SINLetter - September 2007

Welcome to edition 26 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.

August Blog Entries:

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Portfolio Performance:

In the face of an uncertain market, the SINLetter model portfolio managed to notch another record high of 106.79% since inception but posted a modest gain of 1.54% for the month of August. After seesawing through much of August, the major indices got a boost at the finish line when second quarter 2007 gross domestic product (GDP) was revised upwards to a better than expected 4% and helped the indices close the month of August in positive territory as you can see below.

Performance Metric Dow S&P 500 Nasdaq SINLetter
August 2007 1.1% 1.29% 1.97% 1.54%
Since Inception (Aug 2005) 25.74% 19.32% 18.26% 106.79%


SINLetter August 2007 Portfolio Performance

Despite these gains all is not well with the markets, the economy and parts of our long portfolio. As I mentioned in my July 10th portfolio update, when the inventory of unsold homes hits 9 months, housing is in serious trouble. To put this in perspective, housing inventory hit a peak of 9.4 months in the 1990-91 recession. Housing inventory hit a 15 year high of 9.6 months (9.2 months if you only include single family homes) in July 2007 and we are not even officially in a recession. California's inventory of unsold homes came in a little higher at 10.7 months.

Unfortunately a weak real estate market impacts the broader economy at multiple levels and some of these effects can already be seen with weekly jobless claims increasing and non-farm payrolls dropping for the first time in four years. While you might not see its effects at the mall, the consumer confidence index also dipped in August dragging down most retailers with it including our June pick Gymboree (GYMB).

Our WiMax picks Alvarion (ALVR) and Airspan (AIRN) headed in different directions in August with Alvarion gaining 14.71% and Airspan dropping 23.62%. Alvarion reported second quarter 2007 results with revenue increasing 31% to $57.5 million and net loss narrowing by more than half to 482,000 or $0.01 per share when compared to the same quarter last year. The company generated operating cash flow of $2.6 million in the quarter and on a non-GAAP basis actually posted a profit of $2 million or 3 cents a share. The company also increased its full year revenue growth forecast from a previous range of 15-20% growth to a 25-30% growth rate. The news was bleaker at competitor Airspan when it reported second quarter earnings with net loss widening to $11.7 million or 29 cents per share when compared to $7.67 million or 19 cents per share in the same quarter last year. The company was not only hurt by the winding down of its contract with its largest customer Yozan but also by a drop in sales in its non-WiMax products. While the company appears to have enough cash to last through the end of 2007, it is attempting to raise additional capital through the sale of 14 million shares. Unless it sees a lot of acceleration in its WiMax business in the second half of 2007, it is highly unlikely that Airpsan will achieve profitability in 2008 as I had originally expected. I might exit our Airspan position in the near future and unfortunately take a loss both in the SINLetter portfolio and my personal portfolio.

Our put options on homebuilder St Joe (JOE) and trucking company YRC Worldwide (YRCW) have done exceptionally well and were posting gains of 161.42% and 103.85% respectively at the end of August. Since YRC Worldwide had dropped a lot in recent months, I was considering taking profits by selling our options but then came across the following statements by their CEO Bill Zollars,

"I think the economy is a lot softer than people are saying. The Fed needs to move quickly and make some kind of rate cut so that we can generate some kind of economic growth. The demand we expected has not materialized and our customers are telling us that economic recovery has not shown up at this point."

While this is clearly a distress call from the CEO of a leveraged company much like mortgage lender Countrywide Financial's (CFC) CEO Angelo Mozilo's calls for a rate cut earlier this year, it was a clear signal to me that it was best to continue holding on to our put options on YRC Worldwide. These options have appreciated some more and are now posting gains of 169.23%.

I got an email from a subscriber wondering why Gold was not moving up in this environment as it only posted a tiny gain of $6 or 0.9% to close the month of August at $673.20 per troy ounce. It looks like Gold is finally living up to its reputation of being an asset class that is not correlated to the stock market by cracking the $700 level in the first week of September while the major stock indices were down for the week.

Portfolio Readjustment:

Just days after we added Brazilian aircraft maker Embraer (ERJ) to our portfolio, the company reported a sharp 49% drop in second quarter profits. The company's backlog of orders was increasing and so it decided to hire thousands of employees as well as make capital investments to increase production capacity. These moves are certainly going to help the company in the long-term and our long-term investment thesis on Embraer is intact. However this increased spending is likely to impact the next few quarters as well. Given the current environment, I am not very happy about the prospects of holding on to a company that is likely to have a few weak quarters in the near future and am going to sell our position for a tiny gain of 1.88%.


Hedging Your Bets

It is one thing to recount all the bad news out there and worry about it but it is altogether something different to see the writing on the wall early and act upon it to protect your portfolio. Given the economic outlook, it has been extremely difficult to find new stocks to feature in this newsletter and I decided to concentrate on short ideas for this month's investment newsletter. There are a couple of long ideas I am currently exploring and I will post them on the blog over the next few days instead of discussing them in this newsletter. If you are not familiar with shorting stocks and put options, please feel free to check out the section Hedging The Economy Through LEAP Puts from the November 2006 newsletter.

Having picked the homebuilders as potential short opportunities in 2005 and the mortgage lenders in 2006 we protected the model portfolio by hedging our long positions with put options. At this point in the cycle, it may not be prudent to start new short positions or put options on the homebuilders or the mortgage lenders as they could be very close to their bottom. The only homebuilder that has comparatively not taken a very hard hit is Toll Brothers (TOL) and it could be a potential short opportunity. Given below are five broad themes for short opportunities,

1. RV Manufacturers: While a lot of people are focused on Winnebago Industries (WGO) as a short opportunity, I see smaller rival Monaco Coach Corp (MNC) as a much better short opportunity. Even over the last three years while a record number of people were buying homes and feeling flush with cash, Monaco has seen steadily declining operating and net income. Winnebago's balance sheet also happens to be much stronger than Monaco's. Monaco is the BMW of RVs with its cheapest line of RVs starting at almost $100,000 and higher end models crossing the half a million mark. High gas prices make these gas guzzler home-on-wheels highly unattractive even to the rich folks these RVs are targeted towards. While Monaco has been slowing working down its inventory over the last few quarters, it still has $154.97 million in inventory representing nearly half its current assets.

While I had no qualms about picking homebuilders like St Joe (JOE) and mortgage lenders like Countrywide Financial (CFC) as short opportunities, I do feel a little unhappy about picking Monaco as I have personally known people who have worked at Monaco and it is located right outside Eugene, Oregon, a place I love. However emotion has very little room in the field of investing and I was planning on purchasing Jan 2008 or April 2008 $12.50 put options on Monaco but unfortunately there is very little volume on those options and the April 2008 options have not even traded in more than two weeks. Hence to reflect real world trading conditions, I am going to instead short Monaco, even though I prefer put options. Please note that since Monaco has a dividend yield of 1.8%, you will be responsible for paying this dividend in case you short the stock.

2. Furniture Companies: Furniture companies are yet another group that are directly affected by a weak housing. Beyond the commonly known furniture companies like La-Z-Boy (LZB), Ethan Allen Interiors (ETH) and Pier 1 Imports (PIR), you can also look for short opportunities in companies like Haverty Furniture Companies (HVT), Hooker Furniture (HOFT), Italy's Natuzzi (NTZ), Furniture Brands International (FBN) and Cost Plus (CPWM). From my brief analysis of this group of companies, it looks like Haverty (HVT) could fall the most. While most retailers saw same-store sales increase in August, Haverty saw a sales decline of 10.1% at stores that have been open more than a year.

3. Staffing Companies: An interesting event transpired last week when an old SINLetter pick RCM Technologies (RCMT) made a two unsuccessful bids for larger rival Computer Task Group (CTGX). I sold RCMT from my personal portfolio in two transactions at $7 and $8.25 on its sudden ascent to $10 in July. Based on this aggressive acquisition attempt that does not fall under the category of "diworsification" and a P/E of just 12.44, I am tempted to start a position in RCMT once again but am held back by the dismal job numbers and an economic slowdown, both of which bode badly for a consulting and engineering company.

If you think this subprime mess is hurting home builders and mortgage lenders, check out the action on staffing company Manpower Inc (MAN), which has dropped from $92.24 to $63.93 or 30.69% since the end of June. Competitor Robert Half (RHI) has fared a little better with a drop of 17.81%. In the aftermath of the dot com bust, Robert Half lost more than half its value while Manpower weathered that downturn much better. I think there is little doubt that both these companies are likely to fall even more and could be potential short opportunities. Please note that while Robert Half has a rock solid balance sheet with $434.79 million in cash and very little debt ($4.02 million), Manpower is slightly leveraged with $710.8 million in cash and $847.7 million in debt. Manpower also has an astounding billion dollars in goodwill on its balance sheet.

However if there is one stock I would want to short in this area, it would be Monster Worldwide (MNST), the company behind the job website Monster.com. The stock has fallen hard in recent weeks from a high of over $50 to its current price of $33.50. Beyond a weak job market Monster also faces tough competition not only from traditional job websites like Dice.com and Yahoo's HotJobs but also from Craigslist.com and increasingly from social networking websites like LinkedIn. LinkedIn is favored by professionals and I am beginning to see several "LinkedIn exclusive" jobs. A friend of mine who is looking for equity research positions also landed an interview through LinkedIn. I tried using Monster a few months ago and my experience was terrible. Not only was I inundated by ads every step of the way, I also received a lot of spam from people exploiting monster by posing to be employers. Please note that Monster is as much an internet play as a staffing play and the company has tons of cash and investments with very little debt. Since Monster Worldwide is a highly liquid stock and the options are available, I am going to purchase Mar 2008 $30 put options for $2.05 per contract instead of shorting the stock.

4. Retailers: Consumers inability to use their homes as an ATM machine combined with falling consumer confidence, high energy costs and a drop in non-farm payrolls certainly spells trouble for retailers. Even retailers like Costco (COST) and Gymboree (GYMB) have seen their stocks drop in recent weeks. One potential play would be to short stocks of companies like Bebe Stores (BEBE) and AnnTaylor Stores (ANN) while simultaneously buying discount retailers like Ross Stores (ROST) and TJX Companies (TJX), which operates the stores T.J. Maxx, Marshalls, and A.J. Wright in the United States. Beyond a few retailers, I do not follow the retail sector very closely and hence do not plan on initiating short positions in this sector.

5. The Russell 2000 Index: With the exception of the last few months, small cap stocks as represented by the Russell 2000 index have handily outperformed large cap stocks over the last four years. The recent downward trend of the Russell 2000 is likely to continue as small companies are hurt the most in an economic downturn. Office Depot (ODP) blamed small business spending while announcing that third quarter earnings will decline by double digits. The stock has lost almost half its value since early June. I am going to use the UltraShort Russell 2000 ETF (TWM) by ProShares to short the Russell 2000. Since this is an ETF, it will not show up under "short positions" in the portfolio. If you are not familiar with how the UltraShort ETFs work, check out this article.

Note: Shorting stocks or purchasing put options is a highly risky strategy with the potential of losing your entire investment and then some. I only utilize it to hedge a portfolio consisting of long stocks and use very small positions. A half point fed rate cut may also make the markets go up in response and this short-term event should also be kept in mind.

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. However as this newsletter was delayed by a week, it represents the closing price as of September 7, 2007.

Model Portfolio - September 7, 2007

Long Stocks

Stock Number of Shares Cost Current Value Diff ($) Diff (%) Date Added
TWM 50@71.00/share $3,550 $3,550 $0 0% 9/7/2007
BBI 1,500@4.59/share $6,885 $7,395 $510 7.41% 7/9/2007
GYMB 200@42.02/share $8,404 $7,430 $-974 -11.59% 6/14/2007
UL 200@32.53/share $6,506 $6,338 $-168 -2.58% 5/11/2007
EMC 600@13.85/share $8,310 $11,382 $3,072 36.97% 3/31/2007
EPAX 300@29.70/share $8,910 $11,370 $2,460 27.61% 2/28/2007
ICLR 250@37.30/share $9,325 $12,032 $2,708 29.03% 1/31/2007
DO 80@76.65/share $6,132 $8,643 $2,511 40.95% 1/3/2007
ALVR 1000@6.87/share $6,870 $12,720 $5,850 85.15% 1/3/2007
WSDT.PK 1000@7.40/share $7,400 $3,650 $-3,750 -50.68% 11/30/2006
SNDK 200@48.10/share $9,620 $10,586 $966 10.04% 10/31/2006
TEVA 300@35.05/share $10,515 $13,017 $2,502 23.79% 9/1/2006
STP 400@25.93/share $10,372 $13,976 $3,604 34.75% 7/31/2006
PG 180@55.60/share $10,008 $11,785 $1,777 17.75% 6/30/2006
LOGI 240@20.385/share $4,894 $6,425 $1,531 31.29% 5/31/2006
JNJ 200@57.65/share $11,530 $12,336 $806 6.99% 2/28/2006
MED 1000@6.955/share $6,955 $6,450 $-505 -7.26% 11/30/2005
TTM 900@11.94/share $10,746 $15,210 $4,464 41.54% 11/30/2005
AIRN 1700@5.62/share $9,554 $3,800 $-5,754 -60.23% 8/1/2005


Short Stocks

Stock Number of Shares Cost Current Value Diff ($) Diff (%) Date Added
MNC 300@12.64/share $3,792 $3,792 $0 0% 9/7/2007


Options

Option Number of Units Cost Current Value Diff ($) Diff (%) Date Added
BSQOF.X 10@2.05/contract $2,050 $2,050 $0 0% 9/7/2007
JOEMJ.X 3@7.00/contract $2,100 $5,490 $3,390 161.43% 10/31/2006
YUXMG.X 8@2.60/contract $2,080 $4,240 $3,520 169.23% 10/31/2006
Cash     $11,872      
Total     $206,899 $106,899 106.9%  

 

Voluntary Disclosure: I currently own shares of Airspan Networks (AIRN), Medifast (MED), Tata Motors (TTM), Logitech (LOGI), Suntech Power (STP), Teva (TEVA), Mattel (MAT), SanDisk (SNDK), Alvarion (ALVR), WisdomTree (WSDT.PK), Unilever (UL), Gymboree (GYMB) and BlockBuster (BBI).

 


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