Editor’s note: Standpoint Research, an independent research provider, periodically will share three investment ideas generated by its proprietary, 155-variable computer model. Recommendations are made only after heavy fundamental and subjective overlays are applied. For more information on Standpoint Research visit www.standpointresearch.com, or contact Ronnie Moas, president and director of research, at ronnie@standpointresearch.com or ronnie.moas@verizon.net.
This is our second piece for Reuters. In our first piece, from May 7, we recommended WU, GES and TEVA. All three have posted nice gains for us since that date of 5%, 4% and 6%, respectively.
American Apparel APP ($2.00)
Buy Recommendation / 2014-2015 Target: $3.20 / Upside: 60% / P/E: N/A
We recently ran 330 consumer discretionary names through our 155-variable computer model. APP ranked # 317 out of 330. That is the bottom 5% and the first time in ten years I have ever recommended such a low ranking name. This is a special situation though. Below are excerpts from our 23-page> December 2012 report on Aeropostale, Guess, American Apparel and the Retail Apparel industry. The full-length report is available on request for those who agree to a free trial. APP has been an open recommendation of ours since August 30, 2012, is up 80% for us, and remains undervalued.
I do not remember ever recommending a name trading at $1/sh with a market cap below $150,000,000 but I did so in late August – it has been one of our best performing names and still has significant upside. In fact, of our 58 open recommendations, APP is one of just twelve trading with market cap < $600 mln; one of just three trading with market cap < $300 mln and the only name trading < $4 per share. APP does not score well on our 155-variable computer model. I do go against my model from time to time when I see a special situation as this is. In 2008, APP market capitalization topped $1,000,000,000 and then the stock collapsed, so this is not a typical small cap name … and it could go back towards where it was pre-collapse. Year-to-date, the shares have shown signs of life and comp store sales have been rising consistently for quite some time. APP has 254 stores spread out across 20 countries: US, Canada, Mexico, Brazil, UK, Ireland, Austria, Belgium, France, Germany, Italy, Netherlands, Spain, Sweden, Switzerland, Israel, Australia, Japan, South Korea, and China. The company, based in California, employs 10,000 and has e-commerce sites that serve 60 countries. APP does not use Asian sweat shops as their competitors do … in fact most of its products are Made in the USA.
Wide reach and young target: Retail operations principally target young adults ages 18 to 35 through an assortment of fashionable clothing and accessories with a compelling in-store experience. Wholesale operations have a dozen authorized distributors and approximately 10,000 screen printers and specialty companies. APP also has 12 different online stores that can be accessed at www.americanapparel.com. The design team is led by controversial American Apparel CEO, Dov Charney.
RFID ramp-up: Implementation of tighter inventory management systems through the RFID (radio frequency identification) program. In FY13, APP intends to complete the installation of RFID tracking systems in all of its stores. As of 31-Mar-13, it implemented RFID systems at approximately 222 stores worldwide.
Store Renovation: Continued store renovations to improve presentation and sales per square foot, with approximately 70 stores remaining to be renovated. Installation of traffic counters remaining to be completed in more than half of its stores to improve customer conversions. Full implementation of this technology is expected to be completed in FY13.
Productivity Improvement Program: Implementation of the Oracle ATG back-end online system for international store fronts and inventory productivity improvement continues which will result in further reduction in operating expenses and improvement in online sales performance. In addition, APP continues to seek improvements in store labor productivity and workers’ compensation exposure.
New e-commerce platform: In Sep-12, APP implemented a new online store platform to enable faster deployment of online stores to new international regions. As a result of the above initiatives, the company was able to reduce its inventory unit levels by approximately 20% in FY12.
New Distribution Center: In Jun-12, APP entered into a new operating lease agreement for a new distribution center located in La Mirada, California and expects to fully transition its distribution operations to this new facility in the first half of 2013. The new distribution center is expected to contribute to processing efficiencies and effectiveness and will reduce operating expenses and cost of sales. Although these programs have a short-term cost, their completion will allow for further growth in sales and profit margins that fall in-line with the industry.
*** As the projected EBITDA range continues to improve, the company has been able to refinance its high cost debt as we speculated and expected when we initiated coverage on this name on August 30, 2012 ***
Revenue and Profit Estimates: For FY13, the company maintained its outlook for adjusted EBITDA to be in the range of $47 million - $54 million. APP also expects net sales of at least $650 million for FY13. As the store count continues to climb, APP could break through the $1 bln in annual revenue mark by 2017-2018.
Quarterly Sales: For 1Q13, net sales increased 4% to $138.1 million as compared to $132.7 million recorded in 1Q12, on an 8% increase in comparable store sales and a 1% increase in wholesale net sales. Adjusted EBITDA improved by $1.4 million to a loss of $0.7 million in the reported quarter from a loss of $2.1 million in 1Q12. The marginal improvement was a result of retail and online sales growth and the related leveraging of fixed costs.
Gross Margin: Gross profit of $72.9 million for 1Q13 represented an increase of 4% from $70.1 million in 1Q12. Gross margin remained unchanged at 52.8% for 1Q13 versus 1Q12. Higher margins from an improved sales mix were offset by higher freight costs. Operating expenses of $83.3 mln for 1Q13 represented an increase of 4% from $79.9 million for 1Q12. Operating margin remained unchanged at 40% for both quarters. The increase in operating expenses resulted from higher share-based compensation charges, higher rent expense and lease termination costs, and higher expenses related to RFID.
American Apparel APP should go from 250 stores, $650 mln in annual revenues and no profit to 300 stores, $800 mln in revenues and $0.20 EPS by 2015. This would leave the stock with a fair value of > $3.00. Looking beyond 2015, CEO Charney sees the store count near 350 by the end of the decade with a saturation point coming at a store count well above 500. APP has been a very volatile stock the last two years since collapsing from its > $1 bln market cap and $14 share price during the recession. The CEO is holding 45,000,000 shares … 40% of shares outstanding. If he decides to sell any of his shares at this ~ $2 price point, that would pressure the stock. As I warned in my August notes, he is an eccentric, controversial and unpredictable personality who has been sued several times, so there is no telling what he will do. He has been cleared on most claims against him and in my most recent conversation with Investor Relations I was told that Charney is not selling shares and is convinced the market has undervalued APP shares and under-estimated him.
National Oilwell Varco NOV ($66.70)
Buy Recommendation / 2014-2015 Target: $84 / Upside: 26% / P/B: 1.4
This is our third time in NOV—most recently reinstated on November 16, 2012. The first two trades resulted in double-digit absolute and relative (to the S&P-500) gains for us (with short holding periods). We recently ran 780 names from the Russell-1000 through our 155-variable computer model. NOV ranked # 56 out of 780. One of the marks against NOV was on relative strength, but we see that as a contrary indicator. Below are excerpts from our 17-page May 2012 report on National Oilwell Varco, Oil States International, the Equipment & Services industry and the Energy sector. The report is available on request for those who agree to a free trial.
Offshore Rigs Drive Growth: NOV is a leading provider of rig equipment and a dominant player in the deep-water oil drilling industry. With a dominant market share near 70%, NOV has been taking advantage of an up-cycle in the international oil drilling industry since late 2010. It is estimated that secular growth in deep-water oil and gas drilling, the shift towards higher quality assets, the aging of offshore equipment, and an increased focus on safety will lead to a larger number of oil and gas drills by the end of the current cycle. High oil prices and renewed interest in developing offshore resources as an alternative to traditional onshore resources would also help in acquiring new orders. With rig building costs stabilizing at a lower equilibrium and with financing increasingly available, the investment environment is positive. NOV has recently floated additional offshore rig projects for Petrobras in Brazil.
Tech Advancements: In US land drilling, one of the main hurdles to fully maximize land rig capacity is the time needed to transport the rig to its new drilling location and prepare the rig to begin drilling. NOV developed Rapid Rig to solve this problem, with the capability of drilling in shallow-to-moderate well depth. The company introduced its Drake rig, designed as a fit-for-purpose drilling rig for the Marcellus shale plays, where the terrain demands a rig with a relatively small footprint. In addition, the company rolled out a new computerized application, Video Matrix Motion Detection to reduce non-productive time.
Expansion via Acquisitions: NOV has been strategically expanding through acquisitions which have been earnings accretive. In FY12 revenue from the Distribution & Transmission segment more than doubled to $2.05 bln, and that was due mainly to the acquisitions of Wilson and CE Franklin. NOV completed 17 acquisitions with an aggregate purchase price of $2.88 bln in FY12. Some of the named acquisitions of NOV during the fiscal year were NKT, Enerflow, Wilson Distribution, and Fiberspar. While some of the acquisitions will help NOV with complementary products such as down-hole tools, pumps and valves, others will enable forward integration through acquisition of distributor businesses.
Outstanding Distribution & Transmission segment Performance: NOV’s performance in FY12 received a boost due to strong performance from its Distribution & Transmission segment which provides supply chain management services to drilling contractors, exploration and production, pipeline operators and downstream energy processor companies worldwide through a network of 460 branches. The D&T segment generated $3.9 billion in revenue, an improvement of 110% versus FY11. Increased volume, greater cost efficiencies and continued favorable pricing which related to strong demand for this segment contributed to an increase in operating profit percentages.
Strong Balance Sheet: NOV is well-positioned with a healthy cash balance and the company is expected to benefit from its strong balance sheet and capitalization; availability of access to credit, a wide array of product and service offerings backed with a record level of orders. As of 31-Dec-12, the company reported cash and equivalents of $3.30 billion and total debt of $3.15 billion. The company paid $2.88 billion in cash for acquisitions in FY12. NOV has planned capital expenditures of ~ $600 million for FY13 as it continues to pursue certain expansion opportunities; including the completion of a new Flexibles plant in Brazil. The company had a 2012 year-end backlog of $11.8 billion, and $7.4 billion is expected to flow through in 2013.
Internal Advancements: The company has focused activities on replacing old mechanical and DC electric land rigs with improved AC power, electronic controls, automatic pipe handling and rapid rig-up and rig-down technology. It has also built out additional deepwater floating drilling rigs, including semi-submersibles and drill-ships to employ recent advancements in deep-water drilling to exploit unexplored deep-water basins. The replacement of fleet over the age of 25 years should help the company maintain the order bookings at a sustainable rate.
Replacement Market Opportunity: Contractors are retiring older models and substituting them with newer platforms in order to meet the requirements of unconventional drilling techniques. The outlook for shallow-water activity is improving. By 2015, following an estimated 150 deliveries, analysts expect the number of rigs > 30 years old will make up roughly 51% of the worldwide fleet. NOV, with its significant market share of rig packages is positioned to benefit from new jack-up rigs in this cycle.
Financial Advantage: Worldwide deep-water off-shore drilling and strong shale plays in North America contributed to the increased revenue for the Rig Technology segment and Petroleum Services & Supplies segment. Acquisitions made during FY12 contributed to the increase in revenue for 2012 compared to 2011.
NOV shares look attractive on an absolute and relative basis. It is out of favor and we see that as a contrarian indicator. It has lagged a bit in recent years on EPS and revenue growth, but at 1.4X book value, 9X cash flow, 11X earnings, with EV/EBITDA < 8 and P/S at 1.3, the shares are attractive and undervalued. EPS should rise from ~ $5.50 in 2013 to $6.50 in 2014-2015 with revenues going from $22 bln to $24 bln.
Marvell Technology MRVL ($11.30)
Buy Recommendation / 2014-2015 Target: $14 / Upside: 24% / EV/EBITDA: 6.4
We recently ran 780 names from the Russell-1000 through our 155-variable computer model. MRVL ranked # 469 out of 780. Below are excerpts from our March 2013 report on MRVL. The report is available on request for those who agree to a free trial.
Marvell was recently fined $1.1 billion due to infringement of patents claimed by Carnegie Mellon University. This ruling caused the MRVL share price to collapse to $7 late last year in what was a clear over-reaction to bad news. This created a buying opportunity and we went against our computer model on this name. It is still possible that the fine will be reduced (or eliminated). All Marvell products are manufactured outside the US and almost all revenues are coming from Asian customers.
Prospects remain solid and MRVL is gaining market share. MRVL continues to invest heavily in research and development and in Q1 announced that it developed a new quad-core processor for both low-priced tablets and smartphones. Marvell processors can be found in Samsung handsets for China Mobile among others; see below.
Supplier of fully integrated platform solutions: Marvell Technology’s core strength lies in development of complex System-on-a-Chip (SoC) devices in areas of analog, mixed-signal, digital signal processing and embedded ARM-based microprocessor integrated circuits. The company develops platforms that integrate hardware and software to provide optimum computing solutions as compared to individual components. MRVL has transitioned from a supplier of stand-alone semiconductor components to a supplier of fully integrated platform solutions lately. A critical part of its business has been the on-chip software, which acts as the “driver” for the functionality of the chip. These platforms cut across multiple end-markets; integrating components and technologies from different end-markets. MRVL’s PXA920 is a highly integrated 3G communications processor solution that targets the TD-SCDMA (Time Division Synchronous Code Division Multiple Access) smartphone market and addresses EDGE, WCDMA (3G), TD-SCDMA (China 3G) and 4G/LTE (long-term evolution) mobile network standards.
Outsourcing of manufacturing facilities: MRVL has largely been able to avoid the costs of owning and operating its own manufacturing facilities by outsourcing. MRVL currently outsources a substantial percentage of integrated circuit manufacturing to Taiwan and other foundries (primarily in Asia). This allows MRVL to focus its efforts on the design and marketing of the products. The company is planning to migrate to smaller geometric process technology following availability of smaller silicon chip sizes and lower power requirements in order to reduce cost and improve performance. Most of the company’s integrated circuits are fabricated using widely available CMOS (complementary metal oxide semiconductor) processes, which provide greater flexibility to engage independent foundries to manufacture integrated circuits at lower costs.
Low cost 3G platform for both smartphones and tablets: In Feb-13, MRVL announced Marvell PXA1088, a highly integrated quad-core application and communications mobile System-on-a-Chip. The Marvell PXA1088 solution incorporates the performance of a quad-core ARM Cortex-A7 with Marvell’s WCDMA and TD-SCDMA modem technology to provide a low cost 3G platform for both smartphones and tablets. Marvell’s new PXA1088 is compatible with its dual-core single-chip platform, enabling device partners to upgrade their next-generation mobile devices to quad-core without additional design cost.
Major chip supplier to China reaching out to global 3G and 4G broadband: Marvell Technology has become a major chip supplier to the Chinese market and its processors can be found in Samsung’s Galaxy line on China Mobile. Marvell is aiming its new chip at smartphone devices at (or below) the $125 price point. In Feb-13, Marvell announced the availability of LTE TDD/FDD capability on its quad-core platform. The platform will lend support for all global 3G and 4G broadband standards, enabling seamless global roaming; and the latest wireless connectivity technology. Next year, China alone is expected to buy 235 mln smartphones. Worldwide tablet shipments were ~ 120 mln in 2012, and are expected to top 400 mln by 2016. MRVL has a significant opportunity to benefit from this.
Expanding market share in the growing Solid State Drive business: SSD grew roughly 40% in FY13, and the company currently has ~ 50% share in the merchant silicon market. The company can maintain margins as customers transition from the 320 gigabyte per platter to 500 gigabyte. SSD adoption should be slow due to price sensitivity. Still, as the technology reaches a maturation phase, flash storage pricing will drop and drive SSD adoption. The company continues to expand its market share in its SSD business and is expected to post double-digit growth in the first quarter of 2014.
Acquisition of Networking-based companies: MRVL completed three business acquisitions and one asset acquisition in the last two years for approximately $124 million. In Dec-11, it acquired Xelerated Sweden, a company which specializes in network processing and programmable Ethernet switching solutions (for $75.2 million).
Revenue concentration: Western Digital accounts for more than 15% of its net revenue, and two other customers account for more than 10% of net revenue. Western Digital accounted for 19%, 21% and 24% of net revenue in FY12, FY11 and FY10, respectively. Asia has been the biggest market for MRVL. Sales to customers located in Asia represented approximately 88%, 81% and 89% of net revenue in FY12, FY11 and FY10, respectively.
Introduction of the industry’s first 4X4 802.11ac solutions: In wireless connectivity, the company introduced the industry’s first 4X4 802.11ac solutions, targeting the enterprise carrier and access point market. This 4X4 solution is designed to ensure seamless throughput of high-bandwidth, multiple-stream HD video across service provider gateways and set-top boxes. With the HD video distribution market gaining access to the mass market, these new solutions will enable MRVL to have a firmer grip early on (in a profitable industry). Marvell’s share in HDDs increased by roughly 5% in FY13 due to the ramp-up of 2.5-inch, 500-gigabyte per platter devices. We expect share gains on mobile platforms to continue over the course of the year.
Share repurchases and dividend payment: Marvell Technology repurchased 34 million shares in 4Q13 for a total of $283 million. Over the past ten quarters, MRVL has repurchased and retired ~ 184 million shares which represented ~ 27% of its outstanding shares. The company repurchased 57.3 million of its shares for $676.5 million in cash during the nine months ended 27-Oct-12. Marvell paid total dividends of $98.8 million in fiscal year 2013 and the dividend yield is currently 2.2%.
Improving results: MRVL’s HDD business in FY13 performed better than in FY12 due to share gains and 40% y/y growth in its SSD business. The networking market grew 2% y/y in FY13. Revenue for 4Q13 was reported at $775 million – an increase of 4% from $743 million in the same period last year. The increase was attributed to increased demand in mobile, wireless and storage customers. Cash flow from operations for 4Q13 was $205 mln versus $137 mln reported in the prior quarter, and free cash flow for the fourth quarter was $161 mln versus $113 mln in the previous quarter.
We initiated coverage on MRVL March 4 @ $10.27. The shares are up 20% in the last month versus single-digit gains for the S&P-500 and the Nasdaq. Yes, there has been a spike in the share price. That being said, EPS estimates for next year have risen sharply as well and the stock remains attractive on a valuation basis compared to other names in the industry. MRVL is currently trading at 12X (rising) estimates for next year, 0.9X its historical P/E multiple, 9X cash flow, EV/EBITDA of 6.4, and less than 2X sales. MRVL is sitting on $2 bln cash with no debt.
Standpoint Research is the only research firm to beat the S&P-500 by at least 500 bps with > 69% of its recommendations versus more than 150 active firms having a statistically significant sample size of recommendations on file. All 319 recommendations we made since 2008, and through May 6, 2013, have been time-stamped by Briefing.com, Bloomberg and Dow Jones. We did this the hard way — without taking a sector bet, market capitalization bet or beta bet. Ideas are generated by a 155-variable computer model I developed 1998-2003 … recommendations are made only after heavy fundamental and subjective overlays are applied. Standpoint Research is an Independent Research Provider with no conflicts of interest.
Long reports on each of the three names highlighted above can be forwarded on request to those who agree to a free trial.
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