LED: Looking alot Like Lighting’s Future

Our interest in small cap lighting companies was piqued this week with the announcement April

Photo courtesy of trinamao.en.busytrade.com

Photo courtesy of trinamao.en.busytrade.com

25 that New York-based ForceField Energy (OTCQQB: FNRG) had signed a letter of intent to acquire a 60 percent interest in 1-800 NY Bulbs.

The combination seems to make sense. During its 25 years of existence, Bulbs has more than 8,000 commercial clients, is an authorized dealer and distributor of GE Lighting Products and has projected about $5 million in revenue in 2013, according to the press release announcing the letter of intent. ForceField is focused on renewable energy, energy efficiency and LED (Light Emitting Diode) products.

LED lights are the latest in modern technology and energy efficiency, but have been slow to become the standard in households because of their price, according to Time magazine (http://business.time.com/2013/04/25/light-switch-why-youll-start-using-led-bulbs-this-year/). But the Time report suggests LED prices are coming down. Also, the Energy Independence and Security Act, passed in 2007, requires lightbulbs to become more energy efficient  and has led to the phasing out of standard 100-watt and 75-watt incandescent bulbs, with the 60-watt and 40-watt bulbs to follow.

So the day of the LED light could be near, as could be an intriguing jolt of energy to small cap lighting companies.

FNRG (http://www.forcefieldenergy.com) is a lightly-traded, $87 million market cap, pink sheet company with a 52-week trading range of $2.20-$5.64. It is also involved in transforming waste heat from manufacturing and other sources into electricity. It owns 51 percent of TransPacific Energy Inc. FNRG closed April 26 at $5.35, no change for the day.

Charlotte, NC-based Revolution Lighting Technologies (Nasdaq: RVLT, (http://www.nexxuslighting.com/) designs, manufactures and sells commercial grade LED replacement light bulbs and LED-based signage under the Array Lighting and Lumificient brands (Lumificient Corporation is a subsidiary). It was formerly called Nexxus Lighting and operates mainly in the global commercial, hospitality, institutional, retail and sign markets. RVLT closed April 29 at a 52-week high of $4.01, up 45 cents for the day with a market cap of $140 million. Its 52-week trading range is $0.11-$4.01.

Cincinnati-based LSI Industries (Nasdaq: LYTS, http://www.lsi-industries.com/) is a different take on an LED lighting company. LYTS creates LED video screens and LED specialty lighting for sports stadiums and arenas, digital billboards and entertainment companies. Its 52-week trading range is $5.81-$7.77. It closed April 29 at $7.09, up 18 cents for the day, with a market cap of $170 million.

Solon, OH-based Energy Focus Inc (OTC Pink: EFOI, http://www.energyfocusinc.com/) makes LED lighting products as well as products based fiber optic and other energy-efficient technologies. EFOI focuses on the government and public sector markets, as well as the general commercial and pool markets. Its 52-week trading range is $0.16-$0.40. It closed April 29 at $0.22, up 3 cents for the day, with a market cap of $8.4 million.

Is Outlook Sunny for Solar Stocks in 2013?

Photo courtesy of blog.heritage.org

Photo courtesy of blog.heritage.org

The big news for the solar industry this week came in a report from the Solar Energy Industries Association noting that “solar panel installations in the U.S. surged 76 percent in 2012.” That number was driven largely by growth in residential and commercial projects, and a boom in “larger, utility scale (solar) plants,” according to Investor’s Business Daily (http://news.investors.com/technology/031413-648050-solar-installations-up-but-forecast-slowing.htm?ven=yahoocp,yahoo).

The same report cited a slower growth forecast for 2013 of around 30 percent, “amid falling prices for solar products,” according to the IBD story, which is packed with interesting factoids about the industry:

  • Solar was installed in “nearly 83,000 homes in 2012”
  • From 2009-12, the U.S. solar industry grew at a compound annual growth rate of 82 percent
  • The forecast for solar industry growth from 2013-16 is 28 percent
  • A record 3,313 MW of solar photovoltaics were installed in 2012
  • The solar capacity that went online in 2012 “amounts to more than 40 percent of the nation’s entire existing capacity.”

So what does this mean for an investor in solar companies, many of them small caps? Apparently there’s still an oversupply globally of solar panels, prices have continued to fall “amid tech innovation, economies of scale and overcapacity, and price wars “mean manufacturers are producing panels at about half their normal capacity.” All this is bad for manufacturers but good for end-users “as the cost of using solar energy gets closer to parity with fossil-fuel energy sources.” 

Certainly investors could have done a lot worse than bet on solar stocks (particularly SPWR) since the beginning of 2013. While many have seen prices dip from highs in early February and March, a look at recent returns over the past six months shows that those who have been riding the solar wave since then have generally had a good run, although it seems to be easing up in recent weeks. The question is now, will it continue through 2013?

Here are a few of the small cap names we have been following:

San Mateo, CA-based SolarCity Corp. (Nasdaq: SCTY, http://www.solarcity.com) designs, installs and sells or leases solar energy systems to residential and commercial customers, as well as electric vehicle charging products. Back on Dec. 20, 2012, SCTY was trading for $10.67 and its run started from there. By March 6, 2013 SCTY was nearly $20. It closed March 15 at $16.74, up 14 cents for the day, with a market cap of $406.5 million. Its 52-week trading range is $9.20-$20.38.

Tempe, AZ-based First Solar (Nasdaq: FSLR, http://www.firstsolar.com/), which specializes in thin-film solar modules, is not a small cap as we define it but we include it for comparison purposes. Back in late September FSLR was trading for about $20 and was as high as $36.13 in February before it fell. It closed March 15 at $26.61, down 65 cents, with a market cap of $2.2 billion. Its 52-week trading range is $11.43-$36.98.

Ontario, Canada-based Canadian Solar (Nasdaq: CSIQ, http://www.canadian-solar.com/ ), which sells a variety of solar products, closed back in late September 25 at about $3 with a market cap of $130 million. It got above $5 by mid-February and then dipped like many of the others. It closed on March 15 at $3.50, down 3 cents for the day, with a market cap of $151 million. Its 52-week trading range is $1.95-$5.15.

San Jose, CA-based SunPower Corp. (Nasdaq: SPWR, http://www.sunpowercorp.com/), which makes a wide variety of solar products and systems, closed back on Sept. 25 at $4.60 with a market cap of $547 million. SPWR closed March 15 at $11.80, down 24 cents for the day, with a market cap of $1.4 billion. Its 52-week trading range is $3.71-$13.88.

China-based Trina Solar Ltd. (NYSE: TSL, http://www.trinasolar.com/) designs, manufactures and sells photovoltaic modules worldwide. Back in mid-December, TSL was trading for about $3.95, ran up to $5.81 in early January, but has tumbled since. It closed March 15 at $4.11, up 1 cent for the day, with a market cap of $291 million. Its 52-week trading range is $2.04-$8.68. 

China-based Yingli Green Energy Holding Co. (NYSE: YGE, http://www.yinglisolar.com/) makes photovoltaic products including cells, modules and systems. YGE closed back on Dec. 21 at $2.18, then ran up to $3.49 by mid-February, but it, too has been dropping since then. It closed March 15 at $2.47, up 7 cents for the day. Its market cap is now $387 million and 52-week trading range is $1.25-$4.60.

China-based Suntech Power Holdings (NYSE: STP, http://am.suntech-power.com), the world’s largest producer of solar panels, closed at $0.92 back on Sept. 25, 2012, and then rose to $1.87 in early January, but has been falling since. STP closed March 15 at $0.70, up 3 cents for the day, with a market cap of $127 million. Its 52-week trading range is $0.41-$3.68.

St. Peters, MO-based MEMC Electronic Materials (NYSE:WFR, http://www.memc.com) manufactures and sells silicon wafers and photovoltaic materials. Through SunEdison, it’s a developer of solar energy products. In early November, WFR was trading as low as $2.18 and then hit a recent high of $5.66 in mid-February. It closed March 15 at $4.53, down 24 cents for the day, with a market cap of $1 billion. Its 52-week trading range is $1.44-$5.70.

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

Recovering Chinese Economy Sparks Record High Demand for Oil

China’s economy is recovering, according to media reports, and with it comes a significant increase in its demand for oil. According to Platts, China’s oil demand reached record highs in December, suggesting that demand for 2013 will also spike.

Citing data from China’s National Bureau of Statistics, the Platts report noted that China’s economy rebounded by 7.8

Photo courtesy of heatingoil.com

Photo courtesy of heatingoil.com

percent in the fourth quarter of 2012 after bottoming out in the third quarter. Along with that recovery, China’s oil demand rose 7.7 percent year on year in December, or an average of 10.58 million barrels per day, the highest on record. Oil demand “was boosted by record refinery throughput.”For the entire year 2012, oil demand in China averaged 9.68 million barrels per day, a 3.4 percent increase over 2011. If the government continues its stimulus measures and the economy continues to improve, “growth this year could surpass” these figures, the Platt report noted.

This report prompted another look at small cap oil services and oil industry stocks.  Here are four we started following back on Aug. 1, 2012 and two others we have added to the list:

Houston-based Flotek Industries (NYSE: FTK, http://www.flotekind.com/), a company that develops and supplies a portfolio of drilling and production related products and services to the energy and mining industries worldwide, closed back on Aug 1 at $9.71 with a market cap of $480 million. When we checked a little over a month later on Sept. 11 it closed at $12 and its market cap was $596 million. On Jan. 24, FTK closed at $13.44, down 8 cents for the day. Its 52-week trading range is now $8.46-$14.73.

Norwalk, CT-based Bolt Technology Corp. (Nasdaq: BOLT, http://www.bolt-technology.com/) operates in the offshore drilling segment. It manufactures and sells marine seismic data acquisition equipment and underwater robotic vehicles. In January 2011 Bolt purchased SeaBotix Inc. BOLT closed Aug. 1 at $14.45 and Sept. 11 at $14.90, with a market cap of $126 million. BOLT closed Jan. 24 at $15.43, up 3 cents for the day. Its 52-week trading range is now $11.65-$16.09.

Houston-based Tesco Corporation (Nasdaq: TESO, http://www.tescocorp.com/) operates in four divisions serving drilling contractors and the oil and natural gas industry: Top Drives, Tubular Services, Casing Drilling and Reseach and Engineering. In October 2011 Tesco purchased Premiere Casing Services-Egypt SAE. Back on Aug. 1, TESO closed at $11.31. By Sept. 11 it had dropped to $10.39. On Jan. 24, TESO closed at $11.86, down 16 cents for the day. Its 52-week trading range is now $8.70-$16.88.

The Woodlands, TX-based Newpark Resources Inc. (NYSE: NR, http://www.newpark.com/) provides products mainly to the oil and gas exploration industry. It operates in three segments: Fluid Systems and Engineering, Mats and Integrated Services, and Environmental Services. In April 2011 it acquired the drilling fluids and engineering services business from Rheochem PLC. Back on Aug. 1 it closed at $6.68 and by Sept. 11 it was up to $7.67. On Jan. 24 it closed at $8.35, up 2 cents for the day. Its market cap is now $725 million and it 52-week trading range is now $5.19-$9.82.

The Woodlands, TX-based TETRA Technologies (NYSE: TTI, http://www.tetratec.com/) has five different business segments including oil and gas exploration, a products and services segment serving the oil and gas industry, and production testing. Since March 2012 TTI has made three acquisitions. TTI closed Jan. 24 at $8.55, up 3 cents for the day. Its market cap is now $668 million. Its 52-week trading range is $5.35-$10.66.

Houston-based Cal Dive International (NYSE: DVR, http://www.caldive.com/) is a marine contractor specializing in platform installation and salvage services, pipe inlay and burial for a diverse customer base in the oil and natural gas industry. DVR owns a fleet of 29 vessels and barges. It closed Jan. 24 at $1.74, up 5 cents for the day. Its market cap is now $169 million and its 52-week trading range is $1-$4.

From Bananas to Data Switches to SBCs–Some Small Caps to Watch

Photo courtesy of acus.org

If you missed our recent interviews with leading investors/portfolio managers Warren Isabelle, Mary Lisanti and Nick Galluccio, it’s worth the time to go back and read them. All three are highly-acclaimed, veteran small cap stock investors, and each offers valuable insights about what to look for in 2013 and the investment landscape to expect in upcoming months, among other important information.

They called out a variety of stocks to watch, including some small caps. So let’s take a look at the small caps in the group (less than $1 billion in market cap). We’ll come back and check on their progress in a few months.

Santa Clara, CA-based Extreme Networks (Nasdaq: EXTR, http://www.extremenetworks.com) makes data switches among other products. The company has recently brought in new management focused on marketing. Its 52-week trading range is $2.87-$4.43 and its market cap is $357 million. It closed Jan. 18 at $3.76, down 1 cent for the day.

Lexington, MA-based Synta Pharmaceuticals (Nasdaq: SNTA, http://www.syntapharma.com) develops and commercializes small molecule drugs. Its lead drug, Ganetespib, is designed to inhibit the growth of cancerous tumors. Its 52-week trading range is $3.57-$10.83 and its market cap is $664 million. It closed Jan. 18 at $10.74, up 32 cents for the day.

Waltham, MA-based Repligen Corp. (Nasdaq: RGEN, http://www.repligen.com) is a life sciences company that manufactures biologic products used to make biologic drugs. Most importantly it manufactures Protein A, a reagent used to manufacture monoclonal antibody-based therapeutics. Its 52-week trading range is $3.51-$7.31 and its market cap is $213 million. It closed Jan. 18 at $6.83, down 5 cents for the day.

Westford, MA-based Sonus Networks (Nasdaq: SONS, http://www.sonusnet.com) is a provider of voice and multimedia infrastructure solutions and has a new product line of SBCs (session border controllers). Its 52-week trading range is $1.36-$3.11 and its market cap is $643 million. It closed Jan. 18 at $2.29, down 1 cent for the day.

State College, PA-based Rex Energy Corp. (Nasdaq: REXX, http://www.rexenergy.com) is an independent oil and gas company operating in the Appalachian and Illinois basins. It operates approximately 2,120 wells, mostly for natural gas. Its 52-week trading range is $8.80-$14.65 and its market cap is $728 million. It closed Jan. 18 at $13.78, up 17 cents for the day.

Charlotte, NC-based Chiquita Brands International (NYSE: CQB, http://www.chiquita.com) is an international marketer and distributor of bananas and other produce sold under the Chiquita and other brand names in 70 countries and packaged salads under the Fresh Express brand, among others. Its new management is emphasizing bananas and other fruit. Once a $30 stock, its 52-week trading range is now $4.62-$10.57 and its market cap is $347 million. It closed Jan. 18 at $7.49, down 3 cents for the day.

Houston-based Carrizo Oil & Gas (Nasdaq: CRZO, http://www.crzo.net) is an independent energy company and another natural gas play. At the start of 2012 CRZO had proved oil and gas reserves of 935.6 billion cubic feet, most of it natural gas. Its 52-week trading range is $19.04-$31.62 and its market cap is $890 million. It closed Jan. 18 at $22.19, down 20 cents for the day.

Mary Lisanti: Continued Corporate Earnings Growth in 2013 (When the Federal Government Resolves the Budget)

Mary Lisanti is president and portfolio manager of AH Lisanti, an investment management company currently focused on small cap growth companies. She is a 33-year veteran of small cap growth research and investing. For the first 12 years she was a small cap analyst and strategist on Wall Street. During the past 18 years, she has managed small cap portfolios at premier asset management companies. As CIO of ING Investments LLC, (1998-2003) she was responsible for building the active equity management team, and assets under management in her area grew from several hundred million to several billion dollars. Prior to ING, Mary was at Strong Capital Management as Senior Portfolio Manager for both the Small Cap Growth and Mid Cap Growth Strategies and was Managing Director and Head of the Small/Mid Cap team at Bankers Trust Company. Mary was named Fund Manager of the Year in 1996 by Barron’s. She was named #1 small cap analyst in 1989 by Institutional Investor’s All-Star Research Team. In addition, she was ranked #2 and #3 in 1987 and 1986 respectively.

Mary-headshot

I had the pleasure of talking to Mary just before the New Year’s holiday at her office near Rockefeller Center.  We had first met in the late 1980s when she was interested in a technology company that proposed the radical idea of a keyless car ignition or computer security system using a fingerprint.  Interesting how what seemed futuristic now seems almost as old hat as, well, men on the moon.

JA:  How are you feeling about the year ahead?

ML:  Undecided.  I’ll give you some positives and some negatives.  One big positive is that corporate profit growth will still be decent.  Corporations are at very high profit margins, but when you break down what’s going on, there’s no reason they shouldn’t go higher.  Virtualization – the use of cloud computing, and other aspects of today’s high tech should help them cut costs.  For that trend to stop, two things would have to happen: a long period of negative revenue growth, accompanied by fast-rising wages.  Neither of those things is happening.

That will be a positive for the market.  Corporate profits are growing 8-10% and we believe that can continue, and that is widely dispersed across the board.  Small caps can grow even more,we believe, although again there will be wide dispersion in individual results.  This will be a classic stockpicker’s market.

The biggest negative for the market is that we cannot seem to govern ourselves.  That weighs on multiples.  That’s why, four years into this recovery, multiples are still low, particularly when you take into account where interest rates are and how  GDP growth, although below trend, continues to chug along at 2% or so.  In that scenario, logic would have it that multiples would be in the range of 18-19, but they are not.  Why not? I believe it is because of our inability to govern. Politicans are behind the curve;as they usually are, in addressing our structural issues to bring the long term deficit issues under control. Will they address the longterm issues or not?  If they do so now, it will require only modest changes to entitlements and spending. The extent to which we address those issues will affect the performance of the market going forward.

It is psychologically important to multiples: if you can slow the growth in spending at least a bit, you give people more confidence.  In the Clinton years they managed to slow the rate of growth in spending, and Clinton left office with a surplus.  I believe we will spend most of 2013 arguing about entitlements and other budget issues.  Next year it will be the Democrats saying no to entitlement reform, just like this year it was Republicans saying no to taxes.  I don’t know how much it is possible to get done, because it is being done in a fishbowl and from ideological positions that don’t accommodate compromise.

If they do not get something done, I fear that US debt will get downgraded again.

JA:  And would any of the DC politicians feel responsible if that happened?

ML:  I do not believe so, no.  Politicians, in my opinion, are in the business of passing the blame.  If there were another downgrade, it would affect President Obama’s legacy, and I don’t think he wants to be the president who oversaw two debt downgrades in his time in office.  Both sides will have an incentive to compromise and hopefully they will.  The biggest risk to all of us, and to the market, is that the dollar loses a bit of its luster as the currency of last resort.

When you look at Japan and China and Europe, they are getting their act together with regard to being attractive places to invest and could even potentially be attractive as reserve currencies in a few years.  My biggest concern is that we permanently change corporate behavior: if you have a climate of uncertainty for long enough you make people afraid.  Business overall has been clear with Washington that the uncertainty is damaging.  R&D tax credits, farm and agriculture bills, accelerated depreciation – Congress has been handling these as though they were annual issues, and they’re not.  They affect multi-year planning.  When the R&D tax credit was put in place in the early 1980’s, it was in place for 4.5 years.   That would be better—it would give businesses the ability to plan longer term..

These and other things are casualties of this ideological warfare in Washington.

JA:  What do you see as strengths in 2013?

ML:  It is an enormous positive that housing is recovering, and the recovery should continue, assuming Washington does not cut the mortgage deduction..  Unemployment is declining, although it is declining too slowly.  And we have cheap sources of energy.  . A number of industry sources believe that we will be energy independent in the next decade or so, which is a huge positive for our manufacturing competitiveness.

When you look at these things, once we make it through this budget and debt-ceiling problem, things look a lot better.

Governments all over the world have been spending money to fix the problems that caused the recession, and odds are that things will not fall apart again soon.  Over the past several years, we have had a major issue every year that has “terrified” us: last year it was the potential breakup of the Euro and Greek debt default, and this year it was the budget crisis in the U.S. Beyond the budget crisis, I do not see an issue that has the potential to scare investors as much as these two issues have. We should enter a period of more “normalcy,” where macro issues take a backseat to fundamental issues, and that change should allow multiples to increase. But belief in a more stable future will come slowly.

JA:  What should we look for in 2013 when we look at investments?

ML:  As small cap growth investors, we look for earnings growth.  But one of the great positives in this market is that there are many ways to make money in the market.  When I came into the business in the late 1970s, you could make get 7-8% returns several ways.  You could make money with yields –- those companies with no earnings growth offered very high dividend yields, say about 7%; those companies with earnings growth offered more modest dividends, say 2-4% dividends and 4-5% annual growth in earnings.  Growth stocks offered  very little in the way of dividends, but you could get capital appreciation as earnings would increase 10% to 15%.annually. Then, as we moved through the great bull market of the 1980’s and 1990’s, we got to the point where dividends were out of favor and capital appreciation was the only way to make money.. Now dividends are back and once again there are multiple ways to make decent returns in the stock market, depending upon one’s tolerance for risk..That is very, very positive for the equity markets.

JA: How about sectors?  Any of special interest, or any you would avoid?

ML:  There are good companies in every sector.  I would not recommend the utilities, but there are very good opportunities in materials, energy, consumer products and services, industrials and financial services,  In most of these the small caps usually have something unique about the way they do it, or the technology they apply to it.

Tech spending is not forecast to be up much in 2013.  There will be winners and losers.  We need to keep in mind that the corporate world is moving toward Software as a Service, which allows them to stop buying perpetual licenses, and to pay as they use software.  They are going from buying licenses and maintenance contracts, and now are basically paying just for what they use.  Same with cloud computing.  So they are going from spending $20,000 on software and a server to paying $1,000 month.  So even though tech spending is forecast to be close to flat, the companies that will be winners will have SaaS and cloud computing.  These trends will hold down spending.  It’s hard to see how the semiconductor companies are going to prosper in that environment, unless it is the specialty chipmakers who are specialized in populating ever-smaller chips with ever-larger amounts of circuitry for tablets and smart phones – or those companies that are specialized in the ability to manage the signals for those tablets and phones.  But other than those two, I don’t see a lot of growth there.  And I would be careful about traditional license-oriented software companies.  .

JA: What about healthcare companies?

ML:  Interesting.  It’s hard to guess how ObamaCare will play out.  There are some longterm secular trends in healthcare that are worth keeping in mind.  Keep your eye on the value proposition: better, faster, cheaper, more automated.  One of the most interesting areas is the second generation biotechs.  Think about AIDS, for instance.  Over the last 25 years it has become a livable disease – that is, we haven’t cured it, but we can make it possible to live with it, and to do well, not just to survive for a few more months.  Now the industry is working to make cancer livable in the same way; there are whole new classes of drugs that enable people to live with cancer, and not to just be blown away by it in a short time.  Possibly we are spending the same amount of money making cancer livable as we used to, but now we’re spending it over a longer period, and not all at the end of life.  Diabetes monitoring, for instance – the closer we get to continuous glucose monitoring, the better for diagnosis and treatment; One of our investments is Dexcom (DXCM), which has a promising technology for that.  All those big diseases are interesting, and medicine is getting its arms around them too.

JA: How about healthcare IT?

ML:  It has historically been mostly about billing and insurance, but now the future is to move on to quality of care.  Since we have had health insurance as a society, the focus has been on what you might call “industrial metrics,” such as how many patients you can process.  Now the quality of the outcome is more important, and best practices are more important.  There will have to be penalties for readmissions of the same patient.  Mobile apps for monitoring things like blood pressure, glucose, heart problems and blood gases – these things are going to become standard practice over the next 5 to 10 years.

JA:  You mentioned the impact of technology on industry.

ML:  There are lots of new beginnings now, along with outmoding of old things.  Software as a service and the use of the cloud – this is the biggest piece of cost to cut.  If you can cut your IT costs you have overall better margins, and better processes too.  And industrial automation is interesting too.  The first generation of automation concentrated on, for instance, lasers to cut steel.  Now automobiles are being made with lighter materials, so new lasers are needed, lasers to cut nonsteel materials.  Aerospace is an interesting area for this.  Two things that are driving aerospace are new materials that lower weight and cost, and a continuing cutback on oil-based materials.  There is a bit of a renaissance going on in aerospace.

One of our investments is IPG Photonics (IPGP) for the new lasers needed to deal with new lighterweight materials.  Another is Polypore International (PPO), which is making the membranes needed for new electric vehicles like the Chevy Volt and the Nissan Leaf. By the end of 2013, they are expected to be supplying membranes for 24 models of cars.  That goes back to the fact that fuel efficiency standards by 2025 will be at 54.5 mpg.

Another of our investments is Aspen Technology (AZPN), which basically supplies SaaS for factories and plants.  If you are a refinery, for instance, you are required by law to take your systems down every so often for maintenance and test for a number of things such as safety and pollution.  Doing that manually is difficult; it can be done, but it is hard, and if you are global it is harder.  Aspen automates all of that, and they are in a field by themselves basically.

JA:  And energy?

ML:  The shale revolution will be a big job creator, and the move toward natural gas for vehicles is important.  Fleets will be moving to Compressed Natural Gas (CNG), and we believe the infrastructure will be built out for CNG refueling.  Federal Express, UPS and the other big fleets will be the drivers.  We are interested in Westport Innovations (WPRT) for the CNG engines.  And we are watching Clean Energy Fuels Corp (CLNE) for the CNG supply chain, but big oil will be the installer.  We also believe solar will become economical to use, with panels on the roofs, for instance, of warehouses, and power being sold back to the grid when it is not needed.  Between the increased supply of natural gas, shale energy, coal, oil and renewable, we can get to be energy independent.

JA:  How about housing?

ML:  Housing is fascinating.  What happened with housing is what happened with autos.  Now after a period of low sales, we probably need as a nation to do some catching up.  We could need 1.7 million new housing starts for a couple of years.  That would double the current rate.  The Echo-boomers (who used to be called Generation Y) are starting to buy houses; their demand for houses is growing at 5% per year, and will grow at 10% per year soon.  My personal opinion is that this housing cycle will be a long one, similar to what we saw after the housing collapse in the mid 1970’s. In the first few years, we will see a catchup in pricing, but after that we believe housing prices will probably go up a couple of percentage points per year. If they implement the rules on mortgages that are being talked about, the housing market will become a lot steadier and more stable, more like the Texas market, where they tightened the downpayment requirement and favor 30-year-fixed mortgages.  That will be positive for the housing market and for consumer confidence.

There is nothing better for consumers than to have their biggest asset become more valuable every year.  Three years ago if you hadn’t already lost your job, you were still afraid you might lose it.  Your 401(k) and your house were devaluing.  This recovery is more like the late 1970s than the 1990s.  People got burned in the mid-70s and it took a long time to feel better.  When we are operating at full potential, we should have 3-1/2% to 4% GDP growth, and that will come eventually.

JA:  And in 2013?

ML:  I think GDP this year will be 2-1/2% overall because of federal and state problems, but corporate GDP growth will be a good bit better than that, assuming there is a budget deal at some point.  The first half of the year if we watch the government argue about spending, it could be a bit of a damper on growth.  If we regain faith that the politicians will be able to compromise and come up with some answers, the market will go higher.  Having our debt downgraded shook everyone’s confidence.    So the market is at 12-13 times earnings as a result.

If we get a budget deal we could get much stronger investor confidence, but in the short term, our ability to govern ourselves is the big issue.  Once that is resolved, the market will lift.

JA:  Thanks, Mary.

For AH Lisanti:  For financial intermediary use only.  Not for use with investing public.

The information provided should not be considered a recommendation to purchase or sell any particular security.  It should not be assumed that any security transactions, holdings, or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein.  The views expressed reflect those of the portfolio manager as of 12/31/2012.  The portfolio manager’s views are subject to change at any time based on market and other various conditions. The performance reflected herein is not representative of performance of AH Lisanti individually managed accounts or comingled vehicles that AH Lisanti advises.

 

Buzz Zaino: Royce Fund Manager Sees Strong Growth Upside for 2013, Boosted by Housing, Transportation, IT Spending

ZainoB_gBoniface A. (“Buzz”) Zaino is a portfolio manager advising several of the high-profile Royce Funds, to wit, the Royce Opportunity Fund and associated funds. By any measure a veteran of the industry, Buzz has more than 40 years of experience in the financial services industry, the last 14 with Royce. I first met him when he was managing the Value Added Funds for Trust Company of the West more than 20 years ago, but prior to that he was president of the Lehman Capital Fund and a principal of the “original” Lehman Brothers. He went to school at Fordham, and took his MBA from Columbia. In 44 years, Buzz has seen enough economic cycles to offer an MBA from the University of Zaino.

Buzz agreed to talk about his 2013 outlook from his home in Aspen which, like much of the US snow belt, has seen little of the white stuff so far this year.

JA: It seems generally agreed that the US economy is growing at a slower pace than it has coming out of previous recessionary periods. What is your outlook for 2013? Will the economy continue to grow, and if so, will it grow at the same rate, faster or slower?

BZ: The reason that the US economy has had a slow lift-off has been that coming out of recessions in the past, the Fed has lowered interest rates, and people took that opportunity to buy houses and cars. This recession was different, because the banks were not giving out money, because money was scarcer and because bank lending standards were significantly more stringent. So there was a hiatus and it took a lot longer for the economy to recover. The recovery finally started this year, 2012, and it is finally beginning to give a boost to the economy, especially as construction gets going again. That boost is going to continue, and it will help us accelerate in 2013. But the recovery was complicated by the fact that Europe went into recession. American companies tend to be worldwide in scope, and caution at the top levels helped bring inventory levels down due to the European recession. That meant that capital spending was also muted. I think that capital spending is also constrained in anticipation of the budget settlement that is still out in the future. A “normal” recovery was delayed until 2012, and then delayed again by the European recession. But those delays now give us the opportunity to accelerate as 2013 progresses.

JA: Will we get a budget?

BZ: Sooner or later, yes. We will get a budget deal out of Congress. Once we have that deal defined, we can go forward from there. That will be a positive, and will be on top of the acceleration we can expect from normal factors like housing and auto sales. We could get a nice surprise in 2013. But we’re cautious about January.

JA: Why is that?

BZ: Most managers will make their January decisions based on their December orderbooks, and we don’t think the December orderbooks will be strong enough to give them confidence, but as we go into February and March, a lot of the inventory build-up will have started to occur, so the orderbooks will look better. And the trade between China and the US is expanding again, after a period of slower growth. We think that could have an increasing effect, especially after the Lunar New Year. By the end of the first quarter, growth could be looking quite good.

JA: The harsh talk by Washington DC and Beijing won’t slow down that growth?

BZ: The China-US trade is too big a market for both sides, and politics will not interfere with it. Certainly the Chinese government’s expansion plans are not going to be held back. There are Chinese hotel companies looking for hotel properties in the US – to build or to buy. Very smart people, and I don’t think either side is going to let politics inhibit our trade relationships. Nothing is going to come of the yelling.

JA: Will the growth rate be higher going into the second quarter then?

BZ: I think we could have a weak-ish economy and market in January, like I said. Everyone will be paying higher taxes, at least with FICA deductions back in everybody’s paychecks. With orderbooks in December that may not be strong, managers and consumers could still have their hands in their pockets. If we have a warm winter like we had last year, we could have more construction starts. If we have a cold, snowy winter, those starts could be delayed, and the weak period could extend through January. We are looking very favorably at housing. Housing is still somewhat depressed, but the housing stock is aging — and mortgage money is more available than it was a year ago. And the automobile fleet is aging and will need to be updated, as will the commercial truck fleet.

JA: Do you think the growth rate will exceed 2%?

BZ: Yes, better than 2%, but maybe not in January. But after that it could be substantially more than 2%. Four to five percent would not be out of the ballpark, although 5% would be at the high end of probability. And the market would react to that. If the market is down – and cheap – they don’t want to buy, but if it goes up 15%, everybody wants to buy. If UPS starts to replace its fleet and buys trucks, all the others will update their fleets at the same time. It’s much cheaper to run your truck or your fleet on CNG (compressed natural gas) too. A town near Aspen has converted their entire bus fleet to CNG, and although they can fuel up at the bus barn, there are additional CNG stations being built. Boone Pickens and his group are encouraging these new CNG fueling stations. We’re surprised that trucking companies are not moving faster than they are toward natural gas. We have an investment in a building materials company and I asked them if they are considering CNG, and they said they had not looked into it, but they would. Conversions to CNG are not expensive. Ford and GM are now offering pickup trucks with CNG engines.

JA: Is there going to be a fiscal cliff solution?

BZ: Eventually. Whether or not it happens before December 31, there’s no way to tell. But the congress can pass a continuing resolution to postpone the cuts and tax increases while they work on it. Eventually this Mexican standoff will be resolved. And by the way, the fiscal cliff does not seem to be a big motivator for the American consumer. They need to replace things, and they are not overly concerned with the big picture as long as the economy seems to be getting healthier.

JA: What sectors are going to do better as the economy improves?

BZ: IT spending will pick up. There is a big pent-up need factor here, and it has been a relatively easy way to postpone expenditures for the last couple of years. Windows 8 is very much under-rated. It takes a while for people and corporations to decide to make a big change like the change to Windows 8, but it will be very good for PC companies. Corporations need to have the latest and fastest. Technology in corporate environments needs to be the newest and most capable. Areas like IT are why you can think of higher growth rates. After this hiatus, there is enough pent-up need to start a new momentum.

JA: How about healthcare IT?

BZ: I went to see my physician in New York, and he is one of the best, highest-rated doctors in his specialty. He was really annoyed that he was going to have to convert my file, which is a manila folder with all kinds of paper and bits of paper in it – to computer files. I thought, hey, this is 2012, get with the plan.

JA: How about housing? Any areas there where investors ought to be looking?

BZ: We have had a good run with housing companies, and we think that will continue. One area that may have real potential is mortgage insurance companies. It is a fairly narrow field, and some people infer from the papers that these companies may not be able to cover their losses. The reality is that housing prices could be moving up at a rate of nearly 1% per month in the near future, and as a result those liabilities would be decreasing. Mortgage applications for refinancing were up last week 47% year over year. That’s a meaningful number. Apparently not everyone is under water. Those areas that have dropped the most are improving the fastest in some cases. California is one of those.

JA: Any areas where you would be wary going forward?

BZ: Defense companies. We think there will be lots of cutbacks, lots of programs cancelled. Defense personnel contractors may do better as the armed services cut back their personnel. Company by company there may be some good bets in defense, but we believe the sector will be down.

JA: And in summary?

BZ: Other than defense, it is going to be a broad-based recovery. If we have a growing, recovering economy, interest rates would rise, and inflation would rise. Commercial banks will do better. They will use their asset bases to increase lending. The moderating factor will be that regulations will add some cost, but that will not be an inhibitor for the larger banks looking to expand regionally. If I were a larger bank and wanted to expand regionally, it would be attractive to me to buy a regional bank and expand my profitability without appreciably expanding my regulatory exposure.

JA: Thanks, Buzz.

Note: Buzz prefers not to name specific companies in his portfolios. The interviewer has no investments in the sectors discussed, and does not intend to initiate such investments in the next few days or weeks.