Breakout Stocks Weekly Summary
Larsen Kusick
We're pleased by the positive action that has lifted the broad markets over the past month, but this action has been characterized by light trading volumes and limited positive catalysts for stocks. Instead, investors who are looking to buy are being forced to rely on optimism that economic conditions will improve during the second half of 2009. We're starting to see company-specific news drive stocks once again, as opposed to stocks being controlled by the macroeconomic issues that hammered virtually every stock over the past six months.
Thanks to positive developments on Thursday, two names in the model portfolio significantly outperformed the market this week: Shaw Group (SGR:NYSE) and GameStop (GME:NYSE). The ability for stocks to "pull away from the pack" to the upside is an important characteristic of the type of healthy market in which we expect our strategy to work. Consequently, we're becoming increasingly confident that 2009 will be an excellent year for certain names to generate good returns.
In addition to the company-specific moves that we've noted in the stock market, we're also seeing conditions improve in the commercial paper market, which has fully recovered from the massive contraction that spooked investors during October. New bond issues from both governments and banks have been increasing in recent weeks, which shows that the debt markets are also in the process of recovery.
While equity investors often ignore the happenings of the debt markets, these are integral parts of a healthy financial system and were a major reason for the horrible collapse in the stock market during the second half of 2008. We've consistently cautioned that the financial system is undergoing a necessary healing process as we look for new opportunities in 2009. This process will take at least a few months, but will ultimately help investors to gauge the risk levels in equities.
In the meantime, we're left staring at the longest U.S. recession since the 1930s. Unemployment remains in an uptrend. It reached 7.2% in November, according to Friday's latest labor report. Comments from President-elect Obama indicate fears that this number could eventually surpass 10%. By itself, the poor economic environment isn't a reason to dump stocks, but it should inspire caution in anyone who views the rally off of the November lows as an "all clear" signal.
Some pundits insist that the recent gains are merely the result of a "dead cat bounce," but we believe this view is overly simplistic. Buying individual stocks is a play on two predictions: What a company's fundamentals will look like at some point in the future and whether investors will look to buy or sell the stock as those fundamentals materialize.
At this point, we believe the expectations for near-term fundamentals are very low and the probability that selling pressure will be limited over the next six months. Readers should note that trading volumes since November have been modest, which is why many doubt the rally's sustainability.
We believe stocks are likely to be range-bound during the first half of 2009, but that the downside is now much lower for stocks due to low expectations and the fact that much of the forced selling has passed. Our main problem with the current market is the lack of major themes to capitalize on at the moment.
Instead, investors are looking at a market in which the foundations are being built for the next slate of developing stories. Our Watch List features a number of names that we like based on their potential for new growth trends, and we expect to be buyers over the next few months as the broad healing process plays out.
Turning to the model portfolio, the first six trading sessions of the year have been good to us. Six of the names in the model portfolio are up at least 10% during this short period. These gains would be much more encouraging if it weren't for the huge declines of the past few months, but we're pleased to see these strong moves as they could mark the first signs of continued outperformance vs. the broad market. Our intention is to build positions in stocks that can post very large gains from our entry points. We believe that 2009 should provide a large bounce in the names that are already in the model portfolio while we add new names that also offer huge potential upside.
We didn't make any trades this week, although there's a case to be made for trimming two of our positions after both posted large gains. Two-rated holdings Shaw Group and GameStop logged double-digit percentage upticks Thursday after delivering positive news. In both cases, we still believe the upside potential is significant following the recent strength, so we would rather look for higher levels before making sales. As the recent sentiment-driven rally fades, we're looking forward to adding new positions, as well as well as building our stakes in a few of our One- rated names.
In finding new names to add to the model portfolio, our Watch List provides a large sampling of stocks that we're watching. Our Watch List includes: AeroVironment (AVAV:Nasdaq), American Ecology (ECOL:Nasdaq), American Science and Engineering (ASEI:Nasdaq), American Superconductor (AMSC:Nasdaq), Astec Industries (ASTE:Nasdaq), Axsys Technologies (AXYS:Nasdaq), AZZ (AZZ:NYSE), Charles River Laboratories (CRL:NYSE), Fuel Systems Solutions (FSYS:Nasdaq), Genoptix (GXDX:Nasdaq), Gmarket (GMKT:Nasdaq), Greatbatch (GB:NYSE), II-VI (IIVI:Nasdaq), Luminex (LMNX:Nasdaq), Natus Medical (BABY:Nasdaq), Neutral Tandem (TNDM:Nasdaq), Phase Forward (PFWD:Nasdaq), Quidel (QDEL:Nasdaq), RiskMetrics Group (RMG:NYSE), Shanda Interactive (SNDA:Nasdaq), Sohu.com (SOHU:Nasdaq), Synovis Life Technologies (SYNO:Nasdaq), Techne (TECH:Nasdaq), Towers Group (TWGP:Nasdaq), VNUS Medical Technologies (VNUS:Nasdaq) and World Fuel Services (INT:NYSE).
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, $15.13, 500 shares, 4.64% 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 network (CDN) space. Akamai provides services for organizations ranging from News Corp.'s (NWS:NYSE) social networking Web site MySpace to the Pentagon. Competitive pressures and a slowdown in Internet spending pushed down pricing in the CDN space during 2008, but we believe shares have come down to levels where investors could see significant upside. Shares pulled back midweek along with most of the tech sector. Although the weak macroeconomic environment is a negative for the company, we believe Akamai will be a big winner in 2009 based on analysts' considerably lower expectations and the potential for a strong rebound in Internet-related spending. The company remains the market leader in CDN services, and we believe the smaller competitors that have caused price declines in lower-end services are under considerable stress in the current downturn. We believe management's experience from the last economic slump will help them weather the storm this time, and view recent insider buying as a positive sign for investors. A strong balance sheet should provide a solid cushion if the global economy remains weak throughout 2009. We believe shares of Akamai offer an attractive risk/reward from current levels.
Alnylam Pharmaceuticals (ALNY:Nasdaq, $23.12, 250 shares, 3.54%): Alnylam is a biopharmaceutical company focused on developing therapeutics based on RNA interference (RNAi), which is considered to be one of the most notable breakthroughs in modern medicine because it allows scientists to target diseases on a genetic level. Although significant doubts exist as to whether RNA-based drugs can be used in humans without triggering a defensive response by the body, we believe that any progress in overcoming delivery-stage issues would result in huge upside for investors. On Friday morning, Alnylam announced a new collaboration with Cubist Pharma (CBST:Nasdaq) to develop and commercialize ALN-RSV01, its treatment for respiratory syncytial virus (RSV) that is in phase II clinical testing. We view the deal as a positive for the company based on the fact that it illustrates the continued interest from pharmaceutical companies in partnering with Alnylam to develop RNAi-based products. Inking a deal with Cubist isn't as good as inking a deal with one of the giant pharma companies (Pfizer (PFE:NYSE), Merck (MRK:NYSE), etc.), but it's still a positive in terms of building on Alnylam's reputation for driving revenue-generating deals. Doubt remains as to whether any RNAi-based product will ever be commercially viable, but we believe this doubt increases the potential upside for Alnylam. Wednesday's announcement that pharma giant Wyeth (WYE:NYSE) is in discussions to acquire Dutch vaccine-maker firm Crucell (CRXL:Nasdaq) is a bullish sign for a pickup in mergers and acquisitions (M&A) activity in the biotech sector. Alnylam is our favorite small-cap biotech name based on the huge potential upside for the stock if progress is made in the successful use of RNAi-based treatments in humans. Also, the company is sitting on over $400 million in cash that it could use to acquire smaller, struggling RNAi firms that have attractive intellectual property. This is a position we're likely to continue building up over time, especially if additional market-wide weakness keeps shares near the $20 level.
A-Power Energy Generation Systems (APWR:Nasdaq, $4.90, 1,900 shares, 5.71%): A-Power is an under-the-radar name in the alternative energy space. The company designs, builds and installs distributed energy facilities in China and Southeast Asia, providing power generation capabilities separate from national power grids. Shares of A-Power remained volatile this week, initially trading higher on the announcement of the public inauguration of its first wind turbine plant before pulling back as investors' concerns returned to the weak global economy. We added to our position in late December after the company warned that results for the current quarter will be worse than anticipated. Although we're disappointed that the company's growth plans have been delayed by the macroeconomic weakness, we expect to see huge upside in the stock if management is able to successfully begin turbine production and benefit from China's need to invest in clean energy sources. The stock will likely remain volatile until economic conditions improve, but any announcement of new contracts for turbines or distributed energy projects could send shares sharply higher over the next few months. At current levels, the stock remains a risky but attractive play that could yield big gains.
Aspect Medical Systems (ASPM:Nasdaq, $3.75, 2,100 shares, 4.83%): 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 employs a sensor applied to a patient's forehead in order to measure brain activity and ensure that he or she has reached an appropriate depth of unconsciousness for invasive procedures. Shares continued to trade below the $4 level this week as investors wait for any updates from Aspect about its progress in driving sales growth. The selloff in recent months can be attributed to the economic downturn, which is likely to pressure hospital budgets. Nevertheless, we like this name as an under-the-radar play on increased adoption of its BIS technology. Investor expectations are very low, and it's possible that the company could end up as an acquisition candidate if shares remain at current levels. With a healthy balance sheet and a potential reacceleration in sales growth in 2009, we remain bullish on this small-cap stock.
Central European Distribution (CEDC:Nasdaq, $22.14, 350 shares, 4.75%): The company produces, distributes and imports alcoholic beverages, mainly in Poland. We see upside potential in this company based on its strong position in distributing alcoholic beverages in Poland, Russia and throughout Europe. Synergies between the company's recent acquisitions should help drive strong earnings growth in the next 12 months. Shares have recovered over the past month as fears over a complete collapse of the Russian ruble have eased a bit. Central European has an extremely strong business in both Poland and Russia, and our thesis regarding the potential for market share gains and sales growth in Russia remains intact. The stock has been battered along with virtually any name associated with Russia, but the current level discounts a lot of bad news and lower earnings as a result of the ruble's decline. Recent headlines have focused on Russia's dispute with Ukraine over natural gas supplies to Europe, which offer a glimpse into Russia's search for increased control over energy pricing, which remains a key drag on the nation's economic prospects. Shares of Central European are trading near the same level they were when we last added to our position, which we believe remains an attractive price for investors willing to accept the currency risk associated with the stock.
Dolby Laboratories (DLB:NYSE, $31.85, 400 shares, 7.81%): Dolby is a global leader in audio technologies used in consumer electronics and professional content productions, such as films and TV programs. We believe Dolby represents a great play for investors in the current environment, as its license-based revenue and limited competition provide stability amid a poor economic backdrop. We believe the company offers a rare combination of growth potential alongside financial stability, thanks in part to a strong balance sheet and limited competition. We expect growth opportunities such as Dolby Volume to gain traction during 2009, and it's certainly possible that we will begin to see signs of new opportunities for the company that could drive accelerating growth. Because Dolby has such limited competition and relies on high margin licensing revenue, we believe shares will always command a premium valuation. Dolby's strong cash position will allow the company to weather the current weak environment and potentially allow it to acquire small technology firms with attractive properties in early-stage technologies. As a result, the company is in good position for improved sales growth in 2010 and beyond.
Energy Conversion Devices (ENER:Nasdaq, $28.73, 275 shares, 4.85%): The company made strides throughout 2008 in ramping its solar business and is now a major provider of rooftop and BIPV (building integrated photovoltaic) systems in Europe, North America and Asia. On Tuesday, LDK Solar (LDK:NYSE) made a negative preannouncement, lowering guidance for the current quarter and 2009 results. Considering how grim the news was, solar stocks held up surprisingly well. Analyst concerns regarding oversupply and price declines in solar panels during 2009 appear priced in to most stocks in the sector already, and we believe the biggest hurdle for these stocks will be crude oil prices and tight credit conditions that will make it more difficult for customers to secure financing for new solar projects. We believe Energy Conversion Devices is the best name in the solar space given its focus on BIPV systems, and believe the company's exposure to the U.S. is a positive considering the pro-environmental policies that are likely in an Obama presidency. Expectations for the industry are at multiyear lows and analysts' estimates have been cut in recent months, which leaves significant room for upside as the widespread fear subsides.
Perfect World (PWRD:Nasdaq, $18.01, 500 shares, 5.52%): The company is a leading Chinese video-game developer. Perfect World's stable of successful existing games, including "Zhu Xian," "Perfect World II" and "Hot Dance Party," should continue to provide solid revenue results as the company develops and launches new titles. Recent data have shown that trends in Chinese online gaming remain strong despite tough economic conditions. Shares of Perfect World have been range-bound in the $16 to $19 area in recent months, but we believe significant upside exists for the stock as the company releases its latest titles and unveils new games that could drive results during the second half of 2009. Company-specific news has been relatively light over the past month, but we expect Perfect World's core business to hold up well in a tough environment. Shares have sold off along with the rest of the market over the past six months, so we believe that growth-oriented investors can pick up the stock at an attractive entry point. Vocus (VOCS:Nasdaq, $17.69, 550 shares, 5.97%): Vocus is a small-cap company in the software as a service (SaaS) industry, focusing on providing public relations (PR) management to companies across a wide range of industries. Concerns over global IT spending have kept shares in the midteens recently, and we view current levels as attractive for long-term investors based on Vocus' significant opportunities to penetrate smaller companies in the U.S. and expand globally. Shares have traded in line with other tech names over the past couple months, as company-specific news has been light. Looking long term, however, Vocus is one of our favorite stocks based on the potential for shares reflect the company's strong cash flow and potential for continued growth. The SaaS software model offers many advantages vs. traditional software companies like Oracle (ORCL:Nasdaq) and SAP (SAP:NYSE), especially in light of pricing and scalability. With the global economy in tatters, investors' focus has shifted away from Vocus' opportunities in Europe and Asia. In the meantime, the company has a debt-free balance sheet and strong cash flow. Analyst earnings estimates have been reduced over the past month, which we believe sets the stage for Vocus to beat expectations during 2009.
TWOS
GameStop (GME:NYSE, $26.13, 200 shares, 3.20%): The company is one of the world's largest retailers of video-game hardware and software, with more than 5,000 stores worldwide. Research continues to show that video-game sales are holding up better than almost every other segment of the retail market. GameStop confirmed this trend, posting holiday sales data Thursday morning that were significantly higher than analysts were expecting. For the nine-week holiday period running from Nov. 2 through Jan. 3, total sales were up 22.3% vs. the same period a year ago. Same- store sales were up more than 10%, while sales of new video- game software were up 23.5%. The news sent shares of GameStop up more than 13% on Thursday. We were obviously pleased by the results, but remain cautious about adding to our position based on the extremely difficult retail environment. Shares of GameStop have been in a downtrend for almost a year now, as strong financial results haven't been enough to satisfy the high expectations that have been priced in to the stock. At the current levels, we see the potential for significant upside as sentiment improves, but would be more inclined to sell our stake above the $30 level as we look for lesser-known names that aren't as dependent on consumer spending.
Guess? (GES:NYSE, $15.78, 300 shares, 2.90%): 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 of Guess? traded modestly lower this week along with the majority of retail stocks. The apparel space remains extremely difficult to get a handle on, based primarily on the recent steep declines in consumer trends. We've stayed with this name during the downturn based on our view that Guess? is one of the best growth names in the industry, has a clean balance sheet with almost no debt and a management team that has shown the ability to manage inventories well in a tough environment. We plan on sticking with this name as the broad economic weakness plays out, and see significant upside potential as earnings visibility for the entire retail sector improves. Wal-Mart (WMT:NYSE) delivered a surprisingly ugly warning Thursday morning, lowering its fourth-quarter earnings-per-share guidance to a range of 91 cents to 94 cents vs. consensus estimates of $1.06. Same-store sales figures from numerous retailers show that the environment remained weak during December. We see the potential for upside in shares of Guess? during 2009, especially if President-elect Obama's economic stimulus plan is able to curtail rising unemployment and declining consumer confidence.
Shaw Group (SGR:NYSE, $28.37, 375 shares, 6.52%): The company offers an array of services, including engineering, design, and construction, for 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 reactors. The global economic slowdown has decimated stocks in the infrastructure space, but we believe Shaw is worth sticking with based on its favorable exposure to continued interest in nuclear projects. On Thursday, shares rocketed 23% higher after a solid first-quarter earnings report that was overshadowed by numerous surprises during the conference call. The quarterly results included $1.9 billion in revenue and 75 cents in earnings per share. Gross margins were strong, but management left its 2009 guidance unchanged. After trading flat at the open, shares began pushing higher during the conference call as it became obvious that management was being extremely conservative with guidance. In fact, the latest project from Progress Energy (PGN:NYSE) is the largest in Shaw's history, estimated to be $4 billion. Analysts were widely positive on the results, with most boosting their price targets to the $30 area and Citigroup upgrading the shares to a neutral rating from sell. In addition, there's significant potential for Shaw to benefit from President-elect Obama's economic stimulus package, which could include projects that involve nuclear plants or facilities that convert surplus plutonium from nuclear weapons into usable fuel for nuclear plants (similar to the MOX facility that Shaw is constructing in South Carolina). The steep drop in shares of Shaw has been exasperating for anyone who recognizes the company's business strength. Concerns over the global economy remain at the forefront of investors' minds, and we believe shares could trade higher as the global economic outlook continues to improve.
