April 29, 2014 By Leave a Comment
Robert Maltbie Jr. began his career as a retail stockbroker for Dean Witter and quickly learned that there was more to the job than understanding the nuances of buy and hold ratings. He saw firsthand the inevitable conflicts of interest posed by investment banking, and came to recognize the steep odds against individual investors. So in 1999, he set out on his own, launching Calabasas, Calif.-based Millennium Asset Management, specializing in smaller, underfollowed companies on the long side and bigger companies on the short side. In 2005, he founded Singular Research, which now sells small-cap research to Fidelity Investments and other big money managers. Four years ago, Maltbie returned full time to his first love, managing money. Today, Millennium Asset Management manages about $150 million, including a hedge fund called Argonaut Partners, which began operations in 2005. Last year, Maltbie, 55, launched a mutual fund called LoCorr Long/Short Equity I (ticker: LEQIX). Both buy undercovered smaller companies that have historically traded at a 20% to 30% valuation discount and short mid- to large-cap companies whose prospects Maltbie thinks are deteriorating. After a strong performance out of the gate, the LoCorr fund is down sharply this year as investors sell off smaller companies. Some of Maltbie’s holdings also had growing pains, including Advanced Emissions, the largest position in the LoCorr fund. But Maltbie is staying put in the sector, arguing that eventually institutions will discover the charms of the names he owns, prices will climb, and the companies will be added to the indexes. The LoCorr fund’s longer-term performance, he maintains, will rebound: Argonaut, which is almost “a mirror image,” has returned 11.3% a year since inception, versus 7.4% for the Russell 2000 and 0.53% for the HFRX Equity Hedge index. As the market rises, Maltbie’s research is also turning up a number of short positions. To learn what they are, keep reading. Barron’s: Ouch! What happened withAdvanced Emissions Solutions (ADES), the largest position in your mutual fund, which delayed filing its annual report as it looks over its financial controls? Maltbie: We own companies that are underfollowed and underknown. This was news that we’ve known about and we’ve been ready. It’s an adjustment on the timing of when they’ll receive revenues, and it will impact just 7% of revenues. We were accumulating shares. Advanced Emissions provides clean coal technology and helps customers meet increasingly stringent emissions standards from the EPA. That should serve as a catalyst to drive rapid earnings growth. We think the company can earn $1.50 a share this year and then $2.00 in the year 2015. We think the stock will get to $30 from $23 now. Q: What is your market forecast? A: We’ll see another 5% to 15% upside to the S&P 500. This is a year for stockpicking, both long and short, in a market that’s pretty fairly valued. There’s a bullish case based on strong net inflows averaging $20 to $40 billion a month, and that’s even after these big IPOs. The breadth of the market has been strong during the selloffs. Also, the relative value is compelling versus all other alternatives, especially corporate bonds, which are yielding 4%, versus an earnings yield of 5%. Back in 2000, the earnings yield was about 3% to 3.5% on the S&P 500, and the corporate bond yield was 7%. The oldest market rule I’ve ever come across is don’t fight the tape, and don’t fight the Fed. The Fed, despite all the news about tapering, is still stimulating the economy. We look at adjusted M2 [money supply] and compare that to GDP growth and to inflation. Right now, we are getting 2% above GDP growth, meaning the Fed is still stimulating the economy. That’s confirmed by something people forget to look at any more, which is the slope of the yield curve. That’s positive and bullish. There’s a 250 basis point spread between the short and long end. So we are 70% net long right now. Q: So what do you like? A: LSB Industries (LXU). This is a $37 stock. Our target is in the high 40s in the next 12 months. It manufactures chemical products for the agriculture, mining and industrial markets, as well as commercial and residential climate control products. That second business could potentially be spun off. Their fertilizer business is benefiting from global population growth and a change in diet in the emerging markets to more beef consumption. They are adding fertilizer capacity in the U.S. In the climate control business, they are benefiting from a rebound in real estate markets. They have a strong balance sheet. They’ve had a couple of setbacks with their plants. The Pryor, Oklahoma plant had to be taken out of service. They recently announced that they’ve completed the work and resumed business. They’re also spending to create a new ammonia plant. That will expand earnings power. The market cap is $850 million. We think they earn $2.80 for this year, and the earnings power could be $4 to $5 in the next couple of years. Q: Tell us about your short positions. Q: Workday (WDAY) trades at $67 a share. The market cap is $12.3 billion. Our 12-month target is $45. They provide financial human resource ERP accounting software in the cloud, an off-the-shelf solution for small and mid-sized companies so they can eliminate the cost of a fully staffed IT department. The revenues are growing very strongly. It’s the ultimate growth stock, unrealistically overpriced, overhyped, over-covered. It’s off from its highs but there’s a lot more to go. It trades at 30 times sales, a big premium to Salesforce, another cloud outsourcing company that trades at 8 times sales and has better margins. We think it won’t have positive EPS until 2016 at the earliest and we’ve given them the benefit of the doubt, assuming 20% net margins, which would still put the stock at 100 times [our earnings estimate] when it starts making money. One cofounder has sold more than 50% of his personal holding. Institutions are starting to get very nervous, and have reduced their holdings. But Wall Street is bullish. Among the 28 analysts, there are no sells. Part of this is politics — many firms want to stay in the good graces of VCs and their pipeline of upcoming IPOs. Q: How much could it fall? A: It can fall in the next 12 months from $67 to $45, where it will still trade at about 10 times sales. But a haircut by a third would bring it in line with the recent correction in other growth momentum stocks. Q: How about another? A: Sure, Abbott Labs (ABT) is a $39 stock. Late last year, Abbott split into two parts. They spun off their research pharmaceuticals business, AbbVie, and maintained the established pharmaceuticals, nutrition, diagnostic and vascular segments. The separation reduced Abbott’s exposure to the U.S. and to many of the new burdens associated with health-care reform. It also reduced their exposure to the high margin research pharma business. That will reduce returns on equity and invested capital for the go-forward company. Also, growth will be slower than consensus because nutrition, a key segment, is seeing declining trends in developing markets. There are product quality concerns in infant formula, particularly in emerging high growth markets like China. Sales have slowed, a trend that is expected to continue through mid year. So we expect revenue and earnings growth will be below consensus. The recent results support our thesis. Overall first quarter 2014 revenues were down 2.5% on weak performance in established pharmaceuticals, nutrition, and medical devices. Only the diagnostic segment saw positive revenue growth. Adjusted earnings of 41 cents a share were ahead of the Street estimate of 36 cents, but below last year’s adjusted EPS of 42 cents a share. Q: And so — A: Many investors in large caps have an ROE hurdle. This Abbott won’t meet their screens. And Abbott is still rich, trading at a major premium to the S&P 500 on expected earnings this year, despite lower forecasted growth. If you just check on Yahoo Finance, the stock sells at 24 times earnings, versus 17 times for the SPDR S&P 500(SPY). We have a target of $30. Declining growth should compress its multiple. The stock is benefiting from the de-risk trade, but that’s only temporary relief from a secular decline. Q: Last pick? A: Pandora Media (P) is at $22. Our 12-month target is about $17. It’s overvalued based on its growth outlook. The subscriber growth rates are diminishing and there is very much increased competition. Growth in active users continues to slow. Listener hours increased only 12% in the first quarter compared to 16% in the fourth-quarter and 35% a year earlier. Pandora finished 2013 with 76.2 million active users, up almost 14% from the previous year, but this pales in comparison to the 41% growth rate in active users in 2012. Much of this is the result of the law of large numbers, but new competition in the market may be starting to have some effect as well. The competition from Apple is well documented, but there is also Spotify, which many people prefer, and Google. All are aggressively vying for a piece of this market, and each has distinctive, competitive advantages. And the way Pandora is growing might rub users like me the wrong way. Q: How does it rub you the wrong way? A: More commercials. Right now, they’re running about two to three minutes per hour, which is still way below 15 minutes for commercial radio, but that’s starting to increase. They’re going to double that. The risk is the users. They may not like additional ads and iTunes is only a click away and Google Play has no ads and offers its own radio mix. And more and those are coming preinstalled. Q: How do you get to $17? A: We project Pandora to grow revenues of 30% in 2015, and we believe the stock will still trade at a high multiple. We think it could generate earnings of about 55 cents a share. [On a GAAP basis, it lost 23 cents a share in 2013.] Applying a 30 multiple gives us about $17. Q: Thanks, Robert.
January 27, 2014 By Leave a Comment