Value Portfolio

Buckle (NYSE: BKE) announced a special dividend of $1.20, which is the lowest special dividend since the company started announcing them late in each calendar year since 2006, but it is better than the “zero” some analysts were predicting given the weak U.S. retail environment. Furthermore, the company increased its regular dividend for the first time in five years ($0.02 per share, a 10% increase). The stock will go ex-dividend for both the regular and special dividend on Monday, January 13^th.

FutureFuel. The specialty chemical and biodiesel manufacturer’s third-quarter financials were strong, with revenues up 37% and earnings up 17%. Both figures beat analyst estimates, yet the stock sold off 9.2% on the news. In the conference call, President Lee Mikles said that the company was “anxiously” awaiting the release of the EPA’s proposed renewable fuel standards (RFS) for 2014, but had heard rumors that the proposal for 2014 would recommend no increase from 2013 levels in the volume requirement for biodiesel. Prices of renewable identification numbers (RINs) had sold off on such rumors, hitting a three-year low in October. Investors didn’t like hearing Mikles repeat the rumor, and the stock sold off.

On November 15^th, the EPS issued its proposed RFS for 2014 which “maintains the biomass-based diesel standard for 2014 and 2015 at the 2013 level of 1.28 billion gallons.” No increase means that biodiesel manufacturers like FutureFuel cannot expect a government-induced increase in demand in 2014. The result is that analysts now expect FutureFuel’s 2014 earnings per share ($1.05) to be lower than 2013 earnings per share ($1.29).

Keep in mind that one third of FutureFuel’s business is specialty chemicals, which is completely unaffected by the 2014 RFS. Also important to remember is that the 2014 RFS is still just a proposal and could be modified before a final rule is issued next spring. The EPA is soliciting comments on the RFS proposal until January 28^th.

Concerning the $1 per gallon blender’s fuel credit, it looks like Congress will let it expire at the end of 2013. However, as in past years, Congress will likely re-enact the credit retroactively early in 2014.

Lastly, there is a silver lining to the 2014 RFS not mandating an increase in biodiesel. In the conference call, FutureFuel president Mikles noted that a stagnant RFS could cause a shakeout of the biodiesel industry, leaving the strongest companies like FutureFuel to reap the benefits of consolidation:

Without an increase an in the [Renewable Volume Obligation] you’re going to knock a lot of players out of the market. And as they do obviously less capacity would get you an increased RIN price.

We’d like to make acquisitions; the prices that people have been willing to pay and the price expectations from the sellers have just been something we didn’t want to participate in.

I will tell you without an increase in the RVO and if you get any delay in the dollar credit, you’re going to see more properties realistically priced on the marketplace. And given our balance sheet strength and given our desire to want to grow both sides of our business that would be an environment I think where we’d be very active.

So, ironically, FutureFuel could actually come out ahead in 2014 and beyond — thanks to the RFS requiring no increase in biodiesel volumes!

GrafTech International (NYSE: GTI) reported third-quarter sales and earnings that were down from last year, yet the stock soared 37.5 percent over the next three trading sessions on news that the company was initiated a corporate restructuring that would cut costs (including a 20% workforce reduction). Moody’s was less jubilant than stock investors, calling the restructuring announcement a “positive first step” but insufficient to justify a credit upgrade.

Arcelor Mittal recently stated that the global steel industry has “turned the corner” and the bottom of the industry cycle is now firmly in the past. Good news for all steel-focused stocks! Based on GrafTech’s restructuring news and the positive signs of a general steel industry recovery, I am raising the “buy below” price on GrafTech International to $10.

United Therapeutics (Nasdaq: UTHR) skyrocketed more than 30% on December 23^rd on news that the FDA had approved its first-ever version oral form of trepostinil (Orenitram). As opposed to trepostinil dosed through injection (Remodulin) or inhalation (Tyvaso), an oral pill has always been the holy grail for PAH therapy. Orenitram – and the many other forms of oral trepostinil that are likely to follow — promises much wider patient use of UTHR’s trepostinil drug franchise. Great news, as chief operating officer Roger Jeffs stated in the press release:

This approval marks the first time that the FDA has approved an orally administered prostacyclin analogue for any disease — and our fifth approval from the FDA for treatment of PAH — supporting our mission of providing a wider choice of PAH therapies for physicians and patients. We are grateful for the FDA’s thorough review and will continue to build clinical support for the use of Orenitram.

The stock shot up so high because FDA approval was a complete surprise – virtually no Wall Street analyst had included oral trepostinil revenues in financial estimates.

With the stock up so much, some insiders are selling (including $1.5 million worth by CEO Martine Rothblatt), so more near-term upside may be limited. In addition, a government inquiry into the company’s marketing practices may inject some unwelcome uncertainty into the stock. The good news outweighs the bad, however, and Ladenburg Thalmann upgraded the stock to buy with a $138 price target. Based on the FDA approval of oral trepostinil, I am raising the “buy below” price on United Therapeutics to $87.50.

US Ecology (Nasdaq: ECOL) suffered a hiccup on December 2^nd when the company issued revised earnings guidance for 2013 that was better than expected. As much as $0.12 per share of earnings will shift into 2013 from 2014, which will make 2013 financial results even more outstanding. Yet, the stock sold off on the news because the company also revised downward 2014 earnings guidance by $0.12 per share, which will make it very difficult for the company’s 2014 results to show any year-over-year earnings growth.

From a stock-valuation standpoint, this earnings acceleration is actually a positive since the company is getting the income sooner (time value of money). But psychologically, some investors don’t want to own stocks that are expected to exhibit stagnant or declining year-over-year earnings growth. This investor aversion caused a temporary period of price weakness, but the stock has since recovered back up above $37.

In addition, the company announced a secondary offering of 2.6 million shares at a price of $34 per share. Since there are currently only 18.51 million shares outstanding, this secondary offering dilutes shareholders by more than 12%, but the company said it needs the money for “general corporate purposes” including debt repayment and potential acquisitions.

Companies typically only sell new shares when management believes the stock is close to fully valued, so the stock offering may indicate that the company needs time to grow into its current valuation. US Ecology’s business is performing great, but its stock price has risen in tandem with its improved prospects. I remain committed to the current “buy below” price of $32.

Momentum Portfolio

Apogee Enterprises. On December 18th, the manufacturer of commercial construction materials posted solid third-quarter financials with earnings up 18% on a 5% revenue increase. Earnings were in-line with analyst estimates, whereas revenues missed estimates slightly. The stock initially sold off on the Q3 revenue miss, but recovered and actually ended up on the day as investors focused on CEO Joseph Puishys’ forecast of “a very strong performance in the fourth quarter.” In fact, the company raised the lower end of its guidance for fourth-quarter earnings per share. In the conference call, CEO Puishys explained the Q3 revenue miss as nothing more than timing:

I expected some orders that are being contracted today as we speak literally to have hit in the third quarter. So I was surprised by the timing myself. We didn’t lose a single order that we had in our original projections for the third quarter, but we did have some timing movements.

The company’s backlog of new orders has remained steady at $300 million for the past six quarters, despite an increase in awards because Apogee’s clients are taking a “longer period between awards and commitments.” Even a steady order backlog actually reflects above-average growth because as work begins the job’s revenues are removed from the backlog so just to stay even on the backlog requires a continual replenishment with new orders. Revenues have increased more than 7% during the past year, which means new orders in the backlog also grew more than 7%, a feat that CEO Puishys is “pretty proud” of. Even better, the backlog is finally set to break out to the upside from its $300 million plateau in the near future:

I am very confident in what I’ve already seen in the month of December for awards and contracts, we’ve inked leads me to be very confident and having double-digit growth in the backlog in the fourth quarter, and the trend in fiscal ’15 will continue to reflect growth in that backlog.

Zacks rates Apogee a buy and is optimistic about the company’s prospects in the coming year:

Apogee’s backlog remains strong, which bodes well for its future performance. The company intends to add new capacities and fund acquisitions. Focus on operational improvements, expansion in new geographies and markets, and new product launches will fuel Apogee’s revenue growth going forward.

Apogee has faced challenging commercial construction market conditions so far. However, the U.S. construction is finally stabilizing and is on track for the much-awaited recovery, which looks promising for Apogee.

CommVault Systems.  The stock of the “big data” protection and recovery software provider jumped 7.7% on December 17^th on news that Piper Jaffray had reiterated an “overweight” rating and a $96 price target. Other analysts in December reiterating bullish comments towards CommVault include those at BMO Capital Markets and Monness Crespi Hardt. At the December 4^th Credit Suisse Technology Conference, CommVault chief operating officer Alan Bunte was very positive about the Simpana 10 software launch:

Simpana 10 was our most recent launch that happened on March 1^st. We’ve been really pleased with adoption, usage, quality levels, and response from the market. On all those kind of fronts, I would even venture to say it’s been our most successful product to date.

G-III Apparel. On October 2^nd, the apparel company continued its legacy of growth through acquisition when it agreed to purchase shoe manufacturer G.H. Bass from PVH Corp for $50 million in cash. The purchase price was modest, but the potential synergistic benefits are huge, which is why I love this deal. G.H. Bass’s 158 retail outlets will be absorbed by the Wilson’s Leather chain of 167 stores, essentially doubling the size of Wilson’s and significantly reducing G.H. Bass’s overhead expenses. In addition, acquiring a manufacturer of high-quality footwear transforms G-III Apparel from a limited apparel-only company to a full-service “fashion” retailer of apparel and shoes for both men and women. G.H. Bass sells both footwear (65%) and apparel (35%), but its apparel is lackluster and will be vastly improved by G-III’s apparel expertise. The flip side is that G.H. Bass’s 158 stores will act as customer magnets that give G-III an opportunity to market its traditional apparel offerings to an entirely new demographic of high-end shoe wearers. Analysts at Brean Capital call G.H. Bass a “treasure” and expect its acquisition to be earnings accretive for G-III in fiscal 2015 and add $250 million in sales to G-III’s coffers.   

On December 4, G-III released a great third-quarter financial report that saw sales grow 23% to a record high, combined with solid earnings growth of 19%. Both figures blew past analyst estimates and marked the fifth earnings beat time in the past seven quarters. Even better, the company raised its guidance for full-year fiscal 2014 (ending Jan. 31^st), with CEO Morris Goldfarb reporting “across-the-board strength in our business.” Based on the G.H. Bass footwear acquisition and the accelerating rollout of both the Ivanka Trump apparel line and Calvin Klein handbags, analysts expect earnings growth of 17.9% in fiscal 2015, which is above the industry average, and yet G-III still trades at a below-average earnings multiple of 20.6. Good combination!  The Q3 reported prompted Brean Capital to raise its price target on the stock to $80 from $60 and conclude:

We remain buyers of G-III and believe the company is among the best upside-positioned plays in our universe and ideally positioned to beat top- and bottom-line expectations.

The company’ success has resulted in its G-III stock being added to the S&P SmallCap 600 Index on the first trading day of 2014. Because the company is undergoing a positive transformation into a full-service fashion retailer and continuing to execute flawlessly, I am raising the “buy below” price on G-III Apparel to $67.50.

HMS Holdings. On November 8^th, the company released third-quarter financial results that not only missed earnings estimates, but also guided down earnings and revenues for the fourth quarter and full year. Lastly, the company said it couldn’t yet provide guidance for 2014 – as it traditionally has done on the release of the previous year’s Q3 report – because:

The impending Medicare RAC procurement and the ongoing audit scope and rule changes by CMS create a wide range of negative outcomes with probabilities that are so varied that we cannot provide meaningful guidance for 2014 until CMS has clarified its intentions related to the Medicare RAC procurement and program. We now expect to provide full year guidance at the time of our February 2014 earnings call.

On this negative news, the stock initially dropped to a more-than-3-year low of $17.39, only to skyrocket by the end of the day to close up more than 22% at $22.95. Such a dramatic bullish reversal suggests that the stock hit a capitulation low on the poor Q3 report and all the “weak hands” that were looking for an excuse to sell the stock did so on November 8^th. Value investors swooped in and HMS’ shareholder base is now much more stable and strongly committed to the company’s long-term future.

In the conference call, CEO Bill Luria warned that two regulatory changes by the Centers for Medicare and Medicaid Services (CMS) will “cause headwinds for us” during the first half of 2014, resulting in the company having “decreased revenues in Q1 and Q2 at the very least.” The regulatory changes, which are expected to reduce recoveries to the Medicare Trust Fund by $1 billion per quarter, are:

1. The 2-midnight rule, which became effective on October 1^st, automatically classifies hospital stays where the patient is present during two consecutive midnight hours as “inpatient” regardless of the type of care provided. Until this rule went into effect, some types of care (e.g., observation services) did not qualify as inpatient stays even for many days of admittance. This rule increases the frequency with which hospitals can rightfully charge the government for higher inpatient reimbursements, which reduces the ability of auditors like HMS to find violations and collect fees.
2. 6-month extension of the moratorium on the auditing of hospital reimbursement claims for short inpatient stays until April 1, 2014, which eliminates the ability of auditors even to oversee proper implementation of the 2-midnight rule.

On the other hand, business should pick up briskly after the first half of 2014 because new recovery audit contractor (RAC) contracts are expected to be awarded by February 2014 and they will last for five years, which will provide long-term growth that is certain.

House Bill No. 3698 would have suspended the 2-midnight rule until October 2014 and also extended the auditing moratorium until October 2014, but it thankfully was not included in the final December 18^th budget deal after the Congressional Budget Office (CBO) forecast that the bill would increase government health-care spending by $2 billion. The hospital lobby is strong, however, so it could try again next spring to pass the bill.

It’s important to remember that the federal Medicare RAC contract constitutes only 20% of the company’s total revenues. Audit services for state Medicaid programs are much more important at 43% of revenues. HMS is feverishly working to reduce its dependence on federal Medicare auditing by expanding into auditing services for commercial private-sector health insurers (currently 31% of total revenues). Growth in the commercial business line is expected to reach 25-30% in 2014 and the company has hired seasoned executive Doug Williams to orchestrate the push into commercial, which is characterized as a “significant expansion opportunity for HMS.”

Bottom line: the trough for HMS growth will occur in the first half of 2014 and then it’s off to the races for the foreseeable future. Since the stock market generally anticipates six months in advance, the low for HMS’ stock price may already be in the past. I wouldn’t be surprised if the $17.39 low of November 8^th is not seen again for a very long time – if ever.