A Promising Big Picture

I hope you enjoyed your holidays. I must say, it doesn’t take long to get back into the swing of things, does it? It’s only Thursday of the first week in January, but already the holidays feel like they were a while ago.

When it comes to investing, it’s a lot more fun to get back to the regular routine in a good market. That’s what we’ve had for the last month or so, and I continue to have high expectations for the first quarter of 2011 especially, but I think the whole year could be memorable.

We are in a very different spot than we were a year ago at this time. In 2010, the recovery transitioned from temporary support from government stimulus and inventory rebuilding to one of actual growth and expanding business and consumer demand. Households are spending again, and businesses are making investments. Both groups are especially interested in technology and are reaching deep into their pockets for tablets, smartphones, TVs and all kinds of gadgets that connect our world in even more ways. In just a moment, I’ll tell you about a brand-new Breakout stock that’s profiting from this trend.

Most importantly, we enter 2011 with signs of life in private-sector job growth. Even with new claims for unemployment benefits rising more than expected last week, the four-week average fell to a level we hadn’t seen in more than two years. I believe that the pace of economic growth is sufficient to keep the unemployment rate at least steady, and I wouldn’t be surprised to see it start to drop this year.

Of course, we all want to see stronger economic growth to help push the unemployment rate down significantly, and I do expect the pace of growth to pick up here in 2011. It is one big circle: Better economic growth will boost job gains, and job gains will boost economic growth.

Businesses also have a lot of cash on the balance sheets ($2 trillion!) when they are ready to hire. Large firms have generally seen a big improvement in profits. Until now, much of the increase in profits has come through cost containment – notably labor expenses. But as we head into the next earnings reporting season (beginning next week), I expect to see more growth, and that will ultimately lead to more hiring.

As we begin the new year, the big picture is quite promising. The U.S. still has healing to do, but we are in better shape than we were at the beginning of 2010. We are also more economically sustainable and healthier than much of Europe as well as some emerging market countries that are seen as “frothy” or politically instable.

That’s why we’ve already seen significant inflows of money into stocks and out of Treasury bonds. I expect much more to be deployed in the coming weeks, and we want to take full advantage. Let’s get right to our new buy this week.

New Breakout Buy: SIMG

If you haven’t seen them yet, get ready to be bombarded by news stories from the huge Consumer Electronics Show (CES) that kicked off today in Las Vegas. More than 120 thousand people are expected to attend the show to play with 20,000 of their favorite electronic gadgets.

One stock that I expect to get a boost from the show is Silicon Image (SIMG), which makes semiconductor products that improve the consumer video experience. Its chips are found in TVs, cameras, personal computers, cell phones and other mobile devices, and home theatre systems. The company boldly states its goal to be the leader in advanced connectivity solutions for consumers, and that is certainly the prevailing theme in technology today.

SIMG’s customers include practically all the leading video consumer electronic companies such as Samsung, Sony, Toshiba, LG and Vizio.

Product sales account for approximately 85% of total revenue, but Silicon Image also makes money from royalties gained through licensing its intellectual property. Prominent semiconductor companies such as Analog Devices (ADI) and Texas Instruments (TXN) are among those that license products from SIMG.

Making the Turn

Silicon Image enjoyed terrific growth from its initial public offering in 1999 through 2007, fueled by the development of high-definition digital televisions and the growth of other consumer video products. In 2008, however, revenues began to decline sharply as the worldwide recession, product transitions and obsolescence, increased competition and lower average selling prices weighed heavily.

The latest reported results (from the third quarter of 2010) look like an important turning point for the company. Excluding royalties delayed from previous quarters, revenues grew 43% over the prior year to $53 million, which was also a 19% jump from the previous quarter. It was easily the most impressive sales results since 2006. Earnings of $0.08 a share were the highest since 2008, and management also raised guidance for the fourth quarter.

The report did not go unnoticed by Wall Street, and the stock jumped 35% the day after earnings were released. It has continued its upward trend, and I look for the momentum to carry it even higher. That’s why we want to get on board now.

Turnarounds, Takeovers and Trade Shows

In the big picture, faster growth of digital television in foreign markets favors Silicon Image, whose technology is useable in all markets (unlike some of its competitors). But in the near term, the buzz around a couple of newer products and the possibility of a takeover should drive the stock higher.

One of the promising new technologies is called MHL, which stands for mobile high-definition link. This technology should allow continued adoption of high definition pictures to mobile devices, including the burgeoning smartphones and tablets. On its third-quarter conference call, Silicon Image indicated that it is testing MHL products and is in fact already receiving design wins.

Silicon Image has also developed ViaPort technologies that will enhance digital television connectivity. In particular, home theater owners can use an additional HDMI output and an external audio device to receive the highest quality surround sound.

Here’s the kicker: Both MHL and ViaPort will be on display at the Consumer Electronics Show, which runs through Sunday, and I look for the increased attention to bump the stock up.

Just as important, SIMG is a highly attractive acquisition target, and as we’ve talked about, mergers & acquisitions should continue to heat up here in the first quarter. (I’m sure you saw the news this week that Qualcomm was buying Atheros for $45 a share.) Well, Silicon Image has a very clean balance sheet, and the company’s biggest competitors – Texas Instruments (TXN) and STMicroelectronics (STM) – have both the cash and the muscle to acquire a small-cap company like SIMG. ViaPort and MHL are outstanding and potentially profitable products, and I wouldn’t be surprised to see one of them step forward and buy the company at a sizable premium.

Given the buzz from this week’s CES, the likelihood of more corporate deals in the first quarter, the company’s improving sales and earnings, and the stock’s technical strength, I’m targeting a run to $12. At $7.78, the stock is above our usual $5 limit, but with several catalysts lining up to bring us 50% gains, it’s worth loosening up that guideline a little bit in this particular case. Buy SIMG under $8 for a target of $12.

Sell AIB

Allied Irish Banks (AIB) has continued to drift lower the last few weeks, and I will admit that I’ve really stewed over what to recommend you do with the stock. On the one hand, I still see the possibility of huge profits. On the other hand, I’ve been doing some digging and am now concerned about its liquidity here in the U.S., so the risk has increased to the point where I recommend you sell AIB.

As a result of the bank’s issuing 3.7 billion euros of new equity to the Irish government in order to meet its year-end capital requirements (as we talked about in last week’s update and on the message board), the bank effectively was nationalized with the government owning a 92.8% stake. As we said, this is very similar to the Citigroup situation, and it was not unexpected.

As we also talked about, in conjunction with the capital increase, the bank canceled its share listing on both the Irish Stock Exchange and the London Stock Exchange. It intends to transfer its listing to a junior exchange, the Enterprise Securities Market of the ISE.

That was a surprise, but as long as the shares kept trading on the NYSE, I wasn’t concerned. There would be sufficient activity and liquidity for us. The bank has not announced its plans for its NYSE listed shares, but after talking with several people this week, I now think there is a chance these shares could also be delisted.

Let me be clear: This is not a given. The shares may continue to trade on the NYSE. However, my conversations this week have me sufficiently concerned about a delisting (as dumb as it would be) that I recommend you sell AIB and take the 40% loss here rather than risk being stuck with worthless shares.

In the interest of full disclosure, I want to share with you that I am holding on to my shares because I am prepared to take the entire loss if it comes to that. I know most of you won’t be comfortable with that, so it’s better to take your money off the table and put it to work in less risky opportunities, like SIMG or this week’s Top Buys that we’ll talk about next.

This Week’s Top Buys: HRZ, OPTR, PMI

If you’re just joining us or have money to invest, I recommend you look to our new buy this week, SIMG, as well as the following three stocks currently on our buy list that are strong buys right now. Here’s a quick summary of each, and please be sure to watch the video below for my full analysis and why I like them right now:

1. Horizon Lines (HRZ) is the largest oceangoing shipping company in the United States. It’s up 29% since we bought it on Sept. 9, and I expect it to continue moving higher. As I mention in the video, recent data show more goods are being manufactured, and they need to be shipped. Horizon will be one of the biggest beneficiaries. Buy HRZ under our raised limit of $5 for our new target of $7. It surged over $5 today, but you should be able to get in on a pullback.
   
2. Optimer Pharmaceuticals (OPTR) this week was given what’s called “orphan drug status” for pediatric use of fidaxomicin, the drug under development to treat c. difficile infection (CDI), a very serious infection that is a big problem in hospitals and among those with weak immune systems. That gives the company several marketing and costs benefits, including extended patent protection. I look for fidaxomicin to be approved in the second quarter. Buy OPTR under our new limit of $12 for an increased target of $17.
3. PMI Group (PMI) has been stuck under $4 for a while now, but several factors lead me to believe it is ready to break out in the right direction. There has been some stabilization and even improvement in mortgage applications and housing inventory. Interest rates remain incredibly low (mortgage rates dropped to 4.77% last week), and banks are starting to lend again. The stock has moved up from $3 in mid-November to $3.77 today, and I look for it to continue in the coming months, so now is the time to get in. Buy PMI under $4.80 for our $7.75 target.








ZLC Drops on Retail Concerns

Zale’s (ZLC) had a great run in November and December, jumping from the $3.23 when we got in to $5 last week. Since then, however, the stock has pulled back to $4. There hasn’t been any specific news to drive the stock down, but the company will announce its much-anticipated sales for November and December on Tuesday, and the Street apparently has its concerns.

We talked on several occasions about how jewelry was back in vogue this past holiday season and how Zale’s was positioned nicely to take advantage of the consumer’s rejuvenated zeal for glittery and expensive presents. That’s why the stock ran up. Now, some investors are concerned that a respectable holiday season won’t be good enough to maintain the momentum as the company tries to return to profitability. Adding to the concern is the impact of the post-Christmas blizzard that hit us hard here in New York and along the East Coast – and put a big dent in after-holiday spending.

ZLC is still up more than 20% for us, even after the latest decline. And if the company kept pace with overall jewelry sales gains during holidays, it could well lead to a positive earnings surprise. This isn’t a given, of course, but I still like the direction the company is heading, even with some of the air coming out of the stock in recent days. Buy ZLC on dips under $3.75.

LLEN Bounces Back

L&L Energy (LLEN), after taking a beating from CNBC’s Herb Greenberg a couple of weeks ago (as we talked about here), has regained most of that ground since then. It’s up 12% since we talked last Wednesday.

As you know, LLEN operates coal mines in China, but investors have bid it back up largely because of the devastating floods in Queensland, Australia. Australia is one of the biggest exporters of coal in the world, and record rainfalls have shut down some of the mines in the country. The flooding is actually expected to worsen in the coming weeks, and coal prices have risen on fears of a temporarily dwindling supply. About four million tons of coking and thermal coal production have been lost since early December, according to a Deutsche Bank report, and Australia’s coal exports will probably take a few months to recover after the floods. That means continued upward pressure on prices in the near term.

That’s why attention has turned to China, which produced 44% of the world’s coal supply in 2009, according to the U.S. Energy Department (2010 figures aren’t out yet). That easily makes China the biggest source. China also led the world in coal consumption, accounting for nearly half (46%) of usage in 2009.

LLEN should see some strength given the terrible situation in Australia, and I certainly hope those poor people get relief soon. Buy LLEN on dips under $10 for our $14 target. As we know, this can be a volatile stock, so please don’t chase it. If near-term strength carries it up toward our target, be ready to bank those profits.

I know we’re about a week into 2011, but let me wrap up this issue by wishing you the happiest of new years. I remain as excited as ever about the market and our stocks, and I expect it to be a fun and profitable year for us, starting with our new buy this week, SIMG.

Have a great week!

Sincerely,



Hilary Kramer
Editor, Breakout Stocks Under $10

P.S. Thanks to all of you who have commented on our boards recently. I continue to read them and will be jumping into the conversations. In fact, Lalitha posted a good question today about Citigroup (C) and whether to hold the stock through earnings. The short answer, Lalitha, is yes! I’ll post a more detailed response later tonight or tomorrow.