SINLetter - June 2008

Welcome to edition 34 of Suria Investment Newsletter (SINLetter), a free monthly investment newsletter. The objective of this newsletter is to provide you with unbiased initial research and basic facts about individual stocks and other financial instruments so that you can research them further before deciding to add them to your portfolio or not. If you are reading this and are not a subscriber, 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.


Subscriber Number 2000:

It look us 19 months to reach the 1,000 subscriber mark and an additional 14 months to reach 2,000 active confirmed subscribers this May. After subscriber number 1,000 proved elusive, I decided to bump up the prize for the lucky subscriber number 2,000 to a $200 Amazon.com gift certificate. James Altucher and Michelle Leder had agreed to donate autographed copies of their books Trade Like Warren Buffett and Financial Fine Print respectively to subscriber number 1,000 and I might be able to convince them to do the same for subscriber number 2,000 as well. So if you are the lucky one, you can expect to hear from me this week.

My long-term goal with this website is to launch an additional paid newsletter or research service that picks stocks based on certain special situations. While search engines and partner websites have helped drive traffic to SINLetter, a large number of our new subscribers were also on account of word of mouth recommendations. So don't shy away from the Tell-A-Friend link and help us get to 3,000 subscribers by the end of this year. If just half of you were to recommend this investment newsletter to one person, we would probably get to our goal next month.


May Blog Entries:

If you do not subscribe to blog entries by email or in case you missed them, here are the blog entries for May.

If you do not receive blog entries by email, you can subscribe to receive blog entries by email here.


Portfolio Performance And Other Thoughts:

Solid gains in last month's Brazilian commodity play Companhia Siderurgica Nacional (SID), EMC Corp (EMC), Diamond Offshore Drilling (DO) and Medifast (MED) helped offset additional losses in Tata Motors (TTM) and Barclays PLC (BCS), leaving the SINLetter model portfolio with a gain of 1.99% in May. As you can see from the table below, the model portfolio outperformed the Dow and the S&P 500 in May but could not keep pace with the Nasdaq.

Performance Metric Dow S&P 500 Nasdaq SINLetter
May 2008 -1.42% 1.07% 4.55% 1.99%
Since Inception (Aug 2005) 18.97% 13.36% 14.91% 112.39%


SINLetter May 2008 Portfolio Performance

"Ask most economists about inflation, and they'll tell you there is no inflation, except in energy and health care and housing. So as long as you don't have a car, a cough or a roof, you have nothing to worry about." - John Waggoner, Mutual Fund Columnist, USA Today on the Nightly Business Report.


Something is not right about this market. The consumer sentiment index is at the lowest level it has been in almost 28 years, GDP growth in the last two quarters was an anemic 0.6% and 0.9% (revised upwards), weekly jobless claims have been rising, three regional banks have failed since the start of the year and the number of banks on FDIC's list of "problem banks" have jumped in the second quarter of 2008. To top it all food and energy costs are increasing rapidly but are not completely reflected in official inflation number of 3.9%. Yet the market barely flirted with a 20% correction from the highs set in early October and has actually recovered almost half of those losses. As you can see from my 2008 Outlook in the January newsletter, I started the year saying "my enthusiasm for common U.S stocks is the lowest it has been in years" and my sentiment remains little changed right now. If there ever was a time when proper asset allocation, diversification and stock/sector picking were important, this seems to be it.

Though I prefer to stick mostly to just individual stock picking and do not have a crystal ball to foretell what the future holds, not paying heed to what the overall market is telling you can be disastrous. A good example of this was when the weak retail sector dragged down portfolio holding Gymboree (GYMB) all the way down to $26.69 and a paper loss of more than 36% in the model portfolio. I recollect looking at Gymboree' stock at around $28 with a valuation way below Gap's (GPS) despite Gymboree's solid growth prospects and asking a colleague "how could the market possibly value Gymboree at such a discount to troubled retailer Gap?". My conviction of sticking with Gymboree proved fruitful as the stock rebounded a whopping 72.87% in less than 5 months and is now posting a gain of almost 10% in the model portfolio.

Lionsgate Entertainment (LGF) got a boost last Friday with the stock up more than 8% in anticipation of fourth quarter results, which came out after the closing bell. The company reported a 54% jump in revenue to $511.5 million for the quarter ending March 31, 2008 and a 19% increase in net income to $29.8 million or 22 cents per share. For the full fiscal year 2008, the company did not meet analyst expectations of a loss of 50 cents per share and reported a loss of $74 million or 62 cents a share. Investors reacted adversely to this news and the stock dropped more than 4% in after hours trading on Friday. As long-term investors in Lionsgate are aware, the company decided to spend aggressively on production and marketing earlier in the year and while this impacted full year results, the benefits were clearly evident in the fourth quarter. The company generated $137 million in free cash flow in fiscal 2008 and its cash and cash equivalents grew to $371.6 million from $215.05 million in the previous quarter. With a "filmed entertainment backlog" of $437.4 million (revenue that will be booked in the future), I see these results as positive for the company but it will be interesting to see how the market interprets them after the opening bell on Monday.

After a volatile month, Gold gave up most of its gains in the last week of May to close the month at $877.00 per troy ounce, a gain of just $0.40 or 0.04% for the month.

Portfolio Readjustment:

As discussed in the portfolio performance section above, Gymboree the stock has seen quite a turn around (the company was doing just fine all along) in recent months and is up 72.87% from the lows set in early January. While we purchased the stock at a higher level and are only seeing a gain of 9.8%, given the state of the economy and sinking consumer confidence, I believe it may be prudent to take profits off the table with Gymboree at this time. I am going to sell 200 shares of Gymboree from our model portfolio and plan to sell Gymboree from my personal portfolio after this newsletter goes out to subscribers. I still like the long-term prospects of the company and will move the stock to our watchlist in case the stock offers an attractive reentry point in the future.


Textron Inc. (TXT) $62.55

The Story:

As a follow up to my blog entry Copter Crisis: Investment Opportunity?, which focused on the shortage of helicopters due to increased commercial use and by offshore drilling platforms, I wanted to focus on one of the six helicopter related companies listed in the blog. After considering various factors such as size of the company, operating margins, revenue growth rate, insider ownership and valuation metrics, I finally settled on Textron as the company with the most potential over the next few years.

Founded in 1923, Textron is an industrial conglomerate that makes everything from electric golf carts to the Cessna line of business jets and personal aircraft. The company operates as five different segments called Bell (helicopters), Cessna, Defense & Intelligence, Industrial and Finance. Cessna is the largest segment at Textron representing 38% of 2007 revenue and 35.42% of Q1 2008 revenue. Bell Helicopter, the third largest segment at Textron representing 19% of 2007 revenue, makes both commercial and defense choppers. The latest innovation from Bell Helicopter (in partnership with Boeing) is the Bell-Boeing V-22 Osprey, which according to the V-22 website is "the world's first production tilt rotor combining the vertical performance of a helicopter with the high speed and range of a fixed wing aircraft."

However the focus of this investment thesis was the shortage of commercial helicopters and it appears that demand for commercial choppers has indeed been strong at Bell with the segment delivering 268 orders in 2007, significantly higher than the 181 deliveries made in 2006. Demand seems to have softened in the first quarter of 2008 with revenue down $56 million on account of lower helicopter volume but the segment managed to post a $1 million increase in profit due to higher pricing and in the words of the company "favorable program performance".

While choppers may have lead me to Textron, I think the truly exciting part about the company is the potential growth in the Cessna segment and the defense side of the business. According to their website, the Cessna division has built "more business jets than the combined total of all competing aircraft" and in this case it looks like the future could very well be a repetition of the past with an order backlog of $14.5 billion, up from $12.6 billion at the end of 2007. Its latest and biggest business jet, the Cessna Citation Columbus appears to be off to a good start with 36 orders in the first quarter. The popular and smaller Cessna Mustang has an order backlog that extends all the way to 2011. NetJets, the leader in the fractional jet ownership segment, uses a number of Cessna aircraft in its fleet and interestingly Cessna also likes to play in the fractional jet ownership market with its CitationShares program.

Cessna Citation Columbus

Textron inked a muti-year contract with the Department of Defense in March to deliver 167 units of the V-22 Osprey over five lots. The first of these five lots was booked in the first quarter of 2008, helping nudge the overall order backlog at Textron to $26 billion at the end of Q1. This compares with an order backlog of $18.8 billion at the end of 2007 and $12.9 billion at the end of 2006.

Numbers and Valuation:

In the first quarter of 2008 Textron reported revenues of $3.518 billion, up 18.7% from Q1 2007 and earnings per share from continuing operations were $0.93, up 19.2% from the year ago period. Free cash flow in the first quarter was $78 million compared to $28 million in Q1 2007. For the full year 2008, the company expects to book revenue of $15.265 billion, representing revenue growth of 13.36% when compared to 2007 revenue of $13.225 billion. Textron recently bumped up its full year earnings expectations to $3.80 to $4.00 per share, representing earnings growth in the range of 5.8% to 11.4% when compared to earnings of $3.59 in 2007.

The company expects to generate cash flow of $1.3 billion in 2008 and free cash flow of $700 to $750 million after capital expenditures.

Whether you look at Textron's financial metrics such as return on equity or the fact that the company ranked number 1 for the Aerospace & Defense sector in Fortune magazine's list of America's Most Admired Companies, it is evident that Textron is a well run company. Given its growth prospects, the company almost looks cheap with a forward P/E of 13.54, a P/S of 1.13 and a PEG ratio of 1.14.

TXT 1 year chart


A couple of negative things to watch out for include problems in the finance division where revenue increased $4 million but profit dropped $10 million when compared to last year due to increased loan provisions and the higher cost of borrowing money. Non-performing assets increased to 1.84% from 1.34% at the end of 2007.

CEO Lewis B. Campbell sold $36 million in company stock in April and May. While insider sales may not necessarily be negative, the magnitude of these sales certainly caught my attention.

Conclusion:

This company is firing (pun intended) on all cylinders and the drop in January that has left the stock down more than 10% year-to-date provides an attractive point of entry. In keeping with my policy of not investing in defense and sin (or vice) stocks and because I am actually scaling back on the stock portion of my portfolio in anticipation of a big purchase, I do not plan to add Textron to my personal portfolio.


Every month we add 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 (May 31, 2008 for the June 2008 newsletter).

Model Portfolio - May 31, 2008

Long Stocks

Stock Symbol Number of Shares Cost Current Value Diff ($) Diff (%) Date Added
Textron TXT 150@62.55/share $9,382.5 $9,382.5 $0 0% 5/31/2008
Companhia Siderurgica Nacional SID 200@43.15/share $8,630 $9,834 $1,204 13.95% 4/30/2008
Lionsgate Entertainment LGF 1,000@9.41/share $9,410 $10,650 $1,240 13.18% 2/29/2008
Tata Motors TTM 500@17.52/share $8,760 $6,930 $-1,830 -20.89% 2/29/2008
Barclays PLC BCS 200@42.27/share $8,454 $5,986 $-2,468 -29.19% 11/20/2007
Powershares Water Resources PHO 400@22.10/share $8,840 $9,080 $240 2.71% 10/31/2007
Marcus MCS 500@19.94/share $9,970 $8,615 $-1,355 -13.59% 9/14/2007
Ultrashort Russell 2000 TWM 50@71.00/share $3,550 $3,381 $-169 -4.76% 9/7/2007
Blockbuster BBI 3,000@3.925/share $11,775 $9,750 $-2,025 -17.2% 7/9/2007
Unilever Plc UL 200@32.53/share $6,506 $6,610 $104 1.6% 5/11/2007
EMC Corp EMC 600@13.85/share $8,310 $10,464 $2,154 25.92% 3/31/2007
ICON Plc ICLR 150@37.30/share $5,595 $10,575 $4,980 89.01% 1/31/2007
Diamond Offshore Drilling DO 80@76.65/share $6,132 $10,915 $4,783 78% 1/3/2007
Alvarion ALVR 1000@6.87/share $6,870 $7,160 $290 4.22% 1/3/2007
WisdomTree Investments WSDT.PK 1000@7.40/share $7,400 $2,650 $-4,750 -64.19% 11/30/2006
Teva Pharmaceutical TEVA 300@35.05/share $10,515 $13,719 $3,204 30.47% 9/1/2006
Suntech Power STP 250@25.93/share $6,483 $10,635 $4,152 64.06% 7/31/2006
Procter & Gamble PG 180@55.60/share $10,008 $11,889 $1,881 18.79% 6/30/2006
Johnson & Johnson JNJ 200@57.65/share $11,530 $13,348 $1,818 15.77% 2/28/2006
Medifast MED 1000@6.955/share $6,955 $5,850 $-1,105 -15.89% 11/30/2005
  Cash     $34,971.5      
  Total     $212,394 $112,394 112.39%  

 

Voluntary Disclosure: From the stocks that are currently in the model portfolio, I own shares of Lionsgate Entertainment (LGF), Tata Motors (TTM), Canon (CAJ), PowerShares Water Resources (PHO), Barclays (BCS), Medifast (MED), Suntech Power (STP), Teva (TEVA), Alvarion (ALVR), WisdomTree (WSDT.PK), Unilever (UL), Gymboree (GYMB), BlockBuster (BBI) and Marcus (MCS).

 


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