SINLetter – September 2006
Note: This edition was sent out later than usual because I was on vacation during the Labor Day weekend. I mentioned the delay in this SINLetter blog post. The monthly performance and “since inception” numbers are based on close of market on August 31st, 2006. The portfolio at the end of this investment newsletter is based on close of market on September 1st, 2006 as I make portfolio adjustments based on the last trading day before this newsletter is sent out. The difference in the overall model portfolio between these two days was 0.01%.
Welcome to edition 14 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.
New Developments: Based on the record number of subscribers in August, it certainly appears that many of you are spreading the word about SINLetter. A mention on TheStreet.com also helped. A couple of months ago, I was asked by a subscriber if I plan to start covering mutual funds and Exchange Traded Funds (ETFs) in the future. In addition to contributing content to SeekingAlpha, I have now started writing about ETFs for ETFtrends.com, a website that has been mentioned in the Wall Street Journal, BusinessWeek and Barron’s. ETFtrends.com is an excellent source for daily updates about ETFs and my posts on ETFtrends will be republished on the SINLetter blog under the ETF category. Did I mention that you could easily spread the word about SINLetter through the Tell-A-Friend page on SINLetter.com?
We have also created a new page on SINLetter called Dogs Of The Dow that automatically computes the returns of the 2006 Dogs of the Dow every time you visit the page. The Dogs of the Dow theory was used in the January 2006 edition of SINLetter to pick Pfizer (PFE). From this article on MarketWatch.com, it appears that Pfizer is still a favorite amongst newsletter editors.
The SINLetter model portfolio outperformed the three major indices in August powered by strong returns from the trio of Indian stocks in our portfolio, Tata Motors (TTM), Infosys (INFY) and Sify (SIFY). The monthly and “since inception” performance is tabulated below.
|Performance Metric||Dow||S&P 500||Nasdaq||SINLetter|
|Since Inception (Aug 2005)||7.13%||5.54%||-0.53%||67.35%|
The Bombay Stock Exchange (BSE) Sensex gained 955.17 points or 8.89% in August 2006 to close at 11,699.05. In retrospect, the 29.2% correction in the May-June period appears to have been a great buying opportunity. I am glad I stayed the course with Tata Motors and also added other Indian stocks like Infosys and Sify to our portfolio. Tata Motors saw strong July sales numbers, which came in 44.5% higher when compared to the same period last year. The company also received approval to set up a vehicle financing subsidiary, helping the stock post a gain of 16.9% in August.
The Indian internet portal Sify (SIFY), which was featured in the anniversary edition of SINLetter, posted equally strong gains of 17.05% last month as the company continued strengthening its management team and teamed up with a top Indian TV channel for an American Idol type show.
The Chinese solar energy company Suntech Power (STP), which was featured last month also posted gains of 11.84% in August after deciding to acquire a leading Japanese solar company MSK Corp in a two-step transaction worth up to $300 million. On August 4th, Goldman Sachs initiated coverage of Suntech Power with a buy rating. Suntech handily beat analyst estimates when it reported second quarter results on August 15th with revenue increasing a very impressive 205.9% year-over-year and earnings soaring to $26.5 million, or 17 cents per share, from $1.4 million, or 1 cent per share in the second quarter of 2005. I continue to like the long-term prospects of Suntech, Tata Motors and Sify and plan to hold them in the model portfolio and my personal portfolio.
There is widespread speculation that the economy may go into a recession towards the end of this year or the first part of 2007 as the housing bubble unwinds. This perception is certainly helping our trio of defensive stocks, Procter & Gamble (PG), Safeway (SWY) and Johnson & Johnson (JNJ), as investors are shifting towards large dividend paying stocks in the consumer staples and healthcare sectors. Johnson & Johnson (JNJ) also made headlines after the Oracle of Omaha and the second richest man on earth, Warren Buffett, decided to add Johnson & Johnson to his holding company Berkshire Hathaway’s (BRK-A) portfolio. I still remember the shocked look on the face of a friend when I told him about four years ago that there was a stock that traded at about $76,000 a share. I should let him know that Berkshire Hathaway has done well since then and the class A shares now trade at $96,000 each.
Medifast (MED), our top performing stock since June 2006 took a hard hit in August after it released quarterly results that raised concerns about increasing customer acquisition costs (CAC) and slowing earnings growth in the second half of this year. I have posted highlights from the conference call and additional comments on the SINLetter blog. Barron’s also had a negative piece on Medifast this weekend and they expect the stock to fall to $9. Normally such a steep decline would have hurt the model portfolio considerably but having a diversified portfolio containing 16 stocks helped offset this drop. We also took some profits off the table two months ago by liquidating half our position in Medifast based on its rich valuation and heavy insider selling.
Logitech (LOGI) and Intel (INTC) swung firmly into black in August thanks to recent gains in the technology sector. Wall Street sentiment about Intel finally appears to have turned a corner. Speaking of Intel, if you have a couple of minutes and would like to entertain yourself, check out this upbeat voicemail by Mike Masdea, a well-respected semi-conductor analyst. On a more serious note, Intel plans to announce sweeping global layoffs of up to 10,000 employees. While investors usually cheer layoffs (it improves profitability), this magnitude of job cuts at a highly profitable company could be negative unless it is associated with specific unprofitable business units. I plan to hold Intel in our model portfolio until further details of these job cuts and inventory write down emerge.
One of the fundamental rules of trading says that you should sell your losers and hold on to your winners. As you can see from this SmartMoney article, it is a very good rule indeed. On the other hand, according to legendary investor Philip Fisher “If you’ve done the right research up front, the best time to sell a stock is almost never”. In order to finance the new stock this month, I am going to use the former rule and sell one of our losers.
When I featured Eaton Corp (ETN) in the May 2006 edition of SINLetter, I identified a recession or a slowdown in the economy as one of the key risks that Eaton faces. The US Gross Domestic Product (GDP) grew at a much slower pace of 2.5% in the second quarter of 2006 and as mentioned above there is chance that we may see a recession in 2007. Hence I am going to sell Eaton and recognize a loss of 11.51%.
Other Interesting Events:
The hard disk drive maker Seagate Technologies (STX), reported disappointing results on account of its acquisition of rival Maxtor and the stock dropped almost 5% the very same day. I suggested something like this was likely to happen in the May 2006 edition of SINLetter when I said “I expect pressure on Seagate’s earnings in the latter part of this year as Seagate integrates its acquisition of Maxtor”. The stock is now down almost 15% from when we sold it four months ago. Instead of reinitiating a position in Seagate, I would consider investing in rival Western Digital (WDC) who along with Hitachi is gaining market share from Seagate. Investors could also move down one level in the hard disk food chain and consider Komag (KOMG), a company that makes hard disk platters used by almost all the major hard disk makers like Seagate and Western Digital.
The women’s retailer Chico’s (CHS) tumbled in August based on negative same store sales. Retailers can easily skew aggregate sales numbers by opening new stores and hence investors closely watch the same store numbers to see how well a retailer is doing. This was the primary reason I decided not to invest in another specialty retailer Mothers Work (MWRK) back in March and it appears that four months later, The Catablast Media Group came to the same conclusion. But that did not stop the stock from heading higher and it is up almost 60% in six months.
Gold closed the month of August at $625 an ounce, a drop of 1.45% for the month.
The featured stock for September is given below.
Teva Pharmaceutical Industries (TEVA) $35.05
I am sure many of us have had to face the exorbitant cost of healthcare over the last few years, either in the form of high insurance premiums, expensive drugs or seemingly endless tests on highly sophisticated equipment. While the quality of care is excellent (in most cases), the cost is usually appalling. These high costs generally translate into excellent profit margins for companies that operate (pun intended) in the healthcare sector. I have been following the healthcare sector closely since last year and have featured companies like Pfizer (PFE) and Unitedhealth Group (UNH) in previous editions of SINLetter. Other featured stocks like Johnson & Johnson (JNJ) and Philips Electronics (PHG) also have highly profitable medical devices businesses.
Before deciding to buy Pfizer for my personal portfolio and featuring it on SINLetter, I talked to a friend who has years of experience in the pharmaceutical industry. Late last year stocks of big pharmaceutical companies like Pfizer and Merck were trading at their lowest level in five years. These stocks were battered thanks to the triple threat of competition from biotechs, a large number of lawsuits and a record number of patent expirations in 2006.
My friend suggested that instead of Pfizer, I explore two other companies called Teva Pharmaceutical and Mylan Laboratories. When I looked them up, I realized that they were companies that made low cost generic versions of big pharma drugs after their patent expires. However Wall Street was very well tuned into the fact that the generic drug companies stood to benefit from the record number of patent expirations 2006 and had bid up the price of companies like Teva by 45.26% in 2005. I decided to put Teva and Mylan on my watch list and picked up Pfizer instead in December 2005. Fast-forward 8 months. Since the beginning of this year Pfizer has gained 23.33% while Teva has lost 18.01%, just as it is beginning to profit from those patent expirations that Wall Street was so tuned into last year. For a complete list of generic drug approvals by year and month, check out this page on the U.S. Food and Drug Administration (FDA) website.
Israel based Teva Pharmaceutical is one of the largest generic drug manufacturers in the world with 2005 revenue of $5.25 billion and over a billion dollars in earnings. Teva currently has an 11% share of the US pharmaceutical market with sales of $393 million from 326 different drugs. For the second quarter of 2006, sales were up by 77%, while earnings were up an amazing 83% and gross profit margins improved to 53.9%. These numbers may not be surprising for a fast growing young company, but Teva is a company with $5.25 billion in annual sales and went public in 1991. Second quarter earnings per share of 66 cents beat analyst expectations by almost 44%.
The drop in Teva’s price in 2006 is largely driven by the fact that Wall Street looks at future earnings and analysts currently believe that 2007 earnings for Teva may not be as good as 2006 earnings. According to Israeli journalist Shlomo Greenberg, Wall Street analysts are mistaken about 2007 earnings and you can read about it in his article here. Teva recently revealed that it has 148 more applications for generic drugs filed with the FDA and has over 1,000 applications pending approval in Europe (Source: Standard & Poor’s). Based on the number of applications and the fact that Teva’s proprietary drug Azilect for Parkinson’s disease will contribute to revenue growth in 2006 and 2007, I believe that Wall Street analysts are probably mistaken about Teva’s future prospects making it an excellent investment at this time.
Teva competes against big pharma companies like Pfizer (PFE), Merck (MRK), GlaxoSmithKline (GSK) and Novartis (NVS). Teva Pharmaceutical also competes with other generic drug companies like India based Ranbaxy and Dr. Reddy’s Laboratories (RDY), US based Mylan Laboratories (MYL) and Canada based Apotex.
- Teva stands to benefit from the new medicare plan that encourages users to opt for cheaper generic drugs.
- Teva is benefiting from the record number of patent expirations in 2006 and in some cases has a six month exclusive right to manufacture the generic versions.
- Teva is currently awaiting the results of an FDA appeal that will allow it to exclusively manufacture the generic version of the blockbuster cholesterol drug Zocor for 180 days.
- Second quarter 2006 sales and earnings were significantly higher with improving gross margins.
- Teva’s acquisition of generic drug manufacturer Ivax Corp earlier this year was considered a good move by analysts.
- As of 2005, Teva had a strong balance sheet with more than twice the total assets as total liabilities.
- It goes without saying that turmoil in the Middle East is a risk to all Israeli companies.
- In an ironic twist, Teva faces competition from big pharma companies like Pfizer and Merck who are rolling out their own generic versions or in some case significantly dropping prices of drugs that are no longer protected by patents.
- Teva also faces increased competition from other generic drug companies like Barr Laboratories, Ranbaxy, Dr Reddy’s, Mylan and Apotex.
- As of 2005, Teva carried a large amount of Goodwill on its balance sheet ($2.46 billion). In early 2006, it also issued more debt to pay for the Ivax acquisition.
|P/E||417.26||Long Term Debt||$1.77 billion|
Note: I am NOT adding these three stocks to our model portfolio.
After juggling with these three stocks for quite some time, I just could not get myself to commit to one of them. Each of them looked interesting but each faced its own unique risks. I discussed Western Digital briefly in the “Other Interesting Events” section above and have personally invested in the company in the past. However I feel that the stock could head lower and provide a better point of entry. IMAX has taken a terrible hit in August after the company announced an informal inquiry by the SEC into its revenue recognition practices and after it failed to find a company that was willing to acquire it at a price acceptable by the board of directors. So while it looks attractive at these levels and I really like watching their big screen movies, there are a lot of uncertainties surrounding this company. RealNetworks almost made the cut based on its excellent Rhapsody music service and the large amount of cash it received from Microsoft last year as part of a lawsuit settlement. However, digging into the numbers a little deeper left me unconvinced that the company could turn a profit without all the marketing incentives that Microsoft is providing as part of the settlement. Hence I leave you with one stock and hopefully a lot of useful information.
Update: For more about why I chose not to feature RealNetworks, check out my blog entry titled Stocks That Almost Made the Cut: September 2006.
Every month we will add the two featured stocks into a model portfolio started with a cash position of $100,000 on August 2, 2005. To keep calculations simple, trading costs and regular dividends are not included. Prices reflect the closing price as of the last trading day of the previous month. For this newsletter prices are as of September 1, 2006 and only one stock was added to the portfolio.
|Stock/Cash||Number of Shares||Cost||Current Value||Difference($)||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 (STP) and Sify (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.