Breakout Stocks Weekly Summary
Larsen Kusick
Those looking for an explanation for the market's decline can take their pick between the ongoing rise in crude oil prices; credit problems and writedowns at major financial institutions; record-low consumer confidence; concerns over inflation; and the inability of the Fed to offer a plan to alleviate these issues.
In our view, investors are wise to be cautious at the moment, but the real long-term winners on a multiyear basis are those who continue to identify names that are working in the current market, as well as names that have sold off and have significant long-term potential when the market recovers. We are focused on finding small-caps that fit either of these two profiles. Along with our most recent additions to the model portfolio, we've seen surprising strength in many of the names on our weekly Watch List.
This week, two companies on our Watch List posted quarterly results that sent shares up sharply. On Wednesday, AeroVironment (AVAV:Nasdaq) beat consensus estimates by 3 cents a share and provided relatively in-line guidance for next year. What surprised us was that shares jumped more than 10% on what was a good -- but not great -- announcement. Apparently, the market really liked management's comments on the future of the business and the company's potential under either a Republican- or Democrat- led White House in 2009 and beyond. We liked what we heard, and are adding this name back to our list this week.
Another name from our Watch List that surprised us is AZZ (AZZ:NYSE), as its shares jumped an amazing 22% on Friday after blowing out consensus expectations. Although it would have been nice if we had been comfortable enough previously to add this name to the model portfolio, we're glad to see that we're "barking up the right tree," so to speak.
The strong action in both AeroVironment and AZZ this week should be noted by readers, as the strategy of the Breakout Stocks service is to find these small, underappreciated companies that have limited research coverage. The fact that these stocks were able to rally strongly in what was generally a terrible week for the market should give readers an idea of the value of our small-cap strategy. We plan on providing a steady stream of new ideas throughout the summer, and believe great stocks can be found even in down markets -- if investors are willing to look across the entire spectrum to find them.
Along with the returning AeroVironment and the above- mentioned AZZ, our Watch List includes Abaxis (ABAX:Nasdaq), Alnylam Pharmaceuticals (ALNY:Nasdaq), Albany Molecular Research (AMRI:Nasdaq), American Ecology (ECOL:Nasdaq), American Superconductor (AMSC:Nasdaq), Charles River Laboratories (CRL:NYSE), China Natural Resources (CHNR:Nasdaq), eResearch Technologies (ERES:Nasdaq), Graftech (GTI:NYSE), Layne Christenson (LAYN:Nasdaq), Natus Medical (BABY:Nasdaq), Qiagen (QGEN:Nasdaq) and Techne (TECH:Nasdaq).
Now let's look at the model portfolio. As a reminder, Ones are stocks that we would buy at their current quotes, and Twos are stocks that should not be purchased at their current share prices.
ONES
Akamai Technologies (AKAM:Nasdaq, $34.56, 400 shares, 5.47% of the model portfolio): The company is the world's leading provider of Internet content delivery services, with a broad range of offerings and a leading market position in the content delivery (CDN) space. On Tuesday, AT&T (T:NYSE) announced that it will expand its content delivery services and invest nearly $70 million this year to boost its network infrastructure. AT&T had previously offered content delivery services, but has now launched a new unit focused on the CDN space, possibly increasing competition for Akamai. In our view, AT&T's latest effort to increase its presence in this area only illustrates how attractive Akamai's position is as a market leader. Although competition has increased over the past year, we believe the company's huge lead is safe. We remain bullish on Akamai as a long-term growth play, and believe the ongoing weakness in the market is keeping shares at attractive levels for investors looking to make purchases.
A-Power Energy Generation Systems (APWR:Nasdaq, $25.06, 600 shares, 5.95%): A-Power is an under-the-radar name in the alternative energy space. The company designs, builds and installs distributed energy facilities in China, providing power generation capabilities separate from the Chinese national power grid. A-Power is also preparing to enter the wind energy business, with its turbine production facility expected to be complete by the end of this month. Shares pulled back this week as the momentum that had pushed shares from below $22 to above $30 over the past two weeks faded. As we said in our Weekly Summary last Friday, we expect some volatility in this name following the recent strength given the tendency for short-term traders to jump on the rallies. Nevertheless, as long-term investors, we see large upside potential in A-Power, based on its wind turbine business that is scheduled to begin production in the next few months. The company's existing distributed energy business also carries potential as it continues to sign deals to build power-generation systems throughout Southeast Asia. We view this name as a speculative but extremely compelling stock with limited exposure to the many headwinds that are hurting the broad markets.
Aspect Medical Systems (ASPM:Nasdaq, $6.48, 2,100 shares, 5.39%): Aspect Medical is a medical equipment maker that operates in the niche market of preventing incidences of anesthesia awareness. The company's primary product is a Bispectral index (BIS) monitoring system, which includes a sensor applied to a patient's forehead in order to measure brain activity and ensure he or she has reached an appropriate depth of unconsciousness for invasive procedures. Aspect Medical is also working on finding uses for its technology in patients suffering from depression and Alzheimer's disease. On Wednesday, we added 300 shares to our position as the stock pulled back below $6.50. The stock rallied sharply last week after Securities and Exchange Commission (SEC) filings revealed that a pair of Aspect Medical's executives added to their personal stakes in the company. Our thesis for this name focuses on the huge potential gains the stock could see if the company's BIS technology secures a place as a high-demand method for monitoring patients in operating rooms throughout the world. For now, overall sentiment toward the stock remains negative based on a downbeat article published in the "New England Journal of Medicine" earlier this year, as well as management's announcement that it will invest in a larger sales force. We believe there's large upside potential in this name, especially if the company is able to quell the doubts over its technology and hit its 20% annual sales growth target next year. We see shares as attractive at the current quote, but will probably wait until after the company's next quarterly results announcement before considering adding to our stake.
Central European Distribution (CEDC:Nasdaq, $74.72, 225 shares, 6.66%): The company produces, distributes and imports alcoholic beverages, mostly in Poland. We see upside potential in this company based on its strong position in distributing alcoholic beverages in Poland, Russia and throughout the rest of Europe. Central European Distribution is in the midst of an aggressive acquisition strategy that will leave the company with a commanding presence in the growing European alcoholic beverage market. An article in Thursday's edition of "The New York Times" highlighted the ongoing strength of the Polish economy, which is creating a surplus of job openings and luring emigrants back to the country. This economic strength is positive for Central European Distribution, as Poland remains the company's largest market. However, the aggressive expansion plan will result in a dominant position in the Russian alcoholic beverage market, with increasing opportunities in other European markets as well as the U.S. and Japan. We see additional upside potential for this name over the next six months, as the company's attractive market position becomes fully represented in its shares.
Dolby Laboratories (DLB:NYSE, $39.35, 275 shares, 4.29%): Dolby is a global leader in audio technologies that are used in consumer electronics and professional content productions, such as films and TV programs. On Monday, Dolby announced progress in its digital cinema business, as it will begin to enter licensing agreements with manufacturers of digital servers to support its Dolby 3D Digital Cinema playback. We view the announcement as a small step in the right direction for the company's digital cinema technology, which remains a potential catalyst as digital cinema begins gaining popularity. Shares of Dolby have slumped recently, given investors' concerns regarding consumer spending and the broad U.S. economy. While a crunch in discretionary income could affect Dolby, we remain bullish on this name as a long-term growth play that is still generating strong earnings growth from PC-related products.
Guess? (GES:NYSE, $37.75, 400 shares, 5.98%): Guess? is an international retailer and wholesaler of apparel aimed at young men and women. Although the retail sector has been beaten down over the past year, we like this name based on its attractive growth profile, international exposure and consumer base. Shares traded relatively in line with the broader market this week as a number of analysts published positive research reports on the company. None of the reports provided any new developments, but all indications point toward continued success in the company's international growth story. The Guess? brand remains attractive to consumers across Europe, as the company remains intent on growing its presence in France, Spain and the U.K. Asia also represents a major opportunity, and we believe ongoing expansion in China and South Korea will drive share-price appreciation over the next 12 months. We see potential risk stemming from the ongoing weakness in the U.S. consumer, but also see significant upside as a result of the company's international expansion.
Shaw Group (SGR:NYSE, $61.01, 225 shares, 5.44%): The company offers an array of services -- including engineering, design, and construction -- in projects ranging from power plants to environmental cleanup. Shaw's 20% stake in nuclear plant designer Westinghouse Electric provides huge upside opportunity based on potential future nuclear projects, as Shaw receives exclusive access to engineering work on any Westinghouse-designed AP1000 reactor. We added 50 shares to our position Thursday afternoon, as shares sold off alongside the major indices. On Monday, Shaw announced that its Energy & Chemicals Group won a contract to provide procurement for expansion of Hyundai Oilbank's refinery complex in Daesan, South Korea. On Tuesday, the company announced that its Maintenance Group was awarded a contract from Albemarle to provide maintenance, engineering, construction and labor services to locations in four U.S. states. We view Shaw as an attractive long-term play for investors looking to capitalize on the revival of nuclear power plant construction in the U.S., China and other nations. With crude oil prices showing no signs of pulling back, we believe the incentive for governments across the globe to support nuclear power -- which ranks as one of the most cost-efficient and non-polluting sources of reliable power generation -- is strong.
TWOS
Energy Conversion Devices (ENER:Nasdaq, $71.32, 150 shares, 4.24%): The company is a conglomerate in the alternative- energy space with segments that work in solar power and advanced battery technologies as well as applications to develop improved flash memory. Shares of Energy Conversion Devices set a new 52-week high above $83 on Monday, though it finally showed some weakness during the week. The stock has been on an extremely strong run since posting surprisingly strong quarterly results in May. While we've touted the progress management has made in turning around this solar name, we would need to see a significant pullback before recommending buying more shares of Energy Conversion Devices. Additional strength would allow us to continue taking profits for the model portfolio.
Focus Media (FMCN:Nasdaq ADR, $27.05, 225 shares, 2.41%): The company operates a network of advertising platforms in China. Focus Media hit a snag earlier this year due to overzealous advertising in its wireless business, which is now expected to be a non-contributor for the rest of 2008. On Monday, we changed our rating on Focus Media to a Two and trimmed 200 shares from our position in an effort to get more defensive in a market that has been brutal for investors in growth companies. Recent comments from other Chinese media and advertising companies have indicated a high level of uncertainty regarding the post-Beijing Olympics advertising environment. Although we've continuously highlighted the positives at Focus Media and viewed its shares as oversold, we simply are not willing to advise continuing to buy the stock when the market keeps proving that the concerns about the Chinese economy are likely to increase. As such, we advise trimming positions and playing defense until we see some catalysts that are beneficial to investors.
GameStop (GME:NYSE, $42.83, 325 shares, 5.51%): The company is one of the world's largest retailers of video-game hardware and software, with more than 5,000 stores worldwide. On Thursday, weak economic data and rising crude oil prices added to investors' fears over the potential of virtually all growth stocks. We've expressed some concern regarding this position since GameStop announced quarterly results in May that did not satisfy investor expectations, despite beating analysts' estimates. Research firm NDP projects 2008 video-game sales to reach between $21 billion and $23 billion, which obviously bodes well for GameStop. However, we remain cautious due to the impact high gas prices may have on discretionary income. Although we believe video-game sales could hold up better than most other consumer products, we're holding off on adding to this name until we get a better idea of what the catalysts will be in the latter half of 2008.
GFI Group (GFIG:Nasdaq, $8.75, 1,250 shares, 4.33%): This company provides brokerage services to investment banks and hedge funds, with a focus on derivatives, including credit, financial and commodity products. On Tuesday, shares of GFI Group sold off sharply on a bearish note by analysts at William Baird. The note pointed to lower visibility into the company's near-term revenue, based on the pullback in trading activity at major investment banks and asset managers. In previous Alerts, we've highlighted the potential in GFI Group's derivatives platform, which could end up as a major driver when derivatives trading goes fully electronic. However, troubles earlier this year with regard to keeping key employees, as well as the uncertain timetable for the transition to purely electronic trading, make us hesitant about adding to our stake at the moment.
Perfect World (PWRD:Nasdaq, $25.23, 500 shares, 5.00%): The company is a leading Chinese video-game developer. On Monday, we changed our rating on Perfect World to a Two and trimmed 175 shares from the model portfolio. While we've continually pointed to the attractive game generation capabilities and the company's existing popular games, we're taking a more defensive stance on Perfect World based on the increasing risk of a slowdown in the Chinese economy. Rest assured that we're not becoming negative on the company; we're just being more upfront about the possibility that a pullback in the growth rate of the Chinese economy would negatively impact this name. On Wednesday, the company announced a new licensing agreement with IP E-Game Ventures for the "Zhu Xian" game in the Philippines. We've stated in previous weeks how Perfect World has much to gain from additional licensing agreements, as these agreements generate higher margins than revenue from gaming. In addition to the overall market weakness affecting this stock, there are concerns that Chinese online gaming could be negatively impacted as more people focus attention on the upcoming Beijing Olympics. We still believe Perfect World has upside potential as the company generates additional hit games like "Zhu Xian," but we're taking a more cautious stance on this name for now.
Silicon Motion Technology (SIMO:Nasdaq, $15.04, 675 shares, 4.02%): Silicon Motion is a semiconductor company specializing in microcontrollers used in NAND flash memory cards. These cards go into devices that allow users to store data including pictures, video and digital music. On Monday, Silicon Motion announced it will launch three new solid state drive (SSD) controllers that can deliver high performance, endurance and quality for low-cost notebook, mobile and mainstream PCs. The news is positive as this is a way for the company to differentiate itself from competitors -- a necessity for Silicon Motion that has kept us from adding to our position. However, a report from analysts at research firm Cowen on Wednesday pointed to significant oversupply in NAND memory that has caused a contraction in pricing. Last week, the Semiconductor Industry Association (SIA) released global sales data that indicated chip sales will not rise as fast as previously forecast. The trade group lowered its growth expectations for global chip sales to 4.3% from the previous 7.7% forecast. Although there is a lot of negativity surrounding the NAND space, as well as the overall stock market, we believe Silicon Motion deserves ongoing attention because there could be a significant opportunity if the company makes progress in differentiating itself from competitors.
