Breakout Stocks Weekly Summary
Larsen Kusick
This week, Carlyle Capital, a division of private-equity heavyweight the Carlyle Group, announced that it failed to meet several margin calls. In addition, Thornburg Mortgage (TMA:NYSE), long considered a high-quality mortgage play, received a default notice from its bankers due to its own margin calls. These pieces of news were just the latest addition to the already enormous headwinds facing the financial industry.
We also saw publicly traded retailers report their February sales numbers on Wednesday and Thursday. According to Thomson Financial, the results were slightly better than expected, with retailers posting a 2.2% increase in same- store sales. However, this gain was actually the weakest seen since 2003, and there was notable weakness in department stores such as J.C. Penny (JCP:NYSE) and Nordstrom (JWN:NYSE).
Friday heralded the arrival of the long-awaited February jobs report, and the numbers were not good. The economy lost 63,000 jobs, which was well below expectations. In addition, the December and January numbers were revised down. Unemployment came in lower than expected at 4.8%, a function of people leaving the labor force, which may be a sign that they don't see much point in looking for a job in the current environment.
All the data points we've seen this week add up to a slowing economy, so we're not surprised to see the market continue its nasty downtrend. Depending on the trading action we see next week, we may decide to get a bit more aggressive in putting money to work in the model portfolio. The S&P 500 and Nasdaq are nearly 20% off their highs, and the Russell 2000 is roughly 23% off its highs. Plus, many former momentum favorites -- such as Google (GOOG:Nasdaq), Apple (AAPL:Nasdaq) and Amazon.com (AMZN:Nasdaq) -- have gotten smashed, indicating that a lot of the speculative money has left the market.
But again, we are emphasizing our view that investors should take a cautious approach to the market. That's because the action is very uneven and the financial sector's problems are a major obstacle for the economy. When it comes to investing during dangerous times like today, we expect those who take a slow and steady approach to come out ahead down the road.
Now, let's take a quick look at the action in the model portfolio this week:
-- On Monday morning, we added 75 shares to our position in Central European Distribution (CEDC:Nasdaq). Central European was selling off on news of a securities offering, but we considered the decline a buying opportunity given that the company had already announced it would be raising money to fund its acquisitions. We consider this name to be an excellent way to play the booming economies of Poland and Russia, and the stock remains rated a One.
-- Tessera Technologies (TSRA:Nasdaq) took a hit on Tuesday as the U.S. Patent and Trademark Office issued an action rejecting claims of a Tessera patent. While that action was far from final and has no impact on current revenue, the market took it hard and the news does represent a significant headwind for the stock. Tessera remains rated a Two, and we'll look to dump the position on a bounce.
-- On Wednesday, Focus Media (FMCN:Nasdaq) announced a reshuffling of its executive suite, which we believe could lead to a spinoff of some of the company's businesses. Current CEO Jason Jiang is shifting his focus toward running the company's new media businesses, and considering the company's stated intention of spinning off its mobile- phone advertising business, we believe an even bigger deal - - including one in the Internet advertising segment -- could be in the works. Focus Media remains rated a One.
We know that times are extremely tough -- not just for investors, but for everyone out there trying to put food on the table and fill up the gas tank. As always, feel free to email us with any thoughts or questions you may have.
Now, let's look at the model portfolio in further detail. As a reminder, we divide the stock portion of the Weekly Summary into Ones, which are stocks that we would buy at their current quotes, and Twos, which are stocks that should not be bought at their current levels.
ONES
Akamai Technologies (AKAM:Nasdaq, $34.19, 400 shares, 5.5% of the model portfolio): Akamai is the world's leading provider of Internet content delivery services. We remain bullish on Akamai following last week's court ruling that competitor Limelight Networks (LLNW:Nasdaq) infringed on Akamai's patents. Shares of Limelight were subsequently beaten down, which we believe makes it more likely that Akamai is going to make a bid to acquire the company. A merger would make the competitive landscape a bit friendlier for Akamai, which would be positive for the company's margins.
American Apparel (APP:Amex, $11.39, 900 shares, 4.1%): American Apparel is a high-growth apparel retailer operating 175 stores in 13 countries. We remain positive on American Apparel despite the headwinds facing consumers, as the company is well positioned to generate outstanding earnings growth in the coming years. By focusing on young, urban consumers who usually don't own automobiles and/or homes, American Apparel's customer base isn't being hit as hard by high gasoline prices and problematic mortgages as the average consumer. In addition, retailers like the Gap (GPS:NYSE) are slowing their store expansion plans, which is reducing competition for attractive store locations.
Central European Distribution Corp. (CEDC:Nasdaq, $51.76, 225 shares, 4.7%): The company produces, distributes and imports alcoholic beverages, mostly in Poland. We added 75 shares to our position in Central European on Monday after the company announced it intends to offer $310 million in convertible notes, due in 2013. In its prospectus filed with the Securities and Exchange Commission (SEC), Central European said that it plans to use the proceeds for its proposed acquisitions, as well as general corporate purposes. We believe Central European is a great way to play the rapid economic growth in Poland and Russia, and we remain bullish on the stock.
Dolby Laboratories (DLB:NYSE, $44.51, 275 shares, 4.9%): Dolby is the global leader in audio technologies used in consumer electronics and professional content productions, such as films and TV programs. We believe consumer electronics demand will slow down somewhat this year, but we continue to like Dolby given its leverage to fast- growing segments such as HDTVs and notebook PCs. In addition, we believe Dolby's newer technologies -- like Dolby Volume -- could create substantial revenue within the next couple of years. Plus, Dolby consistently generates significant free cash flow, which gives the company ammunition for additional acquisitions.
Energy Conversion Devices (ENER:Nasdaq, $27.25, 525 shares, 5.8%): The company, a conglomerate in the alternative- energy space, has segments that work in solar power and advanced battery technologies and applications to develop improved flash memory. Energy Conversion Devices remains our top alternative energy play, as we believe the company's improving sales momentum and increasing margins make it an attractive investment. Energy Conversion has seen a remarkable turnaround in solar sales in recent quarters, and as it stands now, more than 80% of the fiscal 2009 sales pipeline is full. In addition, the company's stake in memory company Ovonyx could turn out to be enormously valuable if its PRAM memory technology were to take off. While we still consider Energy Conversion to be one the most speculative names in the model portfolio, we remain bullish on the stock.
Focus Media (FMCN:Nasdaq ADR, $43.80, 425 shares, 7.5%): The company operates a network of advertising platforms in China. On Wednesday, Focus Media appointed Dr. Tan Zhi, the former president of the company, to the position of chief executive officer. Current CEO Jason Jiang will remain on board as executive chairman. However, the kicker is that Jiang will continue to work for Focus Media full-time and head up the company's Internet and mobile phone advertising businesses. We believe this news could foreshadow a spinoff of the company's new media businesses. Focus Media is currently exploring a spinoff of its mobile phone advertising business, and we would consider a bigger spinoff to be even more positive for the stock price.
GameStop (GME:NYSE, $42.68, 325 shares, 5.6%): The company is one of the world's largest retailers of video-game hardware and software, with more than 5,000 stores across the globe. We remain very positive on GameStop as we believe the video-game industry is on track to have an outstanding year, based on our analysis of the industry's product lineup this year. The next few months will see several software title releases, including Nintendo's "Super Smash Bros. Brawl" and Take-Two Interactive's (TTWO:Nasdaq) "Grand Theft Auto IV," and we believe these likely blockbusters could drive renewed investor interest in the sector. We view GameStop shares as undervalued at current levels.
GFI Group (GFIG:Nasdaq, $70.98, 275 shares, 7.9%): This company provides brokerage services to investment banks and hedge funds, with a focus on derivatives, including credit, financial and commodity products. GFI remains a top pick for the model portfolio, as we believe the company will benefit from rampant market volatility -- especially in the credit and equity markets. Between concerns about the domestic economy, a declining dollar and a very unpredictable presidential election, we believe market volatility this year will exceed that of a pretty wild 2007. In addition, it is very important to note that GFI does not have any subprime exposure or balance sheet problems like the major banks and brokers do.
Guess? (GES:NYSE, $38.10, 400 shares, 6.1%): Guess? is an international retailer and wholesaler of apparel aimed at young men and women. We believe Guess? will have a successful 2008 because, unlike the vast majority of its apparel rivals, Guess? is seeing tremendous domestic sales momentum. We attribute this to the company's ability to regularly churn out hit products. Guess? is also generating impressive growth internationally, especially in emerging markets like China. Plus, Guess? has successful licensing wholesale and licensing businesses. We believe the stock can hit $50 or higher this year.
Netgear (NTGR:Nasdaq, $21.11, 650 shares, 5.5%): The company develops and markets networking products aimed at consumers and small businesses. We remain quite positive on Netgear for the long term, as the company should continue to benefit from growing demand for broadband Internet access and wireless networking equipment. In addition, we believe Netgear's extremely cheap valuation and $205 million cash balance makes it an attractive takeover target for a larger hardware company. In particular, Cisco (CSCO:Nasdaq) would be a very good fit as it would gain a dominant position in consumer networking products.
Perfect World (PWRD:Nasdaq, $27.05, 675 shares, 7.3%): Perfect World is a leading Chinese video-game developer. Perfect World is our top name in the video-game space right now. The company has delivered two outstanding quarterly earnings reports in a row, has sky-high 53% operating margins, and generates enormous free cash flow. In addition, the company has a very solid catalyst for growth with its recently released title "Chi Bi," which is based on the biggest budget film in Chinese history. At the same time, the stock trades at an enormous discount to U.S.- based video-game companies -- such as Electronic Arts (ERTS:Nasdaq) -- that are growing at much slower rates and are much more cyclical. We believe Perfect World can hit $40 or higher this year.
Silicon Motion Technology (SIMO:Nasdaq, $15.00, 525 shares, 3.2%): Silicon Motion is a semiconductor company that specializes in microcontrollers used in flash memory. We remain positive on Silicon Motion because we believe the flash memory market will grow substantially in the coming years, as prices continue to fall and consumer electronics manufacturers increase the quantities of flash memory they include in products such as mobile phones and MP3 players. In addition, the stock is extremely cheap at roughly eight times expected full-year earnings, which we believe discounts an absolute worst-case scenario for the company. Plus, we could see the company announcing a large share- repurchase program, given its sizable cash balance.
TWOS
Tessera Technologies (TSRA:Nasdaq, $15.13, 200 shares, 1.2%): The company specializes in licensing miniaturization technologies to major semiconductor manufacturers. Tessera took another big hit on Tuesday, as the U.S. Patent and Trademark Office issued an action rejecting claims of a Tessera patent. While this action is far from final and won't impact Tessera's current revenue, we don't believe it makes sense to get aggressive with our position given the company's patent headaches.
Zoltek (ZOLT:Nasdaq, $21.82, 350 shares, 3.1%): The company produces carbon fiber, a strong composite material used to reinforce blades for wind turbines and airplane brake pads. The price of oil at $100-plus is a definite positive for alternative energy stocks, but we're staying cautious on Zoltek for now. Despite rampant demand for carbon fiber, Zoltek delivered lousy first-quarter results, so we don't see any need to get aggressive with our position. We'll look for a decline into the low $20s before becoming bullish on Zoltek again.
