SINLetter – August 2006
Welcome to the one year anniversary edition of the Suria Investment Newsletter (SINLetter), a free monthly newsletter that highlights two publicly traded companies. The objective of this newsletter is to provide you with unbiased initial research and basic facts about individual stocks so that you can then research them further before deciding to add them to your portfolio or not. For those of you who are reading this and are not already subscribed, you can subscribe by going to www.sinletter.com/subscribe.aspx and you will start receiving this newsletter from next month. I have provided relevant links throughout this newsletter, but if you have any questions or comments, feel free to write to me.
Spread The Word: The last year has been an amazing journey and learning experience for me. What started out as a short newsletter that was sent out to a small list of family and friends has blossomed into a comprehensive newsletter (it takes longer to write each month) with hundreds of subscribers. Most subscribers have been kind enough to tell me how they came across SINLetter. Some of you found SINLetter through search engines (all that search engine optimization for keywords like investment newsletter did pay off) while others found SINLetter through the financial website SeekingAlpha, which syndicates my content. However a majority of you learnt about SINLetter through word of mouth and family and friends. To help make it easier for you to spread the word about SINLetter, we recently created a Tell-A-Friend page on SINLetter.com and to make things interesting, if your friend is the 1,000th confirmed subscriber, he or she will receive a $100 Amazon.com gift certificate and you will receive a surprise gift as well. Please help us spread the word so that we can continue to add new features like forums and eventually build a vibrant community of investors.
The SINLetter model portfolio outperformed the three major indices in July with a gain of 1.62% powered by strong returns from ATI Technologies (ATYT), Infosys (INFY) and Safeway (SWY). The overall SINLetter model portfolio is now registering gains of 57.52% since its inception in August 2005. This compares with a gain of 5.29% for the Dow Jones Industrial Average, a loss of 4.73% for the Nasdaq and a gain of 3.34% for the S&P 500 over the same time period. A lot of companies in our model portfolio reported earnings in July and some of these results and individual stock performances are discussed below.
Logitech (LOGI), which was featured in the June 2006 edition of SINLetter based on the stock split theory, was on a downward trend over the last two months and dropped even more right after the stock split on July 18, 2006. This drop in the stock price over came as a surprise since the company would not have done a split and launched a buyback program had they not been happy with their outlook. The company then reported strong quarterly results with income increasing 35% to $30.1 million, handily beating analyst expectations. The stock rebounded very strongly and is now back at the level where we added it to our portfolio two months ago. I continue to remain bullish on Logitech.
Infosys (INFY), the other stock I picked based on the “stock split theory”, also delivered excellent quarterly results and the stock is now posting a return of 16.4% over the last two months. For those of you who are interested, I have summarized the quarterly earnings report in a blog entry titled Infosys Profit Jumps 50%, Sensex Weathers Attacks.
Our take about Eaton Corp (ETN) doing well thanks to increased aerospace activity was right on target as Eaton reported a 21% jump in second-quarter profit. Other companies like Triumph Group (TGI) and Heico Corp (HEI) that supply aircraft parts to Boeing (BA) also did well. However Eaton, which is a diversified industrial company, expects growth to slow down in the second half of the year thanks to rising interest rates. The stock dropped after quarterly results were released and is now registering a loss of 16.37% since we added it to our portfolio. The US Gross Domestic Product (GDP) grew at a much slower pace of 2.5% when compared to growth of 5.6% in the first quarter of 2006. If there are further signs of economic weakness, I will consider selling Eaton from our model portfolio in the coming months.
Another stock in our portfolio that is registering a big loss is Airspan Networks (AIRN). I have discussed the problems faced by Airspan Networks and a potential hedging strategy in a recent blog entry called Hedging Your WIMAX Bet. I plan to continue holding Airspan in the SINLetter model portfolio and my personal portfolio until there is more visibility regarding the Yozan contract.
It looks like Airspan has resolved its liquidity issues by issuing 100,000 additional series B preferred shares to an existing investor Oak Investment Partners and raising $29 million. I speculated that something similar might happen in the previous edition of SINLetter when I stated “existing shareholders could face dilution if Airspan decides to issue more shares through a private placement (Sirius Satellite Radio has mastered this art)”. Since each series B preferred share can be converted into 100 common shares, the price Oak Investment Partners paid works out to $2.9 per share. Airspan shares closed at $1.88 on July 31st, 2006 and I expect the stock to open higher on August 1st. You can read the entire press release here.
The O Organics story is finally playing out for Safeway (SWY) as the grocer reported quarterly income that jumped up 83.73% to $246.2 million and even raised its full-year outlook. This is quite impressive for a retailer in the highly competitive and low margin grocery segment. The stock jumped up 8.76% the day after reporting quarterly results, its highest level in four years and is now registering a gain of 11.78% since we added it to our portfolio in April 2006.
SINLetter turns one year old on August 2, 2006 and I could not have asked for a nicer gift than the acquisition of SINLetter pick ATI Technologies (ATYT) by Intel’s archrival Advanced Micro Devices (AMD) for $5.4 billion dollars in cash and stock. ATI Technologies was featured in the first edition of SINLetter back in August 2005 when it was trading at $13.05 per share. This acquisition of ATI by AMD, which worked out to $20.47 per share based on AMD’s closing price of $18.21 per share on Friday July 21, 2006, represents a 56.86% premium over our purchase price.
The process of portfolio readjustment is very simple this time as I plan to sell ATI Technologies on account of AMD’s proposed acquisition. It is highly unlikely that ATI will get a rival bid and I do not think investors will hold out for a higher price. Since AMD is offering part cash and part stock to acquire ATI Technologies, it is also likely that AMD’s share price could head lower in the short-term thanks to its price way with Intel (INTC). After the sale of ATI for a gain of 54.18% and adding two new stocks this month, we will have 16 stocks in the SINLetter model portfolio. According to this investopedia article, the benefits of diversification drop off once you have 20 stocks in your portfolio. However it is important that these 20 stocks belong to different sectors, market caps (small cap, mid cap, large cap) and geographical locations. Since I am a software engineer, I tend to be overweight in the tech sector and hence hope to have a total of 25 to 30 stocks in the SINLetter portfolio someday.
Other Interesting Events:
GDP growth slowed to 2.5% in the second quarter of 2006 when compared to 5.6% in the first quarter and Wall Street cheered the news sending the Dow Jones Industrial Average up 119 points last Friday. The reason for this rather odd behavior stems from Wall Street’s hope that a slowdown in the economy may give pause to additional interest rate hikes by Ben Bernanke and his colleagues at the Fed. If the unemployment report due out this Friday is not good, the Fed could pause and it may be a good time to start looking at bond ETFs. I will post additional information about bond ETFs on my blog or in the next edition of SINLetter.
Natural Gas prices spiked 15% on July 31st and oil rose to $74.50 per barrel. This is negative for chemical companies like Dow Chemical (DOW) and DuPont (DD) as they use a large amount of natural gas and have already felt the burden of high natural gas prices. The high price of oil and natural gas are positive for alternative forms of energy like solar and form the basis for our featured pick Suntech Power Holdings (STP).
Gold closed the month of July at $634.20 an ounce, a gain of about 3% for the month.
Now that the SINLetter model portfolio has defensive stocks like Procter & Gamble (PG), Johnson & Johnson (JNJ) and Safeway (SWY), I decided to pick some international high growth stocks that I have been following for quite some time. While researching one of my picks Sify (SIFY), I came across some excellent analysis by fellow blogger and Seeking Alpha contributor Himanshu Pandya. Himanshu’s website FinancialNirvana.com has extensive coverage of Indian ADRs and his recently launched sector lists are very useful. I have exchanged emails with Himanshu in the past and invited him to write about Sify for this edition of SINLetter as a guest author and he was kind enough to accept. So without digressing further, let us present this month’s picks.
Suntech Power Holdings (STP)
Over the last few years I have been fascinated by solar energy and the impact it can have on our world. If plants can use sunlight to create food, why have humans with all our technological and scientific advances, found it difficult to harness solar energy in a meaningful way? One of the problems that solar energy faced along with other forms of alternative energy was that it was not competitive on a cost basis with fossil fuels like coal and oil and hence did not get enough investment capital or government funding. As the price of oil jumped up more than 600% from a low of about $10 a barrel in late 1998 to over $75 a barrel in 2006, interest and investment in alternative forms of energy spiked. The holy grail of solar energy has been generating more electricity from solar cells, which are also known as photovoltaic cells. Photovoltaic cells are built using silicon wafers and commercially have an efficiency of about 14 to 16 percent.
Many new companies are developing various ways to generate more electricity from less silicon, through techniques ranging from thin film technology to a patented system called the SunFlower 250 developed by an IdeaLab company called Energy Innovations. The SunFlower 250 uses 25 moving mirrors to focus sunlight onto a solar cell array mounted above. Suntech Power is a Chinese solar energy company that uses thin film technology to build photovoltaic cells. Suntech is one of the few profitable companies in this sector and has been profitable since 2003.
I have been watching the solar energy sector and Wall Street’s short love affair with companies like Suntech, which fueled Suntech’s shares up more than 200% since it went public at $15 a share in December 2005. With the entire sector falling out of favor thanks to concerns about polysilicon supply and eroding margins, Suntech’s stock has lost almost half of its value in recent months. Suntech currently appears to be very richly valued with a Price/Earnings ratio of 86.43 and a Price/Sales ratio of 13.57. I would never consider paying 13.57 time annual sales for a company unless it had an absolutely amazing growth rate. Suntech seems to fit the bill with revenue growth of 188% in 2005 and an expected grow rate of 126% this year. Based on their first quarter 2006 revenue growth rate of over 130% and their projected revenue growth of 163% to 179% in the second quarter of 2006, it looks like they will handily beat analyst expectations for full year 2006 revenue growth.
Apart from Suntech’s profitability and high growth rate, there were two other events that got me interested in Suntech Power. The first event was the $1.25 million contract Suntech won to supply 130 KW of solar energy for the 2008 Beijing Olympics. The Chinese government is very keen to wean itself off electricity generated from fossil fuels like coal. This comes as no surprise when you consider the following facts from this New York Times article (subscription required),
“China uses more coal than the United States, the European Union and Japan combined. And it has increased coal consumption 14 percent in each of the past two years in the broadest industrialization ever.”
“The increase in global-warming gases from China’s coal use will probably exceed that for all industrialized countries combined over the next 25 years, surpassing by five times the reduction in such emissions that the Kyoto Protocol seeks.”
China’s gross domestic product (GDP) grew by an extraordinary 11.3% in the second quarter of 2006 when compared to a 2.5% growth rate in the United States. Given this amazing GDP growth, China is very interested in building energy efficient cities (incidentally New York City is now one of the most energy efficient cities in the United States thanks to increased adoption of green architecture) and is investing in sources of clean energy. Suntech is likely to benefit from this trend and could potentially win additional contracts like the 2008 Beijing Olympics contract.
If you would prefer to invest in solar energy but not in a company that produces solar panels, you could also go one step deeper into the solar food chain and consider investing in a company like MEMC Electronic Materials (WFR). MEMC is one of the leading companies that produce polysilicon, which is used by companies like Suntech power to create their solar panels. Polysilicon has been in great demand in recent months leading to price increases and hence better margins for MEMC. In fact, MEMC released quarterly results on Thursday, July 27 and reported profits that more than doubled to $81.9 million in the second quarter when compared to the same quarter last year.
MEMC recently signed an agreement with Suntech to provide polysilicon to Suntech over a 10 year period. This 10 year agreement was the second event that made me decide to feature Suntech in this month’s SINLetter. MEMC will supply between $5 to $6 billion of polysilicon to Suntech over a 10 year period. According to full year 2005 results from Suntech, cost of goods came in at $157 million. If we consider that $100 million of this amount was for polysilicon, then the only way Suntech would need $5 to $6 billion of polysilicon in a 10 year period would be if it were to grow at an annual pace of 50% for 10 years. This is a very strong signal from Suntech and the drop in price from an intraday high of $45.95 on January 23, 2006 to the current $25.93 could make Suntech a bright long-term investment. For a glimpse of the future, consider the following statement by Suntech’s CFO Amy Zhang during the first quarter 2006 conference call,
“Total net revenues in the second quarter are expected to be in the range of $110 million to $117 million, representing year-over-year growth in the range of 163% to 179%.”
SunPower (SPWR), Evergreen Solar (ESLR), DayStar Technologies (DSTI), Kyocera (KYO) and Emcore (EMKR) are direct competitors of Suntech Power. Suntech also faces competition from companies that create other forms of alternative energy such as wind and fuel cells. Some examples include the aptly named Energy Conversion Devices (ENER), General Electric (GE) on account of its wind turbines division and fuel cell stocks like Hoku Scientific (HOKU), FuelCell Energy (FCEL) and Ballard Power Systems (BLDP).
- Suntech Power has an astounding triple digit revenue growth rate and is expected to grow more than 126% in 2006.
- Suntech is one of the few profitable solar energy companies and has been profitable since 2003, a year after inception.
- The Chinese economy grew at a red-hot rate of 11.3% in the second quarter and the government is keen on investing in alternative sources of energy.
- Suntech has allayed investor fears about polysilicon shortage by recently signing a 10 year supply contract with MEMC Electronic Materials.
- Suntech beat analyst expectations when it reported first quarter 2006 results and improved both gross and operating margins.
- Suntech, along with other alternative energy stocks has been very volatile in recent months, experiencing wild price swings. Just ask anyone who invested in Suntech Power or Evergreen Solar six months ago in the midst of the alternative energy craze.
- A very rich valuation with a current P/E of 86.43 and P/S of 13.57.
- Supply and price of polysilicon, the raw material used to produce photovoltaic cells, are a big concern. The recent 10 year agreement between MEMC and Suntech should hopefully help alleviate this problem.
- Some investors continue to remain skeptical about investing in Chinese companies and are worried about the derailment of the Chinese economy due to governmental interference or the growing gap between the rich and the poor, which has lead to many riots in rural China. Oddly enough there was a story about this in Barron’s magazine just last weekend.
|P/E||86.43||Long Term Debt||$3.7 Million|
Update: On August 2nd, a day after this newsletter was sent out to subscribers, Suntech Power (STP) decided to acquire a leading Japanese solar company MSK Corp in a two-step transaction worth up to $300 million. Suntech’s stock shot up almost 10% that very same day. On August 4th, Goldman Sachs intiated coverage of Suntech Power with a buy rating.
Sify is an Indian company with a foothold in everything (I do mean everything) to do with the Internet in India. According to the Internet & Mobile Association of India (IAMAI), at the end of 2005, India had about 38 million internet users and the number is expected to rise to 100 million users by end of 2008. The current internet penetration in India is barely 5% and will only be 10% by 2008, when it reaches the 100 million mark. Sify, so far, has been an underachieving company but there is hope for the future. Raju Vegesna (A Silicon Valley based investor and founder of ServerWorks, which was later sold to Broadcom) bought a majority stake (as well as became the chairman) in Sify late last year, igniting a run in the stock from about $5 to the mid teens. Raju Vegesna took over as the CEO in an announcement made on July 18, 2006 and Wall Street reacted negatively, pushing the stock down considerably in recent weeks. I am however willing to give Raju Vegesna a chance to see if he can fulfill the potential of this company. Having a US based CEO is a plus for Sify as it needs to expand internationally and find ways to make money overseas. This is exactly the number one priority of the new CEO. If he can gain leverage internationally there is a lot of potential for Sify in the short term and the long-term prospects for this company is a no-brainer given the expected rise in internet usage in India.
Sify has positioned itself to take advantage of this growth in a big way. Let us look at everything Sify is involved in:
- Portals: Sify has one of the most popular portal in India (Sify.com) and recently launched India’s first broadband portal SifyMax.com. One of its new initiatives is launching localized portals for major Indian cities. So far Sify has launched BangaloreLive.in and MumbaiLive.in, which are broadband portals with lots of local content for people living in those cities. This is a first in India and I see a lot of potential in this. Portals for other cities will be launched soon. The company recently bought a travel portal catering to the US – India travel segment called Globe-Travels.com. Portals are one area where Sify always underachieved but the recent initiatives are paying off. The portal business grew by 96% year-over-year when Sify reported results last quarter.
- Cyber Cafes – Sify has about 3400 Internet cafes all over India (34 of these Cyber Cafes are company owned and the rest are franchisee owned). Most people in India cannot afford computers and their primary way of accessing the internet is through Cyber Cafes. iWay also offers the following,
-VOIP – Sify iWay’s offer cheap rates to call internationally and domestically.
-Internet training classes
-E-Ticketing, travel services and other eCommerce
- GameDromes – Sify Gamedromes are specialized Internet gaming cafes. Gaming is still in its infancy in India, but like everything else, is growing at a tremendous rate.
- MMORPG Gaming – Sify has teamed up with a South Korean company to customize its MMORPG game for Indian tastes. This game was recently launched so it is hard to measure its success.
- Broadband – Sify has about 191,000 broadband cable subscribers. Sify is the third largest ISP overall and the biggest private player. In the recent quarterly earnings conference call they stated that they plan to have 350,000 subscribers by the end of this year.
- Enterprise Services – Enterprise services provides the biggest chunk of revenues for Sify.
- VPN Services
- Hosting Services
- Application Services.
- Global Infrastructure Management Services (Huge potential here)
Portals: Rediff.com (REDF), IndiaTimes.com (Private), Yahoo (YHOO), Google (GOOG) and MSN (MSFT).
ISP: VSNL (VSL) and MTNL (MTE) and other local Indian outfits.
Sify also has several local competitors for its other business units.
- The new CEO, Raju Vegesna, has stated that focusing internationally is their number one priority.
- Sify is focusing on content for its portal since it’s very hard for Indian portals to compete with Yahoo and Google over services such as Email and Instant Messenger. This is the right strategy.
- The new local portals for Indian cities.
- Infrastructure Outsourcing – Sify won 2 US customers in Q4 that will generate revenues of $2 million each year for the next 5 years.
- Gaming – Still very early in India but a huge market.
- Online Travel – Another growing market but a lot of competition. Sify will have to leverage its portals and cyber cafes to promote the travel site.
- Cyber Cafes – Lots and lots of potential here.
- Potential buyout target – I have written about this in detail here.
- Sify faces major competition in pretty much every field.
- Sify has failed to take advantage of the mobile growth in India.
- The stock is relatively unknown when compared to other Indian stocks even though it was the second Indian company to list on NASDAQ.
- Competition and margins are tough in the ISP business.
|P/E||N/A||Long Term Debt||$0.057 Million|
Every month we will add the two featured stocks into a model portfolio started with a cash position of $100,000 on August 2, 2005. To keep calculations simple, trading costs and regular dividends are not included. Prices reflect the closing price as of the last trading day of the previous month (July 31, 2006 for the August 2006 newsletter).
|Stock/Cash||Number of Shares||Cost||Current Value||Difference($)||Difference(%)|
Voluntary Disclosure: I currently own shares of Airspan Networks (AIRN), ATI Technologies (ATYT), Royal Philips (PHG), Nokia (NOK), Medifast (MED), Tata Motors (TTM), RCM Technologies (RCMT), Logitech (LOGI), Intel (INTC), VA Software (LNUX), Suntech Power Holdings (STP) and Sify Ltd (SIFY).
- Suria Investments, Inc. does not warrant the completeness or accuracy of the content or data provided in this newsletter.
- Suria Investments, Inc. does not comprise any solicitation to buy or sell securities.
- Suria Investments, Inc. will not be liable for any investment decision made or action taken based upon the information in this newsletter.
- We suggest you check with a broker or financial advisor before making any investment decisions.