Slow and Steady Wins the Economic Race

A week ago at this time, the Dow was flirting with 12,000 – a number that isn’t terribly important in and of itself but does sound good, so it’s important in that sense. It popped over 12,000 intraday last Wednesday, Thursday and Friday before selling off to close the week at 11,824.

Tuesday was an even better version of one month before. Remember how January started with a 92-point up day? Well, February got off to a great start with a nearly 150-point jump, and the Dow closed solidly above 12,000.

I’m happy to say that the signs continue to point to a strong market over the next several months – and maybe longer – beginning with January. I’ve seen my good friend Sam Stovall, Chief Investment Strategist with Standard & Poor’s, all over the news this week talking about research he’s done on what the market’s performance in January tells us about what’s likely to come.

Since World War II, when the S&P is positive in January – it was up nearly 2% this year – it has gone on to finish higher 85% of the time, and the average gain of the remaining 11 months is 11.6%. That would put us around 1425 at the end of the year, and I think we would be very happy with the gains we’d see in our Breakout stocks.

Beyond history, the fundamentals continue to improve. I know all of us would like to see a faster recovery, but honestly, slow and steady is much healthier for stocks in the long run.

We’re past the halfway point of earnings season, and the results so far continue to be solid. Standard & Poor’s expects earnings from the last quarter to grow 32% from the year before, more than 3X its forecast at the start of the year. With close to 60% of S&P 500 companies reporting, more than 70% have beaten estimates. The strongest industry groups have been financials, telecoms, materials and energy companies.

When you factor in fourth-quarter reports, Standard & Poor’s believes S&P 500 profit growth for all of 2010 will be 51%. That’s very, very good.

Even better is that growth is being driven by higher sales and a better economy, not just cost-cutting measures. Approximately 72% of S&P 500 companies have beaten their revenue estimates, and S&P estimates revenue growth for the quarter will be 8.1%. This is consistent with U.S. sales gains of 7.1% reported by the Commerce Department last Friday, with the expectation that they will grow another 6.5% this year.

Consumer spending and exports helped drive those gains, and today we once again saw surprisingly strong sales numbers. The retail sector reported that same-store sales grew 4.2% in January, which was way ahead of expectations of 2.7%. Many people, including yours truly, thought sales might suffer because of the horrible winter weather in many parts of the country. (I don’t know about you, but I’m ready for winter to be over!)

Consumers continue to spend in part because they are either becoming employed or feeling more secure about their jobs. Here again, the news was good today as fewer people than expected applied for jobless benefits in the past week.

Fed Chairman Ben Bernanke is also sounding a little more optimistic, saying today that growth will probably increase this year, even with the unemployment rate higher than anyone would like. He highlighted increased household spending, confidence and bank lending as the reasons.

The current worry, of course, is the situation in Egypt, but the market has continued to push forward. We don’t need to make any changes to our strategy, and I am both hopeful and confident that we will avoid a long period of strife in the Middle East and that world oil supplies will not be compromised.

However, it is a serious situation that I will continue to watch closely. If its potential impact on the market becomes significant enough to overshadow all of the positives we just talked about, we may look to lock in profits in some of our big winners.

There are also stocks that are very attractive right now regardless of the situation in Egypt, so let’s turn to this week’s Top Buys.

This Week’s Top Buys: MEA, YMI, MRT

These are three stocks currently on our Buy List that I think are excellent buying opportunities right now. As always, I recommend you look to these first if you’re just joining us or have money to put to work. Here’s a quick summary of the stocks, and then be sure to check out the video below for my in-depth look at why I like each of them right now:

1. Metalico (MEA) bought out a scrap metal recycling company called Goodman’s Services this week. Although the acquisition isn’t large, it does show how opportunistic management is in making deals to increase business in any way possible. Goodman’s locations complement Metalico’s existing facilities and will become feed sources – a smart move to make as the recycling business is expected to pick up in 2011. Buy MEA below $6.00.
2. YM Biosciences (YMI) is our newest addition to Breakout Stocks. It briefly popped over our $2.50 buy limit on Monday, but it’s dipped back and is ripe for buying. YM is a Canadian pharmaceutical company focused on cancer treatments, and their most important product in trials right now is showing significant improvements in test patients. If the drug makes it to Phase III testing, it would be a significant milestone for the company and likely a significant payoff for us shareholders. YMI is a buy under $2.50.
3. Morton’s Restaurant Group (MRT) pulled back under our buy limit on Friday, so now is a good chance to buy if you don’t own it. Morton’s was named the official steakhouse of the PGA Tour today, marking the company’s first official league-wide partnership. This is just the latest move to continue the turnaround started in 2010 as the improving economy, increased business travel and company initiatives to eat locally have helped to fill their restaurants. The company has also increased its global presence, particularly in Asia. Watch for this to be an important market for Morton’s resurgence, especially in Macao, the gambling capital of the world. Buy MRT under $6.50.

CRBC Dips Then Bounces After Earnings; Prepare to Sell

Citizens Republic Bancorp (CRBC) reported earnings last week, and the results were mixed. The bad: CRBC reported its worst quarter of 2010, a loss of $0.28 per share. The good: I applaud management’s efforts to clean up its balance sheet. The company moved aggressively to pare down problem loans, with nonperforming assets down 35% in the quarter. Plus, the allowance set aside for bad loans was higher than non-performing assets for the first time this year, so there may be a chance to reduce that provision in coming quarters.

CRBC is one of those stocks that you could probably put in a drawer (as we used to say) for a while and then pull it back out and realize you’ve made a lot of money. However, looking at it from a short- and even intermediate-term view, I’m concerned that it will be difficult for the stock to break out in the way we all want it to.

One reason I’m now more concerned is the company’s tangible book value, which is essentially the hard assets on the balance sheet and, theoretically, the amount we as investors would receive if the company sold everything and went out of business. In the last quarter, tangible book value declined sharply from $1.39 a share the previous quarter to $1.02.

That’s still higher than the current share price of $0.66, so it does provide some protection against significant downside. Unfortunately, book value has been dwindling and will continue to decline as long as the company reports losses, which I now think will continue at least a little while longer. Earnings aren’t rebounding as quickly as I expected, and even though capital ratios are solid, they are falling. That’s not what I want to see. If losses continue much of this year, the bank may need more capital, which would dilute shares and reduce earnings further.

For these reasons, I want us to get ready to sell our shares. CRBC fell from $0.69 to $0.62 after earnings came out, and it has bumped up a few cents in recent days to $0.66. Investors are sniffing around the financials these days, so I wouldn’t be surprised to see a short-term bounce on a couple of good market days to between $0.70 and $0.80, which the stock touched in early January. At that point, we’ll likely sell into the strength, as additional upside would get harder to come by, and focus on bigger and better Breakout opportunities.

I’ll keep you posted and let you know when to sell.

SNV Continues to Strengthen

 Synovus (SNV), unlike CRBC, is moving in the right direction. The company lost $0.23 a share in the fourth quarter, which was its best quarter of the year. The quarterly loan-loss provision ticked up slightly to $252 million from $239 million in Q3, but this was offset by sharply lower foreclosure expenses as foreclosures declined due to the recent national controversy. Charge-offs jumped to $385 million from $237 million, as the company aggressively sought to lower nonperforming assets, disposing of assets with a book balance of $573 million in the quarter.

That still sounds a little scary, I know, but there are signs of improving credit. Nonperforming assets fell to $1.28 billion from $1.55 billion. Furthermore, past-due loans slipped to 0.82%, the lowest level since the financial crisis hit. Synovus’ Tier 1 common ratio, which is a measure regulators look at to determine financial health, slipped a little bit to 8.63% from 9.07%, but it is still much improved from the 6.66% at the start of the year, reflecting the company’s $630 million stock offering in 2010. Investors like to see that number around 10%, and Synovus is heading that direction.

Best of all, management SNV indicated it expects to return to profitability in 2011 (though not necessarily for the full year) thanks to improving conditions and aided by cost-cutting initiatives. To me, that implies much lower provisions set aside to cover bad loans than the $252 million taken this quarter.

With credit trends improving, I still like Synovus a lot. The story is taking longer to unfold than I originally expected, but that is true with the financials across the board. The expected return to a profitable quarter should be a big catalyst for the stock here in 2011. SNV has broken out 35% higher in a little over two months to today’s price of $2.72. I continue to target $5.50, making SNV a strong buy at current prices and up to our limit of $3.15.

Upcoming Earnings: SIMG, BPOP, MGI, AHII

We’ll get more earnings reports in the coming week, starting tonight with Silicon Image (SIMG), which just reported after the close. At first glance, the numbers look solid. Fourth-quarter revenue was up 46% over the prior year, and for the full fiscal year 2010, revenue increased 27% over 2009. Earnings for the quarter were $0.05 per diluted share (GAAP), ahead of expectations for $0.03 and much improved over the loss of $0.89 a year ago. I’ll post more on the SIMG message board tonight after I’ve had a chance to dig into the report a little deeper and see what management had to say on the conference call.

Two more of our companies report tomorrow, with both Popular (BPOP) and MoneyGram (MGI) releasing results before the open. Next week, Animal Health International (AHII) will be out with its report on Tuesday, Feb 8. As always, I will post updates on the message board and follow up with more details in next week’s newsletter.

Breakout Stocks News & Notes

Optimer (OPTR) jumped yesterday and today on more good news for its Phase III antibiotic fidaxomicin, which is in trials to treatment the very serious c. difficile infection (CDI). The New England Journal of Medicine published trial results that showed patients treated with fidaxomicin had significantly lower recurrence and increased global cure rates when compared with vancomycin, the only current treatment for CDI.

As I mentioned in last week’s update, the drug recently was given priority review by the FDA, putting it on the fast track for a decision, which at this point I expect to be an approval. Once commercialized, I look for this drug to dominate on the market, and these trial results are a big step in that direction.

The stock jumped almost 6% today and is up 25% since we added it in early October. OPTR moved briefly over our $12 buy limit today before dipping back under. Buy under $12 anytime you get the chance.

Zale Corporation’s (ZLC) deal to sell its mall-based chain Piercing Pagoda to private equity firm Apollo Group may have hit a roadblock, at least according to a report in the New York Daily News. The article cited sources, so nothing has been confirmed, but it wouldn’t surprise me. They’ve been in on-and-off talks, and the article said it’s possible talks could resume later this year.

Given Zale’s $573 million enterprise value, proceeds from the sale, estimated to be $100 million to $150 million, would be significant for the company. While this would be a disappointment, it wouldn’t change my outlook for the stock. And I wouldn’t be at all surprised to see the deal go through eventually anyway.

The stock dropped almost 7% on the news but has since gained it all back. There is still significant upside here if the company can realize sustained profitability. That’s what I’ll be watching for during Zale’s February 23 earnings conference call, where hopefully we will see continued improvement in the core jewelry business. Continue to buy ZLC while it’s under $5.

TranS1 (TSON) announced yesterday it is on a well-defined path to achieve a Category I reimbursement code for its proprietary surgical approach to treat degenerative disk disease and instability in the lower lumbar region of the spine. This is the same procedure that private health care company Humana recently initiated coverage for. As you may remember, the stock jumped more than 40% in one day, so additional reimbursement progress would be a big boon to the company.

TSON hopes to achieve this new category code, which would be an improvement from its current reimbursement level of Category III, sometime in the next two years. TSON will begin making its case at the October AMA Current Procedural Terminology meeting.

Shares were little changed on the news because the process will take a while. However, I still view this as an important announcement, as there is now a time frame in which we can expect the possibility of meaningful revenue from the company.TSON is currently above our $3.25 buy limit, so hold your shares as we target $5.

Wendy’s (WEN) held its annual Investor Day last Thursday. There was no big news concerning the company’s plans to put its Arby’s sandwich chain up for sale (CEO Peltz’s rhetoric tells me he’s easing off his aggressive sales process), but there were a few interesting operational developments that are worth mentioning.

First, new menu items will be rolled out in the second half of this year, including a new burger offering – an area where Wendy’s may have grown stale in recent years compared to competitors. Opposite of that, the breakfast menu rollout has been scaled back. The company will now serve breakfast at 1,000 locations by the end of 2011, versus previous expectations of a national launch.

One of the reasons is that Wendy’s is allocating its resources to expand internationally. For example, management outlined plans to develop restaurant locations in Argentina as part of an initiative to increase its presence in several international markets.

In conjunction with the meeting, the company announced preliminary results for the fourth quarter of 2010. As I posted on the message boards, WEN expects to earn $0.01 a share in the quarter, excluding $0.04 of charges, compared with $0.07 last year, excluding $0.10 a share in charges. Adjusted EBITDA for the quarter fell 6.4%. I will have more details after the company officially reports earnings on March 3.

WEN is up more than 15% in the last two weeks and has moved above our $5 buy limit. WEN is still is a great brand name that can attract customers with the right product, and I look for the new menu initiatives to spark the shares this year. Any Arby’s deal would also be positive, and I continue to think the company could be acquired at a nice premium. WEN remains a buy on dips below $5.

Sincerely,

Hilary Kramer
Editor, Breakout Stocks Under $10