David Fondrie from Heartland Advisors: A Glass-Half-Full Guy Looks at the Sequester and Economic Growth

David Fondrie is a Senior Vice President and Portfolio Manager for the Select Value Fund at Heartland Advisors in Milwaukee (www.heartlandfunds.com).   He joined Heartland in 1994 and subsequently served as Heartland’s Director of Equity Research for ten years from 2001 to 2011.  He also held the position of CEO of Heartland Funds from 2006 to 2012.  He’s a Badger from the University of Wisconsin and served with the armed forces in Korea.  He started his career with Price Waterhouse and is a CPA.  Our paths have crossed repeatedly over the years since we had interests in some of the same companies.  Like many Midwesterners, he is a plain-spoken man.

Dave Fondrie, Heartland Advisors Inc

Dave Fondrie, Heartland Advisors Inc

We had an opportunity to chat on March 1, the day the much-discussed government spending sequester went into effect, and I asked him what he thought would happen as a result.

DF:  The headline effect is likely to be worse than the real effect.  It’s not going to be as devastating as the articles in the press would have us believe.  There will no doubt be some pain inflicted on defense stocks, for instance.  But for the most part people have been expecting this to happen, so it is not a surprise, and it is built into the market.  There are too many green shoots in the economy now for something like the sequester to knock them all down.

JA:  Are you seeing it more like a speed bump than a brick wall?

DF: Yes, exactly.  I think Congress will get around to the budget and the cuts, adjusting them to what makes more sense.  If you look around at the United States economy right now, what is striking is what is going on in the oil and gas field.  Suddenly we are one of the lowest-cost energy producers and consumers in the world.  Not only does that have a direct effect on business, it is creating a new industry that is building out the infrastructure that will allow us to provide low-cost natural gas energy to industrial America.  This has put us in quite a positive situation.

We are paying $3.50 for natural gas, where Europe is paying $12.00 and Japan is paying  $16.00.  So to me that means that companies that rely on energy for their operations are much better off here than in other major developed economies around the world.  A steel forge, for instance or a company like Precision Castparts Corp (PCP), which use enormous amounts of energy in making parts, are a lot better off here than anywhere else.  Fertilizer plants.  The renaissance in chemicals here is extraordinary.  There are 12 new ammonia plants on the drawing boards, and they all will have a reliable and lowcost stream of natural gas as both energy and raw material.  We can use that ammonia domestically and stop importing it from other economies.

LNG.  There are a number of proposals for LNG plants.  These days we are talking about exporting LNG, where we never thought about anything but importing it in years gone by.  I think this low-cost energy source is underappreciated.  In fact it will spur the continued development of oil and gas, infrastructure, chemical plants, and other types of industrial expansion.   All of that is good for the economy.  Add to that some continued improvement in employment and housing, with home prices increasing, and we foresee stronger consumer confidence, especially as a result of higher home prices.  Already 401(k) values have been improving, and it is undeniable that we are in a low interest-rate environment as well.

All this headline talk about the sequester risk is overblown.  There is no doubt that federal spending and the size of the national debt have to be brought under control.  Entitlement plans have to be rationalized.  But add to the overall situation the fact that China is clearly recovering.  Chinese electrical usage is up, their industrial consumption of materials and energy is up, and as China grows, their growth is good for the other economies that feed her growth.  Europe is not likely to get any worse.

We’re looking for 2.5% to 3% GDP growth in 2013.  The stock markets continue to be reasonably valued.  Corporate balance sheets are good; earnings are good and continuing to improve modestly.  The S&P 500 is trading at 14 times earnings, where in the past it has traded at an average of 16 times earnings.

The wild card is what happens with interest rates.  People have not yet abandoned bonds, but the inflows have receded after several years.  There have been outflows from the equity markets for five years.  Now we are seeing a trickle-back return to the equity markets.  Sadly there is a pattern that is repeating itself, with many buyers entering at the midpoint of an equity run, not at the beginning.  But this is the way cycles go.  We are in the 4th or 5th inning if you take a long view of this bull market over the last three years.

JA:  So are you buying energy companies?

DF:  Not particularly.  Low energy prices are not particularly favorable for exploration and production companies.  But we are looking closely and buying companies that supply goods and services to the energy patch.  For the last two or three years, for instance, it has been apparent that there will have to continue to be huge investments in the energy patch.  If you are drilling in North Dakota, you may have no infrastructure to bring the liquids you are pumping to the refineries, which all tend to be downriver by quite a distance.  We have huge backups in Oklahoma because there is not enough pipeline to carry all the energy.  One company we have owned for 2 to 3 years is Mas Tec Inc (MTZ).  We bought it in the 12s and it closed Friday at $30.78.  Part of their business is in pipelines, and they have also done well at the gathering systems in areas where energy is being produced at the wellhead.  Those are both high-growth areas; the stock was trading cheap two years ago, and it has given us a reward.  Quanta Services Inc (PWR) is very much the same story – we used to own that stock as well, but we sold it when its valuation reached what we thought was a sensible level; in their case they are exposed to pipeline development and new high-voltage lines.

JA:  How about life sciences companies?

DF:  The FDA has been problematic as they have increased their oversight of the industry resulting in complex regulations and inspection observations (commonly called 483 observations).   We own Hospira Inc (HSP), which was a spinout a few years back from Abbott Laboratories  (ABT).  They have run awry of the FDA at a manufacturing facility in Rocky Mount, North Carolina.  In Hospira’s case, addressing the 483 observations and revising processes and procedures has resulted in over $300 million in costs and reduced output of drugs that are already in short supply.  We are all concerned with safety; however those concerns should be balanced with a sensible and timely regulatory process.

JA: Does that put a caution flag out?

DF:  I can’t speculate on what kinds of furloughs the FDA will have to put into effect.   I doubt that we will have chickens rotting on processing lines waiting for FDA inspectors as the press and certain congressional members have suggested, but the big issues around drug approvals will continue to be important, and is likely to be slowed down even further with the automatic budget cuts.  Hopefully they will prioritize their cutbacks and the expense reductions will have less impact than we might expect.  But government does not always work very efficiently.  We hope they will be smart and furlough the poor performers instead of just following  a LIFO pattern.

JA:  How do you feel about ObamaCare and stocks?

DF:  I do sense that there is a bit more thought being given to the impact of ObamaCare.  We just reviewed the 2014 Medicare Advantage benchmark payment rates by the Centers for Medicare and Medicaid Services (CMS), and the cuts were more draconian than expected.  But the government was clear that they are not trying to cripple the HMOs because they are a vital part of the new program.  I am a glass-half-full guy most of the time, and I think if people sit down and talk they can get to some reasonable results; let’s hope that happens.  There is always give-and-take with reimbursement rates, and they end up meeting someplace in the middle.  US businesses are resilient; once they know where the boundaries are, what the rules are, they adjust.  What happens is what you expect in a capitalist system: change comes quickly.  Capitalism works pretty well.

JA:  Where do you think people ought to be looking in the equity markets this year?

DF:  I am in the camp that says we will continue to have a modest economic recovery.  In that kind of environment you have to look at cyclical companies.  We are overweight in industrials and information technology companies.  Everyone is going to look at productivity, and technology is important there.  People will continue to invest in technology to improve productivity.  We are going to be hooking up all kinds of machines at home and in factories to the Internet.  We think tech plays work.  We might stay away from actual PCs, but mobility will continue to expand, and downloads will continue to grow, keeping  Internet growth robust.  Probably financials are good, due in large part to a stronger housing market.  We are a little more cautious on that because the interest rate environment does not allow much net interest rate gain to banks.  But housing will drive loan growth, and the banks have plenty of capital to lend.  With business loans at 3.5%, it is hard for banks to make money.  If we got an uptick of half a percent, it would do wonders.

In tech companies, we like Cisco Systems Inc (CSCO).  We see Cisco as a chief enabler of the infrastructure of the Internet.  Cloud computing is driving a lot of internet traffic.  Cisco is cheap at 12 times earnings, and there is that nice dividend yield of 3% too.  The balance sheet is pristine; altogether it is a very attractive risk-reward proposition.  I run a value-oriented multicap fund.  Cisco is seen as a growth stock, but right now it is also a value stock.  They have gotten their act together after some unwise acquisitions a few years back; we think the downside is minimal.

JA:  What about social media?

DF:  Social media doesn’t really fit our style.  Even Google is not in an area where we play.  Thematically I like agricultural plays like Archer Daniels Midland Company (ADM).  It is trading a bit above book value, and the dividend yield is 2.4%.  If we have a big corn crop, ADM is going to benefit from processing all that corn.  I believe we will have a big corn crop this year, and we need one.  ADM’s PE is under the S&P 500.  I can’t predict the weather, but we are getting moisture that we badly need in the Midwest, so the water table can support strong crops this year.  We’re looking at fertilizer companies, seed companies, and farm equipment (especially on a dip).  Railroads are a bit expensive right now, but it is worth noting that the number of rail cars carrying oil is growing at 25%, which makes those cars part of the infrastructure for moving energy.  Oil companies and refiners are buying those cars and the rails are moving them.  We’ll buy rails on dips too.

One final area that is more in the later innings is deepwater offshore.  We are particularly interested in drilling off the east and west coasts of Africa.  We like the companies that build out those platforms and subsea infrastructure to bring that oil to market.  We like the boat companies that service those rigs.  These are long-cycle investments; the big international oil companies don’t start-and-stop those projects.

JA:  What about shipping companies?

DF:  There may be too much capacity there.  OSG went bankrupt.  What has happened in the US is that we are importing less oil than we were five years ago, and the amount we are producing here has increased.  Our demand for oil from overseas has decreased.  So tanker ship demand has decreased as well.  If China starts to really boom again, that could absorb some of the excess capacity, but I don’t see that as near-term.

JA:  How about the greenback?

DF: The euro is at risk, but the dollar should hold its own.  If the Chinese let their currency float more that might affect the dollar, but for now the dollar is fine.

JA:  Is there an upside to the 2.5% to 3% GDP growth you mentioned?

DF:  Maybe in the back half.  If we resolve our government problems, that might restore more confidence.

JA:  Thanks, Dave.

Allen & Caron owns none of the stocks mentioned in this interview, and Joe Allen owns none of the stocks mentioned in his personal accounts.  Please do your own research.  JA

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Report: Investments in Smart Grid Technologies to Reach $200 Billion by 2015

New investments to so-called Smart Grid technologies to replace the current decades-old electrical grid technology will total $200 billion worldwide by 2015, according to a recent research report by Pike Research, a market research firm that specializes in global clean technology markets (http://www.pikeresearch.com/newsroom/smart-grid-investment-to-total-200-billion-worldwide-by-2015).  While smart meters are “the highest-profile component of the Smart Grid,” the investments will mostly go to “grid infrastructure projects including transmission upgrades, substation automation and distribution automation,” said Clink Wheelock, Pike’s managing director.

If accurate, that opens up a whole lot of potential revenue for a wide variety of companies large and small. Some of the bigs include Qualcomm, Duke Energy and JDS Uniphase, just to name a few. But several small caps are thriving in different niches of the market. Here are a few randomly chosen companies involved in this market.

Newton, MA-based Ambient Corporation (Nasdaq: AMBT, http://www.ambientcorp.com/) provides utilities with solutions for Smart Grid initiatives. It has designed a secure, flexible and scalable smart grid platform called the Ambient Smart Grid communications and applications platform. Ambient announced Oct. 4 that it was establishing a European subsidiary to focus on the “growing and vibrant” European market. AMBT has a market cap of $83 million and a 52-week trading range of $4-$9.75. It closed Oct. 9 at $4.89, down 11 cents on the day.

San Jose, CA-based Echelon Corporation (Nasdaq: ELON, http://www.echelon.com/) is an energy control networking company. Echelon technologies currently connect more than 35 million homes, 300,000 businesses and 100 million devices to the smart grid. ELON offers a wide variety of products focused on smart buildings, smart cities and the smart grid and it recently announced that two of its products were granted China State Grid approval. ELON’s market cap is currently $166 million and its 52-week trading range is $2.50-$7.43. It closed Oct. 9 at $3.88, down 5 cents on the day.

Irvine, CA-based Lantronix (Nasdaq: LTRX, http://www.lantronix.com/) makes products that make it possible to access and manage electronic products over the Internet or other networks. The company offers smart machine-to-machine connectivity solutions and other miscellaneous products that offer remote access, control and printing for data center, enterprise manufacturing, branch office and home applications. LTRX has a current market cap of $27 million and a 52-week trading range of $1.15-$3.40. It closed Oct. 9 at $1.82, down 12 cents for the day.

Calabasas, CA-based National Technical Systems * (Nasdaq: NTSC, http://www.nts.com/) is a diversified engineering services company, providing a wide range of testing and engineering services to the aerospace, defense, automotive, telecommunications and energy industries worldwide. NTSC now offers a comprehensive certification program for Smart Grid devices that includes areas identified by major utility companies as vital for new products in Smart Grid networks. NTSC’s market cap is now $86 million and its 52-week trading range is $4.02-$8.80. It closed Oct. 9 at $7.48, down 8 cents for the day.

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

Small Cap Stocks See Significant Opportunities in ‘Cloud Computing’

You may know that the term “cloud” as a synonym for the Internet is based on the use of a cloud as the symbol representing the Internet in flowcharts and diagrams. Services that are hosted on the “cloud” are hosted over the Internet.

In general, hosted services over the “cloud” come in three service categories: Infrastructure, Platform and Software .

Graphic courtesy of yokotechspace.blogspot.com

A cloud service has characteristics that differentiate it from traditional hosting: it is sold on demand at a given time and the service is fully managed by the provider (the consumer only needs a personal computer and Internet access). A cloud can be kept private for a select group of users or made public for as many users as possible like Amazon (Nasdaq: AMZN) Web Services, http://aws.amazon.com/.

Cloud computing is at an early stage, with a fragmented group of providers large and small delivering a slew of cloud-based services, from full-blown applications to storage services to spam filtering. As companies and consumers take advantage of cloud computing technology, there will be significant growth opportunities for data center hardware and services along with demand for virtual services and storage solutions.

So let’s take a look at some small cap companies involved in cloud computing.

Chanhassen, MN-based Datalink Corp. (Nasdaq: DTLK, http://www.datalink.com) provides data center solutions and services to mid- and large-size companies in the United States. It engages in designing and supporting infrastructures, such as servers, storage, and networks.  DTLK has a $170 million market cap and trades about 140,000 shares a day. Its 52-week trading range is $6.11-$11.50. It closed June 29 at $9.55, up 31 cents for the day.

Alpharetta, GA-based MedAssets (Nasdaq: MDAS, http://www.medassets.com) provides technology-enabled products and services for hospitals, health systems and other providers  in the US. It operates in two segments, Spend and Clinical Resource Management, and Revenue Cycle Management.  MDAS has a $790 million market cap, trades about 500,000 shares per day and has a 52-week trading range of $8.52-$14.58. It closed June 29 at $13.45, up 21 cents for the day.

Chicago-based Accretive Health (NYSE: AH, http://www.accretivehealth.com) provides revenue cycle management services that helps hospitals and healthcare companies manage their revenue cycles, which encompass patient registration, insurance and benefit verification, medical treatment documentation and coding, etc. Its market cap is near $1 billion and trades more than 1 million shares a day. Its 52-week trading range is $7.75-$32.82. AH closed June 29 at $10.96. up 27 cents for the day.

San Diego, CA-based The Active Network (Nasdaq: ACTV, http://www.activenetwork.com) provides organization-based cloud computing applications services to business customers internationally. The company offers ActiveWorks, an organization-based cloud computing platform that transforms the way organizers record, track, manage, and share information regarding activities and events.  ACTV has a market cap of $900 million and, trades about 400,000 shares daily. Its 52 week trading range is $12-$20. It closed June 29 at $15.39, up 43 cents for the day.

San Diego, CA-based CommerceTel Corp. (OTC: MFON, http://www.commercetel.com) develops marketing solutions and platforms for mobile devices. It provides a suite of services and technologies that enables brands, enterprises, marketers, and content owners to communicate with consumers via their mobile phone.  MFON’s market cap is small, only about $13 million and it trades less than 10,000 shares daily.  The 52-week trading range is $0.27-$2. It closed June  29 at $0.59, no change for the day.

Sold! EBay Buys into Alternative Energy Fuel Cell Power

Fuel cells made headlines in the major financial publications this week with the announcement that eBay is planning to build a new data center in Utah powered by, yes, alternative energy fuel cells. The new eBay data center will use approximately 6 million watts of power generated on-site by fuel cells made by Sunnyvale, CA-based, privately-held Bloom Energy, according to the New York Times (http://www.nytimes.com/2012/06/21/technology/ebay-plans-data-center-that-will-use-alternative-energy.html?scp=1&sq=james%20glanz%20ebay&st=Search).

eBay logo courtesy of LiewCF.com

While the new center, which will also serve eBay’s payment service PayPal, will be hooked up to the electricity grid as a backup, the news is considered a major victory for alternative energy backers, fuel cell believers and the environmental industry in general which has long complained that Internet companies are too often relying on coal power to run their data centers.

The Times’s story notes that fuel cell arrays are being used by major corporations including AT&T, Kaiser Permanente and Wal-Mart but nothing of this scale. Nearly all comparable data centers now draw the majority of the power from the grid.

Bloom Energy’s version of fuel cells are “essentially large batteries whose charge is maintained by by the hydrocarbon energy contained in natural gas,” according to the Times. Since the price of natural gas has plummeted in recent years, fuel cells have become more economically competititve, the story notes. And since the charge in the Bloom Energy cells is maintained by chemical reactions, not combustion, important efficiencies are gained. Another advantage is the fuel cells generate energy on-site, meaning no energy is dissipated as it travels along transmission lines.

All great news for environmentalists, Bloom Energy and, hopefully, eBay. But does it translate to hope for the mostly struggling small cap fuel cell companies? Based on investor reaction to the news, there seemed to be little benefit, at least initially.

Lathan, NY-based Plug Power Inc. (Nasdaq: PLUG, http://www.plugpower.com/) manufactures fuel cell systems for industrial off-road markets and stationary power markets. The PLUG stock, which was as high as $9 in early 2011, has traded much lower in recent months. Its 52-week trading range is now $1.11-$2.71 and its market cap as of June 21 was about $44 million. Roth Capital cleantech analyst Phillip Shen initated coverage of PLUG a year ago with a buy and a price target of $4. PLUG stock closed June 21 at $1.12, down 2 cents for the day.

Danbury, CT-based FuelCell Energy Inc. (Nasdaq: FCEL, http://www.fuelcellenergy.com/) makes a variety of fuel cells and its stock trades actively, more than 2 million shares a day on average. But apparently its second quarter numbers showing revenues down 15 percent from a year ago has soured investors. Its 52-week trading range is $0.80 to $1.95 and it closed June 21 at $1.06, up 2 cents on the day.

British Columbia-based Ballard Power Systems (Nasdaq: BLDP, http://www.ballard.com/) manufactures and sells fuel cells and fuel cell materials for the automobile and other markets. News from Ballard included business partnerships with Brazilian and European bus companies. But the company this week announced a revision in 2012 revenue and adjusted EBITDA downward due in part to contract negotiaations with a Brazilian customer. The stock, which was a high as $2.42 in April 2011 has dropped in recent months. It closed June 21 at $1.12, down 5 cents. Average daily trading volume is now about 124,000 shares.

Ontario, Canada-based Hydrogenics Corp. (Nasdaq: HYGS, http://www.hydrogenics.com) designs, develops and manufactures hydrogen generation and fuel cell products based on water electrolysis technology and proton exchange membrane technology. HYGS recently announced a significant order for a “power to gas” project for energy storage in Germany. The 52-week trading range of HYGS is $4.47-$7.10 but the stock trades lightly, about 7,500 shares a day. Its market cap is about $38 million. HYGS closed June 21 at $5.85, down 42 cents for the day.

As the Storage Market Booms, So Does Potential for Small Cap Growth

Considering the moves to cloud computing, virtualization and the regular onslaught of information that gets pumped over the Internet by the second, it’s not hard to understand the growing need for data storage. Hence the headline in the recent NY Times Bits blog: “Data Explosion Lifts the Storage Market” (http://bits.blogs.nytimes.com/2011/09/09/data-explosion-lifts-the-storage-market/?scp=1&sq=emc%20howard%20elias&st=Search).

The article notes that sales of disk storage systems rose more than 10 percent in the second quarter, to $7.5 billion, according to International Data Corporation (IDC) reports. And it adds that the storage boom is an indicator that technology is working the way it should: “you get more for less.”

According to Bits, the most rapid growth is in the more technologically sophisticated storage systems “that can quickly shuttle data back and forth.” Virtualization software also requires “more capacity and more high-performing storage” so the demand just keeps on growing.

Predictably in big pubs like the NYT, the two big storage specialists, EMC and NetApp, grab the highlights and perhaps rightfully so since they are grabbing market share. But there are several small cap stocks toiling in the memory/storage arena that feed products into the datacenter industry that might benefit from the rapidly expanding growth in this sector.

Salt Lake City-based Fusion-io Inc. (NYSE: FIO, http://www.fusionio.com/) develops and sells storage memory platforms for data decentralization. The company’s platform enhances the processing capabilities within a datacenter by relocating process-critical or active data from centralized storage to the server where it is being processed. Despite signing up huge customers like Apple and Facebook in recent months, Auriga Securities analyst Kevin Hunt took the rare step earlier this month of initiating coverage with a Sell rating and a $16 price target (http://blogs.barrons.com/techtraderdaily/2011/09/07/fusion-io-slips-auriga-starts-at-sell-16-target/?mod=yahoobarrons) because he believes the stock is too expensive and cash flows don’t justify its current price, according to Barrons. FIO stock closed Sept. 14 at $20.40, down 48 cents on the day.

Santa Clara, CA-based Inphi Corporation (NYSE: IPHI, http://www.inphi.com/), among other things, creates high-speed analog semiconductor solutions for the communications and computing markets, including an interface between analog signals and digital information in high-performance systems such as data center servers. It was formerly known as TCom Communications. CEO Young Sohn formerly worked at Intel and is the former President of Agilent Technology’s semiconductor group, now known as Avago Technologies. IPHI stock sold for about $27 in February, but has been falling (like many small caps) throughout the summer. It closed at $9.69, up 24 cents, Sept. 14.

Irvine, CA-based Netlist Inc.* (Nasdaq: NLST, http://www.netlist.com/) designs, manufactures and sells intelligent memory subsystems for the datacenter server, high-performance computing and communications markets. One of its products, called HyperCloud Memory module, was designed to improve server utilization by improving performance in memory-intensive applications such as high-performance computer simulations, virtualization, and cloud computing applications. NLST announced Sept. 13 that HyperCloud has been qualified on GIGABYTE’s high density server motherboard. NLST stock closed Sept. 14 at $1.60, up 6 cents. Last October it traded for nearly $4.

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

When are 2 Googles Like a Cup of Tea?

Physicist Alex Wissner-Gross claims two Google-type searches combine to leave the same carbon footprint as boiling a cup of tea.  http://technology.timesonline.co.uk/tol.news/tech_and_web/article5489134.ece

This piece has piqued the technorati’s attention. One Google defender suggested that less frequent trips to the libary to look up information more than offsets his individual searches.  Another demands to examine his math.  Whatever the validity, it should remind us that Internet use gobbles up a huge amount of electricity.

Data centers consume more than 1.5% of US energy use each year.  US data centers’ energy use more than doubled from 2000 to 2006, when it reached $4.5 billion.  Under current conditions, that figure wil hit $7.4 billioin by 2011.

Cooling costs are a big part of running a data center.  The cost to cool a data center now exceeds the cost to lease the space for it.  For every dollar spend on new server hardware in 2007, more than 50 cents was spent on powering and cooling.  http://www.wwpi.com/top-stories/6493-getting-ahead-of-the-data-storage-energy-crisis-the-case-for-maid

Two small-cap firms that are addressing this issue are Netlist* (Nasdaq:NLST,  http://www.netlist.com/) and Amerigon (Nasdaq:ARGN, http://www.amerigon.com/).

Netlist develops high-density memory products for server applications.  Its low-voltage solutions offer substantial energy savings by significantly lowering power consumption and minimizing cooling costs.  Consider that a typical server memory system uses 25% of total system power and Netlist’s modules reduce memory power usage by 30% and 8% of overall server system power.

Amerigon provides spot cooling (and heating) by running electricity through a solid-state heat pump.  commercially successful in automobile seats, Amerigon and its BSST subsidiary are developing thermoelectric technology applications for larger spaces, such as data centers.  The energy saved by providing spot over ambient temperature control promises huge energy savings in a number of personal and industrial applications.