apparently reliable. Not only are they now being used as taxicabs, which take a notorious beating, but the Times story notes that Toyota reports that 90 percent of all Prius cars it sold since introducing the model are still on the road. 

The story includes a note that one large Houston Ford dealership reports that its sales of hybrids are up 400 percent from a year ago. Nationally, Ford reports it’s selling 3,000-4,000 of its C-Max hatchback hybrid, a direct competitor to the Prius V station wagon, according to the Times.

While Toyota’s hold on the hybrid market has dropped from 73 percent to 63 percent, thanks to competitors like Ford, the overall market size is much bigger, meaning “both automakers are sharing a bigger pie,” noted the Times.

Unfortunately, hybrid vehicles are difficult to link directly to small cap stocks. So we’ve taken some liberties and included companies like Tesla Motors, which makes electric vehicles and is a mid-cap, and Axion Power International, which makes a battery used in a hybrid 18-wheeler made by a private company called ePower.

Palo Alto, CA-based Tesla Motors (Nasdaq: TSLA, http://www.teslamotors.com/) manufactures the Tesla Roadster, the Model S and other electric vehicles and electric powertrain  components. The last time we looked at Tesla last on Feb. 20 it closed at $38.90 with a market cap of $4.4 billion. But it came out with promising news this week, saying car sales nearly doubled in the first quarter of 2013 compared to the fourth quarter, and expects to turn a profit. TSLA closed April 2 at $44.34, up 41 cents, with a market cap of $5.1 billion. Its 52-week range is now $25.52-$46.68.

New Castle, PA-based Axion Power International (OTC: AXPW, http://www.axionpower.com/) has developed a specialty PbC battery technology designed for micro- and mild-hybrids, as well as an advanced energy storage device. A private Pennsylvania-based company, ePower, is developing 18-wheeler hybrid trucks with the Axion PbC batteries. Axion closed April 2 at 26 cents, down 1 cent for othe day, with a market cap of $30 million. Its 52-week trading range is $0.20-$0.47.

Santa Rosa, CA-based ZAP (OTC: ZAAP.OB, http://www.zapworld.com/) makes a variety of all-electric vehicles including trucks, motorcycles, shuttle buses and sedans and was formerly known as ZAPWORLD.COM. Most of its business at this point is with government or military customers. When we last checked on Feb. 20 its stock closed at $0.08 with a market cap of $24 million. It closed April 2 at $0.17, up 2 cents on the day with a market cap of $51 million. Its 52-week trading range is $0.06-$0.27.

San Diego-based Maxwell Technologies Inc. (Nasdaq: MXWL, http://www.maxwell.com/) was formerly known as Maxwell Laboratories. The company manufactures ultracapacitors that are energy storage devices and power delivery systems for use in transportation, automotive, IT and industrial electronics.  MXWL closed Feb. 20 at $10.01 with a market cap of $292 million. It closed April 2 at $4.98, down 17 cents for the day, with a market cap of $145 million. Its 52-week trading range is $4.92-$18.33.

Does the ‘Car of the Future’ Have a Future? Tesla Says Yes

Does the “car of the future” have a future? That’s the question Time magazine asks as the end of its recent story on electric cars that ran under the headline “Electric-Vehicle Acid Test” (http://www.time.com/time/magazine/article/0,9171,2134523,00.html). While more and more battery-powered and hybrid vehicles are being introduced and prices continue to be slashed, sales continue to disappoint. Nonetheless, Cadillac, Fiat, Ford and Honda have announced that they will launch new all-electric vehicles this year.

Auto analysts say the biggest hurdle electric cars face is range, according to Time. Pure electric cars like the Nissan

Photo courtesy of Motortrend.com

Photo courtesy of Motortrend.com

Leaf list a range of about 80 miles before it needs a recharge, which can take hours. The Tesla Model S electric car boasts a range of 265 miles, although that’s currently the source of much debate, based on a kerfuffle kicked up by New York Times reporter John Broder’s test drive (http://www.nytimes.com/2013/02/10/automobiles/stalled-on-the-ev-highway.html?pagewanted=all&_r=0&pagewanted=print). When Broder reported that the Model S failed to live up to the range claims,  among other issues, Tesla founder Elon Musk took offense and offered other reporters a similar test drive to prove Broder was misleading readers and failed to fully recharge the batteries. Incidentally, Tesla reported its fourth quarter/year end results Feb. 20 and reconfirmed its guidance that 20,000 Model S vehicles will be sold this year and, in what was a new outlook, said the company will be profitable in the first quarter of 2013, not later in the year as they had guided investors earlier.

There’s little debate the fact that electric and hybrid vehicle prices are being slashed considerably. The lease price of the Nissan Leaf, which was about $449 per month in 2010, is now $139 monthly. Time reports that General Motors executives say the cost of next year’s Chevrolet Volt “will be thousands of dollars cheaper than last year’s.”

So how does a small cap investor play the electric and hybrid vehicle market? Here are a few randomly chosen options:

Palo Alto, CA-based Tesla Motors (Nasdaq: TSLA, http://www.teslamotors.com/) manufactures the Tesla Roadster, the Model S and other electric vehicles and electric powertrain  components. It’s too large for our focus, but just as a reference, the last time we looked at Tesla last September 19, 2012 it was trading at $31.05 with a  market cap of $3.3 billion. It closed Feb. 20 at $38.90, down $0.38 for the day with a market cap of $4.4 billion. Its 52-week trading range is now $25.52-$40.

Santa Rosa, CA-based ZAP (OTC: ZAAP.OB, http://www.zapworld.com/) makes a variety of all-electric vehicles including trucks, motorcycles, shuttle buses and sedans and was formerly known as ZAPWORLD.COM. Most of its business at this point is with government or military customers. Its stock, which traded for 20 cents last March 13, 2012 with a market cap of about $45 million, closed Feb. 20 at $0.08, no change on the day. Its market cap is now $24 million and 52-week trading range is $0.06-$0.21.

San Diego-based Maxwell Technologies Inc. (Nasdaq: MXWL, http://www.maxwell.com/) was formerly known as Maxwell Laboratories. The company manufactures ultracapacitors that are energy storage devices and power delivery systems for use in transportation, automotive, IT and industrial electronics.  MXWL closed back on March 13, 2012 at $18.69 with a market cap of $522 million. MXWL closed Feb. 20 at $10.01, down 48 cents for the day. Its market cap is now $292 million.

U.S. Division of Chinese Automotive Components Maker Outbids Others for A123

Photo of Wanxiang America courtesy of siteselection.com

Photo of Wanxiang America courtesy of siteselection.com

As a follow-up to our recent posts about the auction of the assets of bankrupt battery maker A123 systems, it was announced this week that Wanxiang America Corp, the U.S. arm of China-based Wanxiang Group Corp. was the winning bidder at $256.6 million. The deal must still be approved by the U.S. Bankruptcy Court, which supervised the auction, and the Committee on Foreign Investment in the U.S., a group overseen by U.S. Treasury that regularly reviews any sale that results in a foreign country or person gaining control of a U.S. business.

The hearing in the bankruptcy court was scheduled for Dec. 11.

If approved, Wanxiang would receive A123’s automotive battery business, grid energy storage division and other commercial business assets including U.S. facilites in Michigan, Massachusetts and Missouri. The government business previously owned by A123 is being sold to Navitas Systems, a company spun off from Sun Microsystems, for $2.25 million.

Johnson Controls, one of the bidders that lost out in the auction, told the Wall Street Journal that it is still interested in A123 if the regulators do not approve the deal with Wanxiang. Johnson Controls bid “about $250 million” for A123, according to the WSJ.

Wanxiang Group Corp. is the largest automotive components maker in China. A123 Systems has been the sole battery supplier for Anaheim, CA-based Fisker Automotive. Fisker has halted production of its $100,000 hybrid Karma because of a shortage of A123 lithium ion batteries.

Once Promising Battery Maker A123 Systems Now Focus of Controversial Auction

Many media eyes are watching the auction of bankrupt battery-maker A123 Systems, which is currently underway in Chicago. Bids were accepted starting December 6, but the auction apparently could run into next week before a buyer is announced because of the complexity of the deal.

Some of those watching, also including politicians and military leaders, have expressed concern that the A123 lithium ion battery technology, much of it funded by the U.S. government, could wind up in foreign hands, according to

Photo courtesy of AP

Photo courtesy of AP

the Chicago Tribune (http://www.latimes.com/business/la-fi-a123-auction-20121206,0,359683.story). The Tribune notes that A123, which was once called “one of the most promising U.S. innovators in the clean fuel auto industry,” was awarded a $250 million grant in 2009 and had drawn down about $132 million of it before bankruptcy.

While none of the companies has commented publicly since the bidding opened, four suitors, including one American company, have qualified to bid, according to the Tribune story and other reports: Milwaukee-based Johnson Controls (NYSE: JCI) is the American company and NEC Corp of Japan, Siemens AG of Germany and Wanxiang Group Corp of China (the largest automotive components maker in China) are the others. The Tribune notes that Johnson Controls bills itself as “one of the last standing American companies competing in and building this U.S. advanced battery industry.” (New Castle, PA-based Axion Power International, among some others, would argue with that statement. See below)

As we noted back in August, Wanxiang made a bid to buy A123 back and thought they had a solid agreement, according to the Tribune. But apparently, due to concerns politics would be problematic, A123 never agreed to make the deal.

Other companies are apparently interested in buying parts of A123, according to the Tribune, but no names have yet been made public.

There are a few small cap battery makers that could be considered peers of A123, although most of them are not in the lithium ion battery business. They include:

Newark, NY-based Ultralife Corp. (Nasdaq: ULBI, http://www.ultralifecorp.com/) designs, manufactures and offers services for power and communications systems, including rechargeable and non-rechargeable batteries as well as communications and electronic systems and accessories, and custom engineered systems. ULBI operates in two segments: Battery and Energy Products, and Communications Systems. The battery segment includes lithium 9-volt, cylindrical and various other non-rechargeable batteries, as well as rechargeable batteries. ULBI has a 52-week trading range of $2.39-$5.50 and a market cap of $46 million. It closed Dec. 7 at $2.62, down 8 cents on the day.

Salt Lake City-based Oak Ridge Micro-Energy Inc. (OTC: OKME) is a development stage company that licenses thin-film, solid state batteries for industrial, medical and government applications. The applications include wireless smart sensors, security cards, RFID tags, semiconductor memory chips and implantable medical devices. The thin-film lithium and lithium ion batteries are ideally suited for a variety of applications where a small power source is needed. OKME has a 52-week trading range of $0.06-$0.51 and a market cap of $20 million. It closed Dec. 7 at $0.20, down 3 cents for the day.

Carrollton, TX-based Universal Power Group (AMEX: UPG, http://www.upgi.com/) is a supplier and distributor of batteries and related power accessories. UPG sells, distributes and markets batteries and related power accessories under various brands and its own brands. Back in August, UPG’s market cap was $11 million and was trading for about $2.15. Its current 52-week trading range is $1.26-$2.35 but its stock has fallen. It closed Dec. 7 at $1.66, down 3 cents for the day. Its market cap is now $8.3 million.

New Castle, PA-based Axion Power International * (OTCBB: AXPW.OB, http://www.axionpower.com/) manufactures high-performance, low-cost lead-carbon (PbC) batteries for a variety of markets, including mild- and micro- hybrid vehicles, which may be the commonest form of hybrid in the US within a couple of years (and already the most common in Europe). AXPW announced in May that the U.S. Department of Energy had awarded it a $150,000 grant toward the commercialization of its PbC batteries for micro hybrids. PbC batteries are as easy to manufacture as the older lead-acid batteries, but they use activated carbon instead of half the lead and are lighter, 100% recyclable, have a higher charge acceptance and faster recharging rates, all ideal for the micro-hybrid and mild hybrid markets.  AXPW has a 52-week trading range of $0.20-$0.64. It closed Dec. 7 at $0.30, no change on the day.

*Denotes a client of Allen & Caron Inc., publisher of this blog.

Soaring Automobile Sales Attributed to Superstorm Sandy, Low Interest Rates

Soaring November automobile sales were all over the news this week. Honda, Nissan, Hyundai and BMW had their best November ever, according to the Los Angeles Times  (http://www.latimes.com/business/la-fi-autos-auto-sales-20121204,0,2696209.story). Volkswagen had its best November since 1973.

photo courtesy of www.boston.com

photo courtesy of http://www.boston.com

Overall, imports did better than domestic brands thanks largely to new products like the revamped Honda Accord and Nissan Pathfinder, according to the Times report. A total of 1.1 million vehicles were sold in the month, 15 percent more than a year ago. Fuel-efficient cars, hybrids and small SUVs were among the most popular vehicles and “for the first time since it started selling hybrids in the U.S. in 2000, Toyota had serious competition in the hybrid market,” the Times noted.  In only its second month of sales, Ford sold 5,000 of its new C-Max hybrid in November and 6,500 hybrids overall in the month.

Just how much to read into the sales totals is difficult to say, according to experts, because Superstorm Sandy was credited for bolstering the numbers. An estimated 250,000 vehicles were destroyed in the storm and the purchase of replacement vehicles probably skewed the monthly numbers. And, as we reported in October, low interest rates are also stimulating the auto market.

Over the long term, any increases in automobile sales should benefit small cap automobile industry-related stocks, which have been hit in recent years by the global slump in sales. Here are a few randomly chosen small caps:

Troy, MI-based Meritor Inc (NYSE: MTOR, http://www.meritor.com/) develops drivetrain mobility and braking solutions for trucks, trailers and specialty vehicles and aftermarkets in the transportation and industrial sectors. Its products are marketed globally under its Meritor brand or under the brands Euclid, Mascot, Trucktechnic and Gabriel, among others. In January 2012 Meritor sold its France-based axle operation to Renault. MTOR has a 52-week trading range of $3.83-$8.74 and a market cap of $427 million. It closed Dec. 4 at $4.42, up 11 cents on the day.

Detroit-based American Axle & Manufacturing Holdings (NYSE: AXL, http://www.aam.com/) designs and manufactures driveline and drivetrain systems and related components and chassis modules for light trucks, SUVs, passenger cars and commercial vehicles. The company’s products include axles, drive shafts, power transfer units, transfer cases, chassis and steering components, transmission parts and driveheads, among other products. AXL’s 52-week trading range is $7.93-$13.08 and its market cap is $765 million. It closed Dec. 4 at $10.22, up 10 cents for the day.

New York, NY-based Fuel Systems Solutions (Nasdaq: FSYS, http://www.fuelsystemssolutions.com/) designs and manufacturers alternative fuel components and systems for the transportation and industrial markets. Its components and systems control the flow and pressure of gaseous alternative fuels such as propane and natural gas used in internal combustion engines. The company operates in two divisions: IMPCO Operations and BRC Operations. In April 2011, IMPCO U.S. purchased NaturalDrive. FSYS’ 52-week trading range is $13.38-$29.41 and market cap is $294 million. FSYS closed Dec. 4 at $14.67, down 51 cents for the day.

Northville, MI-based Gentherm * (Nasdaq: THRM, http://www.gentherm.com/) is a global developer and marketer of thermal management technologies for a broad range of heating and cooling and temperature control applications. It’s also developing more efficient thermoelectric devices. THRM’s Climate Control Seat system, based on its proprietary thermoelectric technology, is being offered in more than 50 vehicles made by the world’s leading automobile manufacturers including Ford, General Motors, Nissan, Toyota, Kia/Hyundai, Land Rover and Jaguar, among others. THRM’s 52-week trading range is $10.06-$17.74. As recently as early October it was trading for more than$13. It closed Dec. 4 at $11.48, down 42 cents on the day. Market cap is $341 million.

Southfield, MI-based Federal-Mogul Corporation (Nasdaq: FDML, http://www.federalmogul.com/) is a global supplier of powertrain and safety technologies. Its customers are OEMs of automotive, light, medium and heavy-duty commercial vehicles, agricultural, marine, rail, aerospace, off-road and industrial applications as well as the worldwide aftermarket. It operates at 169 manufacturing, distribution and technical facilites. Last July Borg-Warner sold its spark plug business to FDML. Its 52-week trading range is $6.90-$17.97 and market cap is $706 million. FDML closed Dec. 4 at $7.14, down 15 cents for the day.

* Denotes client of Allen & Caron, publisher of this blog

Nick Galluccio on Economic Recovery Outlook for 2013, Equity Valuations, Sectors to Watch

Nicholas F. Galluccio is President and CEO of Teton Advisors, Inc. (www.tetonadv.com), based in Rye NY, which runs a family of listed mutual funds under the family name of TETON Westwood, and representing a range of investment strategies. Teton Advisors is itself listed under the ticker “TETAA.” It is affiliated with GAMCO Investors, Inc. (NYSE: “GBL”), a large and well-known diversified asset manager and financial services firm (www.gabelli.com).

Nick was a journalist early in his career, starting as a staff writer at FORBES, and moving into the financial services business as a semiconductor analyst at Lehman Brothers Kuhn Loeb. He and I first met during the 25 years he spent at Trust Company of the West, where he was Group Managing Director and headed smallcap value and midcap value funds. Seven years after TCW was acquired by Societe Generale, he joined Teton Advisors, and has built the platform to $1.2 billion in assets under management (AUM). Today he is at the helm of Teton, and runs the TETON Westwood SmallCap Equity Fund.

I asked Nick before the national election if we could talk after the election in broad strokes about the state of the economy, the vigor of the recovery, his outlook for 2013, and generally about which sectors he finds most promising going forward. He agreed, and we met shortly after Thanksgiving at his offices in Rye.

JA: To start off, I wonder if you have some thoughts you could share about the overall economy, the fiscal cliff or other issues, and what your crystal ball says about 2013.

NFG: We think the US economy will get stronger as we go through 2013. Capital spending was constrained during the extended campaign as business managers and investors put off spending until the outcome of the elections was known. And of course there was a long-running debate over the fiscal cliff. Now we believe that the pent-up need for capital expenditure, which had been delayed during the campaign, will begin to be implemented, which will have a positive effect on the economy.

We are seeing a recovery in housing, underscored not only by the builders themselves, but by good results from companies like Home Depot (NYSE: HD), which had strong comps up 4.3%, and Lowes (NYSE: LOW); both of those are riding at 52-week highs.

The tech sector has been impacted by slow spending by consumers and a slight inventory build throughout the supply chain, but we think that spending will be stronger in 2013. And we think that the Christmas season will show good retail sales comps this year, better than it has been in many years.

It’s important to recognize that the European economic situation has been a drag on the US economy, as consumption of US products by Euro-zone consumers dropped. We believe the biggest declines from the downturn in the European Community are now behind us, which may not be much of a plus, but it will be less of a minus or a drag on the economy.

Finally we are seeing a very accommodating Federal Reserve, with all signs pointing to QE3, which will actually expand the capacity of the Fed’s balance sheet. We’re speculating that Chairman Bernanke may be replaced by someone like Janet Yellen, current Vice Chair of the Fed and head of the San Francisco Fed. If she were to succeed Chairman Bernanke, we believe her leadership would continue to foster the accommodative monetary policy established over the past several years under Bernanke.

JA: Does that mean you see a strong recovery in 2013?

NFG: We believe we will see a somewhat stronger economy, with growth improving from sub-2% to better than 2%. That still represents a rather anemic economic outlook, which will change for the better when we get some major tax and entitlement reform, which would instill the confidence among business leaders necessary for them to jumpstart capital spending. And let’s not forget that the consumer needs to believe the country is on the right path. We need exemplary leadership from both our President and his Republican counterparts.

JA: Do you think Washington will come up with a solution for the fiscal cliff? Will they just kick the can down the road?

NFG: My gut says that they will do something this time. The Tea Party was partially discredited in the election, and that means that the extreme right wing of the Republican party may lose some clout, with the likelihood being that the Republicans will regroup right of center. It behooves the Republicans to work out a compromise with the Democrats. On the other hand, Obama only won by a margin of 2.4% of the popular vote, not what you’d call a mandate. He wants to leave behind a legacy, and will move from far left to just left of center, in order to get things done. He has to make some changes, and I believe he will. He hasn’t shown the kind of leadership that Clinton and even Bush did. If he wants to leave a legacy in four years, he is going to have to cross the aisle toward compromise.

JA: And Grover Norquist and the tax pledge?

NFG: Outdated.

JA: What is it going to do to the market?

NFG: We have been in a bull market since the bottom in about March of 2009, Since then the market is up over 100%. We have had a correction since the election, and that correction has discounted a lot of the negatives. If we make any progress toward resolution of the fiscal cliff, we will enter the next phase of the  bull market in 2013. I believe we are in a secular bull market. It is ironic that as the market moves up on relatively low volume, retail investors have continually sold equities. Retail investors have had net redemptions every month of 2012, even with the market moving higher. Over the past five years, domestic equity mutual funds have had $500 billion of net redemptions. At some point the retail investor will come back to the market and money will start to move back into equities. That would be a driver of the next phase of the bull market.

For several years, money has been flowing out of the equities and into the bond market. Money keeps coming into fixed income, and at some point that will turn. As rates move up, investors at the lower rates will get burned, and many will move back to equities. Many fixed-income investors are actually losing money, adjusted for inflation. If rates were to move back above 2-1/2%, there would be many reasons to be bullish on equities. Overall sentiment among retail investors is still bearish, but valuations are very cheap, at decades-low levels. The S&P is selling at 14 times earnings and smallcaps are at 8 to 12 times earnings. Even though retail investors don’t yet have an interest in small caps, it is a great opportunity for contrarian-minded investors.

JA: Would this be a second leg of a bull market then?

NFG: Coming out of a recession, small caps usually lead the market higher. Small caps get sold down hardest in a downturn, and then they gain faster coming back out of a downturn. We believe that in 2013 we could have a credible strong fundamental underpinning to surge in small caps, because their valuations have fallen further than large caps. And when liquidity comes back into the market, it acts as a slingshot with small cap equities.

JA: What sectors would be the most interesting if that happened?

NFG: The hardest-hit sectors have been industrials and technology, because they are the most sensitive to economic changes. Likewise,  as car companies and auto parts companies had a good 2010 and 2011, inventories built up. After we exited 2011 we had a destocking of inventory, but now those inventories have come back into balance. With housing picking up, the economy will begin to restock in earnest, which will create the next leg up in the cycle. Stocks have already discounted a weakened economy, so valuations are very good for buyers.

In the industrial sector we like suppliers to the commercial aircraft industry. The global aircraft industry has designed more fuel-efficient planes, which the airlines badly need. The buyers, however, are both the aircraft leasing companies and the airlines, which have restructured over the last several years with some big bankruptcies. The backlogs of Boeing and Airbus show a growth in demand for many years. Remember that the international carriers are healthier. The order book is full, and no one wants to drop out of the queue because it is hard to get back in line. We own Woodward Inc (NYSE: WWD), Hexcel Corp (NYSE: HXL), Moog Inc (NYSE: MOG.A and MOG.B), Carpenter Technology (NYSE: CRS), and the smallest market cap of the group, AAR Corp (NYSE: AIR).

JA: Any other sectors?

NFG: Energy is very interesting, particularly oil and natural gas. We believe there is great promise in horizontal drilling, as well as in hydraulic fracturing, both of which will be essential to move the US to be the largest fossil fuel energy producer in the world by 2035. Fraccing may have problems state by state, but overall there is too much national need for it to get stopped. We believe it will go ahead in Ohio, Pennsylvania, upstate New York, Wyoming, Montana. In the energy space we own Patterson-UTI Energy (Nasdaq: PTEN), which is a major high-tech horizontal driller that is hired by energy majors and independents. On the E&P side, we own Energy XXI Ltd (Nasdaq: EXXI), which is a beneficiary of Exxon divesting energy assets in the Gulf of Mexico. We also own Approach Resources (Nasdaq: AREX), a natural gas exploration company with properties in the Permian Basin in West Texas. And we own Comstock Resources (NYSE: CRK), which has most of its assets in the Gulf of Mexico, Texas and Louisiana. We believe that natural gas will be the energy of the future.

JA: How about one more?

NFG: Financial services. We have about 14% of our portfolio in regional community banks that are primarily home and small-business lenders. Most of  the charge-offs in that industry have already been taken, so going forward the provisions will decline and the bottom lines will improve. We see a pickup in demand, both from small businesses and from homeowners. These banks will see profits from mortgage origination, mortgage servicing, and mortgage refinance, even if the mortgages themselves are securitized and sold to others. In addition, these smaller banks will be making car loans, home equity loans, and small business loans.

I read the FDIC reports, and a few quarters ago we saw the first pickup in several years in loan demand, although that pickup was rather small, in single digits.

In that area we like ViewPoint Financial (Nasdaq: VPFG), an over-capitalized Texas bank that has a balance sheet that needs to be converted to loan volume. We also own Washington Trust Bancorp (Nasdaq: WASH), a clean Rhode Island-based bank that has a significant trust department and an attractive lending franchise in the corridor including Connecticut and Massachusetts. We also own Oriental Financial Group (NYSE: OFG) which, in spite of its name, is the best-capitalized bank in Puerto Rico.

JA: So I take it you believe there will be a meaningful step taken on the fiscal cliff before Santa Claus gets here?

NFG: We think there will be a first step toward a solution before the end of the year, yes. Even so, investors are braced for the worst, which is reflected in their redemptions from equity funds, and the bears that caused the correction after the President was re-elected. Since then all indications are that both sides are willing to compromise.

JA: Many thanks for your time and for sharing these thoughts with us, Nick.

Editor: None of the companies mentioned in this interview is a client of Allen & Caron, the publisher of this blog.  We do not make recommendations with regard to investments; please do your own research.