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August 5, 2006
S&P 500- 1,245
Fuel-Tech
(FTEK $11.30, NMS)*
Year Ending December 31, 2003 2004 2005 2006E 2007E
Revenue ($ millions) 36 31 53 68 85
Net Income ($ millions)** 1.1 1.6 7.6 10.8 14
Cash EPS, Diluted ($/share)** .05 .07 .31 .45 .58
Avg. Diluted Shares (millions) 22.4 22.2 23.1 24 24.5
**Net income and EPS presented exclusive of non-cash taxes and FASB 123R expenses
Generating electricity isn't as easy as you think. The simple view is you spray or dump some fuel into a boiler which ignites producing a hot flame that heats water up which is in tubes running through the boiler and either this hot water is used for something or it is superheated into steam that than turns a turbine in a magnetic field, thus generating electricity. But behind this process are all sorts of problems that our new recommendation, Fuel-Tech, can help a utility or large industrial customer address.
A fairly obvious one is air pollution. Burning oil or coal can produce a lot of pollutants, in particular sulfur-dioxide (SO2) and sulphur trioxide (SO3) and nitrogen-oxide (NOx). The latter is a particular culprit in creating visible, undesirable smog. And the battle/problem here faced by each company is that the less pollutants a given fuel produces, the more costly it is likely to be. Nobody wants pollution in the air, so the government first has had utilities install expensive scrubbers to get the sulphur out of the stack emissions and now more recently in 2003-2004 has gone after the NOx part of the problem. The program called the SIP Call program requires NOx reduction for 700-800 utility boilers and 400-500 industrial units in 19 Northeastern states in the first wave. Then the Clean Air Interstate Rule will bring 12 more states east of the Mississippi into the loop and after that NOx reduction will be extended into Western states. Fuel-Tech makes air pollution control equipment to remove NOx emissions.
And get this, an ingredient which is combined with a catalyst to accomplish NOx reduction in the more expensive $100 million Selective Catalytic Reduction systems (sold by others) uses anhydrous ammonia… Should a truck load of that tip over on the highway, the kill radius is said to be 5 miles. Scary stuff! But Fuel-Tech has a solution for that also with its NOxOut Ultra which uses urea to provide the ammonia source instead for those systems.
Moving past the stack emissions and back inside the boiler… have you ever heard of slag? It is essentially impurities like sodium and iron that are in the fuel, especially coal (which provides 50% of U.S. electricity generation). When the fuel is burned in the boiler these deposits of impurities don't combust, but sort of melt and build up these slag deposits inside the boiler, often on heat transfer tubes and surfaces. That therefore doesn't help with the efficiency of transferring the boiler's heat to the water inside these tubes. So that's a problem, but a more serious one is that these slag deposits inside the boiler can get HUGE, up to the size of boulders in a very big boiler unit, and eventually they can break off (at this point they are called clinkers) and plunge from considerable heights doing serious damage to tubes, etc. at the bottom of the boiler often causing steam leaks. The unit then has to be shut down, repaired, deslagged (which can be a 6-12 day process in itself) and all the while the utility may have to be out there buying energy in the open market at $150/MW during peak season, to make up for the shutdown.
Part of the problem here is that Powder River Basin coal has come into favor in an effort to reduce SOx emissions, but this coal has a higher sodium content which causes increased slagging. So this has lead many plants to seek lower sodium coals to combat this and this has in turn caused the prices of those coals to rise.
So is there any other way to combat this slagging problem? Fuel-Tech's Fuel-Chem division has come up with an innovative way to handle slagging and fouling with minimal mechanical changes or capital investment. Fuel-Tech's TIFI (Targeted In-Furnace Injection) sprays small amounts of a chemical reagent into precisely targeted areas inside the boiler that allows plants to burn fuels prone to slagging with almost none of the normally associated problems. Indeed Fuel-Tech even has incredible pictures of the disappearance of previously existing slag deposits inside a boiler after just 24 hours of using the TIFI process. This saves money on down-time for cleaning (which can take 6-12 days using a process called "explosive deslagging") and on the cost of repairs from crashing clinkers and the associated higher cost of replacement energy purchases, plus boiler inefficiencies due to slag build-up on the heat transfer tubes. Installing TIFI on a boiler can provide a 3 to 1 ROI. Fuel-Chem's business is already generating $4.8 of the Company's $17 million in sales for Q1, with higher gross margins (55% vs. 46%) than the pollution control equipment. For the full year this portion of the business is projected to grow to 40% of total company sales projected at $65 - $70 million.
Now, take everything above and also apply it to India, China, Mexico, Europe and the rest of the world… which FTEK is now doing. With the increasing industrialization of China and India in particular, both have increasing smog problems which they are starting to address. Also, with China hosting the Olympics in 2008, it has become increasingly interested in cleaning up its environment. In fact Fuel-Tech has some very good contacts in China. The country is expected to add 325 new coal-fired boilers by 2010. And it is expected that many of these units will have some form of NOx control imposed upon them. Against this backdrop the Company was awarded two contracts totaling $15.3 million to install its NOx-OUT technology in China. With a foot in the door and a lot of interest, the Company said in its Q1 conference call that it has never been more excited about an opportunity than it is about China right now.
FuelTech's lower cost pollution control systems that, for example, provide 30% of the NOx reduction of a $100 million system for 1/20th of the cost, should find quite a niche especially overseas where countries are waffling about doing anything at all due to the expense… Fuel Tech's systems can provide a good solution. The Company is also finding new markets with municipal waste incinerators, waste to energy plants and cement kilns.
Okay, I trust the light bulbs are coming on by now? I could go on for pages. Suffice it to say that there is a huge opportunity out there for Fuel-Tech. One concern I had in recommending the Company is that this year it has begun reporting fully taxed, at 42% no less, which hurts comparisons and so I have elected to show EPS on a "cash basis," before income taxes (which FTEK now has to show for GAAP but does not pay in cash) and also before non-cash FASB 123 charges. Other analysts are also looking at Fuel-Tech this way. Another concern I had was that EPS is to be released on Monday as we go to press. But while there could be some volatility due to this, at the end of the day I could not table my best idea because of that of all reasons. So I am forging ahead. The bottom line here is Fuel-Tech is in a period of rapid growth with revenues increasing 42% in Q1, for a second consecutive quarterly record, pre-tax income doubled, and the Company just seems to be in a big sweet spot everywhere you look right now. Fuel-Tech has no debt, $18 million in cash, a BI Rank of 8.8, and I do own 5,000 shares, so far. The run to $17 and back was largely a Cramer event (of TheStreet.com). Recent trading volume is on the lower end of what I like to see, so use limit orders and don't get greedy. FTEK is a Buy to the $13 - $14 range, but call the Update Line before buying to make sure the green flag is still out in the wake of Monday's release. (203) 425-9830 Stamford, CT www.fueltechnv.com
Update
There is increasing talk of an economic slowdown. Last year when I saw my pre-pay plan oil bill (which caps the price) for the year ahead, and it was nearly double the year before, I worried here about the impact on the economy. Somehow consumers shrugged it off. Now this year talk of a slowdown has resurfaced because oil prices are even higher and I know my prepay plan is up about another 40%. So, combining this with the economic expansion getting a bit long in the tooth, housing slowing (though not as much as some feared), interest rates still on the rise (but hopefully near subsiding) and commodity prices still high, there is increasing worry about an economic slowdown … though not a pending recession at this point. Value Line, for one, sees growth in GDP of 2.5-3% over the year ahead. Note that GDP growth slowed from a relatively torrid 5.6% in Q1 to 2.5% in Q2.
In this environment, while the market remains up for the year to date, it is off considerably from its highs this spring. With the market still in its worst 4-6 month stretch of the year until October (depending on which index you look at), I feel more comfortable at a 70% invested, 25% money market posture for now. Currently most attractive for purchase are Fuel-Tech, Bodisen, Aspreva, ICT Group, Taseko, LifeCell, Continental and more speculative Centene. After a long run I am closing out Great Basin. The next issue goes out on 9/18.
LIFECELL* (LIFC $28.45 NNM, +129%); BI Rank = 10.0 - Buy (Sold 25% at $23, +85%; sold 25% at $28.05, +126%) (908) 947-1100 NJ www.lifecell.com (5/05)
LifeCell makes products (most notably- AlloDerm) from human tissue that is stripped of everything that could cause it to be rejected. The resulting tissue matrix is used in reconstructive surgery and once stitched into place is then naturally repopulated by the surrounding tissue and blood vessels. Its most common use is in hernia repairs, but is also used for reconstructive breast surgery, bladder slings, to add strength to rotator cuff repair, and has even been used around the heart with good results.
Q2 results were everything you could want, and more, and the Company raised its 2006 guidance more than 10% ... and the stock sold off after the release. I love my job… (anybody want it?) Get this- Q2 EPS, with $.04 of FASB 123 reflected, came in at $.15 vs. $.11 last year (w/o FASB 123). That was 2 cents better then the consensus. Plus the Company took its 2006 EPS guidance range up by a huge $.07 - $.09, to a range of $.59 - $.63. AND it also took its revenue forecast up by nearly 10% to a range of $143 - $148 million ... and the shares, which justifiably tacked on $2 shortly after the open, then tanked $3 to end the day off over a point. The stock has since recovered that but the bottom line is that despite this good report and taking EPS guidance up about 12-14%, the shares haven't budged since our last issue. Meanwhile the BI Rank eats this up, soaring to 10.0. Product revenues advanced 60% in the quarter led by AlloDerm revenues up 73%. The Company is working on a new product called Xenoderm which is much like AlloDerm, but initially harvested from animals rather than humans. Similar products are already on the market, but LifeCell feels its product will have competitive advantages and unlimited supply. It also has an exciting new ACL application- Buy.
BODISEN* (BBC $13.06 ASE, +6%); BI Rank = 11.7 - Buy IR- (212) 481-2050 NY www.bodisen.com (Recommended- 6/06)
Bodisen is a rapidly growing environmen-tally friendly fertilizer company doing all of its business in the farming region of central China. However, the stock is only traded in the US and the United Kingdom. The shares are off to a decent start (they're up) in a challenging stock market environment. The Company announced that it expects to report record revenues and net income for the quarter ended June 30, 2006. In the second quarter of 2005, Bodisen reported revenues of $8.42 million and net income of $2.69 million. Bodisen experienced better than expected sales growth in Q2 due to strong customer demand for its environmentally friendly bio fertilizer products. Q2 results are expected around 8/10. Of course the Company doesn't actually make projections, and even now did not divulge Q2 sales, but the lone analyst was looking for about $15.5 million in sales for Q2 with EPS of $.25 (and $19.7 million for Q3). Given a forecast of $.90 - $.95 for 2006, however, and with Q2 being the biggest of the year, I am hopeful of some upside relative to that $.25 EPS "consensus." Two analysts are looking for $60 million of revenues for the full year… I'm at $56 million for now. If BBC were to trade at just 20 times my 2007 EPS estimate of $1.45, it would more than double over the year ahead. Note its relative earnings rating is in the 99th percentile … and 95th for relative strength, and the BI Rank is 11.7. Accordingly BBC remains a Strong Buy.
HEALTHWAYS* (HWAY $53.54 NNM, +560%); BI Rank = 6.6 - Hold (Sold 25% 10/03, +173%; Sold 50%, -1%) 615-665-1122 TN www.americanhealthways.com (8/02)
Healthways is arguably the leader in the field of disease management, and as the biggest, purest entry is the go-to stock for funds who want to invest in this timely concept. The Company released results for its May 31st Q3 shortly after we went to press last time. Revenues increased 36% to $106 million and EPS increased a comparable percentage … but there are a lot of ways to present that. The ongoing core business exclusive of FASB 123 and assorted nonrecurring weirdness was $.36 (vs. $.26 last year, +38%). But if you reflect $.02 a share the Company is spending getting ready to make a move into the international market, and the $.03 it lost (for now) on its two Medicare test pilots, and FASB 123 charges of $.06, then they made $.26 vs. $.19 last year.. up 37%. Take your pick. The Company increased lives under management by 35% to 2.2 million. With the August quarter the two MHS pilots will finally be able to book a big slug of revenue earned over the past year and henceforth an adjustment for that will go away. International should eventually turn from an up front invest-ment cost to a contribution to EPS but the Company has had little to say about this push so far. However, at the end of the day no matter how you slice it the growth rate is impressive and the Company hopes to soon close on the LifeMasters acquisition which will add over 600,000 lives under management- Hold.
ASPREVA PHARMACEUTICALS* (ASPV $23.97, +52%); BI Rank = 9.1 - Buy (Sold 40% 2/9/06 @ $26.40, +68%) (250) 744-2488 BC www.aspreva.com (1/06)
Aspreva is a specialty pharma company engaged in partnering with pharmaceutical companies to develop new indications (such as Lupus Nephritis) for their already approved drugs, generally addressing smaller market opportunities that are relatively insignificant for the innovator to pursue or are simply not in its area of focus. Results for the second quarter were nothing short of dreamland. Revenues came in at $51.7 million vs. $14 million last year, while net income for the quarter soared to a whopping $28 million or $.78 per diluted share as compared to $1.2 million last year and $.03 a share. Net income easily absorbed (and reflects) a $2.2 million FASB 123 hit. The driver continues to be revenues generated by Roche's CellCept for autoimmune indications. In that regard Aspreva is in Phase III trials for CellCept's use for Lupus Nephritis, Myasthenia Gravis and Pemphigus Vulgaris and expects to file drug applications for all three with the FDA during 2007. With no good drugs in existence for these diseases, and a growing body of evidence that CellCept works well on these autoimmune diseases, each study and each conference presentation and each medical journal article and each word of mouth conversation drives an ever increasing amount of off label usage even as Aspreva works towards FDA approval.
Meanwhile, investors wait impatiently for the Company to sign additional partnering agree-ments that will allow the Company to dance with other existing drugs and pursue new indications for them in markets that are too small for the major pharma company. One of them might be with Roche, but the Company is now making progress on multiple fronts with, it now sounds like, more than the two unnamed companies it has previously discussed with investors. I believe it is just a matter of time before it finalizes negotiations and brings other compounds and agreements into its business model. However, in the meantime, investors grow impatient because CellCept goes off patent in 2009. But management appears confident that it will eventually land additional deals, as am I. The 2006 EPS consensus is $3.37- Buy.
ICT GROUP* (ICTG $26.02, -1%); BI Rank = 9.3 - Buy IR: (212) 750-5800 NY www.ictgroup.com (5/06)
ICT Group is a leading global provider of customer management and business process outsourcing solutions. The Company reported a 15% increase in revenues to $111 million resulting in a 57% increase in operating income and a better than doubling of net income to $3.9 million. EPS came in at $.25 vs. $.14 last year, significantly exceeding the consensus of $.21 - $.22. Without a $.03 hit from FASB 123 in Q2, which is not in last year's number, EPS essentially doubled to $.28 a share. Call volumes were up 17% over last year and are expected to be up 18% in H2. For the third quarter ICT expects EPS of $.25 - $.27, representing 40-50% growth on revenues of $106 - $108 million. 2006 ESP guidance was raised $.05 to $1.08 - $1.13. After improving its operating margin 150 basis points in 2004 and 120 basis points in 2005, ICT is targeting a further 100 basis point improve-ment in 2006 which is helping to fuel this earnings growth as is the trend to handling more business offshore. While revenues come down a bit with the lower offshore costs, the margin improves. The shares remain a Buy.
PALOMAR MEDICAL TECH.* (PMTI $36.70 NNM, +60%); BI Rank = 7.8 - Hold (Sold 50% 11/25/05 @ $35, +53%) (781) 993-2300 www.palomarmedical.com (6/05)
Palomar, which makes and sells aesthetic (cosmetic) lasers, is a technology leader in its industry. Indeed this is what attracted us to this company which spends the most heavily on R&D (16%) "creating the products that others try to emulate." Having won a fat award in June as the result of the settlement of a patent infringement suit with Cutera, analysts' estimates for 2006 of $1.87 (vs. $.91 in 2005) currently carry a giant bulge for this one-time event. That said, estimates have come down from $2.00 two weeks ago, despite the Company beating estimates in Q2. The reason for this is that the estimate of the damages and related interest and legal fees has come down from $22 million (which was already paid I should note) to $19.6 million. Okay you can never be too happy when a couple million dollars of windfall disappears, but hey, it was one of those one-time shots routinely ignored by investors in any event. Or so I thought. However, when EPS for Q2, with the lesser settlement, weighed in at $.86 instead of the $1.00 expected, the news wires reported it as a $.14 EPS miss. Meanwhile, however, the consensus was more like $.29 without the settlement and Palomar weighed in at $.31 on that basis. Regrettably the Company (which does not give guidance), stuck with a strictly GAAP earnings presentation and offered no reconciliation to ongoing earnings (though the pieces were in the release for those with a sharp and accurate pencil), allowing confusion to reign and the shares sold off a staggering $8 at the worst before closing off $5… Yikes!! What are investors smoking?
Product revenues were up 37% to $21.6 million and the Company reported that "the outlook has never been better." The only other thing that surfaced in the call was some softening of the level of certainty management exuded with regards to the likelihood (and timing) of FDA approval for the light-based hair removal device for home use being developed with Gillette. With class actions today as common as umbrellas on a rainy day if a company has any sort of a miss, my guess is this more conservative tone came from legal. The Company simply reported Palomar has heard back from the FDA regarding this filing "and is in the process of answering its questions. As is always the case, the FDA, as a government entity, has considerable discretion with respect to review and timing." Previously the Company has generally indicated it expected to hear (favorably) by September. Whether this little subtlety could cause the slide in the stock seems doubtful. Management had built in time for questions and answers with the FDA (which is routine) into its time line, has dealt with the FDA on other devices many times, and I think just wanted investors to know there is this process and nothing is ever certain but death and taxes. They did not appear to think anything had gone amiss to make approval any less likely. Also I think few, if any, analysts have yet factored royalties from this device into their estimates. However, Gillette has until 9/30 to make a go or no-go decision, which has always been a known risk. A "Go" would trigger a $2.5 million royalty payment that I believe Palomar will amortize over the following 12 months, and another "Go" a year after that would trigger another $10 million. With 20 million shares out, this arrangement could be a significant contributor to EPS… but… nothing is certain except death and taxes, and an (unexpected) disappointment here would weigh on the stock price. It is interesting to note that Palomar replaced Laserscope (which we recently closed out due to its pending acquisition) in the S&P 600 on July 12th- Continue to Hold.
INVENTIV* (VTIV $28.07 NNM, +64%); BI Rank = 5.6 - Hold (800) 416-0555 NJ www.ventiv.com (6/04)
inVentiv provides sales force teams to pharmaceutical companies on an outsourced, contract basis and also provides a wide assortment of commercialization and other services needed to market pharmaceutical products and support the sales teams… especially by smaller pharmaceutical companies who seem to be generating the bulk of the NDA's lately. The Company was slated to release earnings on 8/8, the day after we go to press and there is not much news of any significance. This isn't really news but it was interesting to see inVentiv listed in an article talking about "Finding (Peter) Lynch's 10- Baggers" as one of the stocks on the author's list to keep an eye on to catch the next Starbucks… One can only hope. The consensus for the quarter is still $.32 with $1.35 envisioned for the year, fully burdened with about $.15 of non-cash FASB 123 charges, $1.50 without- Hold
MAJOR DRILLING* (MJDLF.PK $20.03, C$22.82, -18%); BI Rank = 7.2 - Hold (866) 264-3986 www.majordrilling.com (4/06)
Major Drilling is one of the leading drilling companies for metals and minerals (vs. oil and gas). Major Drilling has sold off with the correction in resource stocks, though the price of gold and copper has not really dropped that much from the peak. Prices are still excellent but investors' fondness for related stocks has diminished. The Company says that about 45% - 50% of the drilling it does is for companies looking for gold, and therefore its stock price is fairly closely correlated with an index of gold stock, for example the TSX (Toronto) - Precious Metals index. But there is a complete disconnect with what the stock is doing and the level of drilling activity. Drilling activity remains as robust as it has been and the Company believes that as long as gold stays above $450 and copper above $1.30, drilling activity will remain strong. On that, it is worth noting that gold for 2010 delivery is $808, considerably higher than the current price of $650. And this should keep drilling interest high for the foresee-able future. MDI is on an April fiscal year so just finished Q1. Results should be reported in the first week of September. In the wake of selling off UDR's operations and its profits, MDI has softened and the consensus has dropped to $1.60 from the $1.75 I was using, clipping the BI Rank- Hold.
....Well you get the idea. We go on for 12 pages in all with detailed updates on each stock we have recommended and not yet advised selling.
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