Monday, December 1, 2008

Third Quarter Earnings

Here is an update on the investments in my portfolio and my thoughts on third quarter earnings.


For the 3rd quarter revenue fell 10% pushing the company into a loss of $.1 million. Backlog continues to point towards declining sales. Total backlog is down 29%, comprising of a decrease of 35% domestically and a decrease of 25% internationally. K-Swiss is heading for a loss of $10-35 cents per share in the forth quarter. During the conference call manegment said that they are expecting a loss in 09 that could possibly burn through 10-20% of their cash. Separately K-Swiss announced during the past month that they will pay a special $2 dividend to shareholders on December 24th. This is a very positive sigh because on an enterprise value basis K-Swiss trades for less the 2 times my estimate of earnings a few years down the road. The CEO and CFO are two of the most candid managers out there, the decisions being made by the company show their philosophy of not thinking short term. I’m hoping the stock gets cheaper in the near term as I’m ready to buy a lot more. K-Swiss should easily be able to earn $60-90 million in net income when the economy improves. K-Swiss is currently trading for $400 million with nearly $300 million in cash. My estimate of intrinsic value $1250.5-$1478 million

Read my investment thesis on K-Swiss here

Freightcar America:

FCA is suffering from a downturn in the coal car cycle after the cycle peaked in 06 and customers over ordered. The poor economy also has a large negative effects on FCA. The 3rd quarter results were good but with the threat of a recession it is premature to say that the bottom of the coal car cycle has been reached. For the quarter sales were $238 million compared to $162 million in the same quarter last year and for the 9 months ended sales were $474 million compared to $680 last year. Net income declined to $7.4 million from $8.7 last year for the quarter. For the 9 months period the net loss was $3.7 million compared to a net income of $43 million last year. Orders during the quarter were 2329 compared to 1400 last year. Backlog at quarter end was 4401 units. FCA delivered 3082 railcars in the quarter compared to 2072 in the 3rd quarter last year. For the 9 months ended FCA delivered 6695 railcars compared to 8677 last year. FCA was hurt by material cost increases and large costs to close the Johnstown facility. To date the cost of closing the facility was $51 million and the remaining costs are small. FCA is trading for $258 million with $128 million in cash. My estimate of FCA’s normalized free cash flow is $36 million. FCA’s enterprise value is $130 million. My estimate of intrinsic value is $40-60 per share.

Read my last post on FCA here

American Eagle Outfitters

For the third quarter American Eagle had net income of 30 cents which includes a 9 cent writeoff of investments in auction rate securities. That compares to earnings of 45 cents last year. Sales were up 1%. Third quarter same store sale were down 7%. Operating margin was $95 million compared to $151 million or 12.6% vs. 20.3% in the same period last year. Results in the 3rd quarter 2008 include a $19.9 million impairment on the value of auction rate securities. Net income was $43 million vs. $99 million. The bright spot was AE Direct where sales increased 35% in the quarter. American Eagle has a market cap of $1.9 billion. Cash and investments total $616 million resulting in an enterprise value of $1.3 billion. Operating margins have averaged around 20% in the past compared to 12.6% in the last quarter. Even with operating margins around half of what they have averaged historically, American Eagle will be able to generate around $180 million in earnings a year. In addition American Eagle is an enduring brand with a lot of growth ahead with the new ventures such as aerie, Martin and Osa, AE Direct and 77 kids. A conservative estimate of intrinsic value is 2-3 times the current price.

Read my investment thesis American Eagle

Nicholas Financial

Nicholas Financial reported earnings of $792 thousand down from $2.6 million in the 3rd quarter last year. Revenue increased from $12.6 million to $13.5 million as the company continued to write new contacts. The new contracts are extremely profitable as NICK’s competitors retreat from the market. This pushed net finance receivables up to $210 million from $189 million in the quarter last year. The provision for credit losses was $5.1 million up from $1.6 last year in the quarter. This pushed the net portfolio yield down to 2.5%. The provision for credit losses is 9.86% so a 30% increase in the reserve would cause losses. The factor that most effects NICK is the unemployment rate. Management expects the charge off rate to worsen slightly in the fourth quarter. The strong point though is NICK’s reserve for credit losses that stands at over $23 million. This compares to charge offs over the last 6 months of $11 million. So the reserve is at a very healthy level. Nicholas Financial is trading for $25 million with $83 million in book value.

Read my investment thesis on Nicholas Financial

Pinnacle Airlines:

For the 3rd quarter Pinnacle reported revenue of $220 million vs. $203 for the same period last year. Operating margin improved to 9% from 7.3% last year. Operating income was $20 million compared to $15 million last year. Pinnacle has $64 million in cash and $127 million in auction rate securities. For the 9 month period operating income was $29 million vs. $43 million but the 2008 period contains a $13.8 million impairment on the value of the goodwill related to Colgan. Pinnacle currently has seven addition aircraft in it’s fleet that are being flown temporarily for Delta. Pinnacle has lead all regionals in operating performance for the past 22 out of 33 months. Colgan’s operations are beginning to turn around as its contracts with the government were rebid during the quarter. Management expects that Colgan will be profitable in 09. Also all the Q-400's are operational. Operationally Pinnacle is doing alright. The over supply of 50 seaters in operation is hurting them. They continue to generate a healthy amount of cash and a $30 million tax refund will be received in the first quarter.

Mohnish Pabrai began selling his stake in Pinnacle a few months back. No matter what, airlines are problem businesses. I now regret my investment in Pinnacle. My mistake was that I focused on PNCL as not really an airline company and I didn't consider the macro factors. I assumed that the contracts were solid. But when the customer is making all the money and the operator has the control, there is going to be problems. What Delta did was also caused by the over supply of 50 seaters in the market today. It doesn't make sense that the airlines would tolerate the regionals making so much money when economic conditions have caused them to be losing a ton on the other side of the deal. But the contracts do allow the parents to swap the 50 seaters for larger planes on a one for one basis. The result is yet to be seen but clearly Pinnacle has been impaired. But, PNCL has $200m in investments and 3rd quarter results were not bad. A healthy level of FCF is being generated. In my last post on Pinnacle I considered the worse case scenario and estimated a liquidation value. Given the price Pinnacle is trading at I’m holding.

Read my other posts on Pinnacle here