Value Portfolio

For the first nine months of the year, however, fund outflows from sub-advised funds and institutional accounts have worsened. Not sure why outflows have occurred, since the company’s investment performance has improved as of late, but sometimes there is a time lag before improved performance is recognized. In any event, Diamond Hill’s stock keeps rising and is now the second-best-performing Roadrunner recommendation with a 68.5% return.

Investors have bid up the stock in anticipation of another hefty special dividend at the end of the year. The company did not disappoint, announcing the payment of a $3.00 special dividend. Ex-dividend date is Friday, December 6th. This will be the smallest special dividend since they began being paid in 2008, but investors seem happy nonetheless, with the stock jumping 2.5% on the news and currently at all-time highs.

Stepan (NYSE: SCL) reported third-quarter financials that exhibited healthy revenue growth of 8%, but nearly flat earnings growth of only 1%. Earnings missed analyst estimates by a penny, whereas revenues beat estimates. Stepan enjoys the third-highest sales per share in the specialty chemicals industry.

I’m okay with the flat earnings because they were caused by necessary investment expenses in R&D and emerging-market growth initiatives plus one-time charges associated with both the start-up of a Singapore manufacturing plant and the shut-down of a China plant that the Communist government required be moved to another location.

In the conference call, the company isn’t holding its breath that the Chinese government will provide adequate compensation for the plant dislocation, but the growth potential of China remains undeniable. Brazil and Singapore business is picking up the slack. As for the exciting move into the oilfield services space, the sale of enhanced oil recovery (EOR) chemicals is going a bit slower than expected with “some delay in project implementation.” In 2014, however, the delays will be history and the company expects “improved performance.”

CEO F. Quinn Stepan Jr. is upbeat about the future:

We remain optimistic about our long-term growth. The slow start to the year has made achieving full year earnings growth difficult, but we continue to pursue investments that will accelerate our growth.  In 2014 we will realize the benefits of our recent acquisition and other capacity expansions.

In addition, the company increased its quarterly dividend by 6%, marking the 46^th consecutive year that the dividend has been raised. I like Stepan because it is such a shareholder-friendly company that focuses on returning excess cash while waiting for the global economy to strengthen. We are paid to wait!

United Therapeutics (Nasdaq: UTHR) continues to thrive in the three months since I labeled its second-quarter conference call the most optimistic in history. In fact, it is the best-performing stock in the Roadrunner universe – up 75% since it was recommended less than a year ago. Third-quarter financials continued the trend of strong results, with revenues up a strong 24.6% and adjusted earnings (i.e., before non-cash charges) up 23.6%. Revenues beat analyst estimates with all three main products (Remodulin, Tyvaso, and Adcirca) performing well. Even better, the company raised its guidance for full-year revenues and now expects to exceed the upper end of its previous guidance of $1.05 billion.

In the conference call, CEO Martine Rothblatt’s discussion about Remodulin’s future refers to Winston Churchill and is very inspirational. Although Remodulin has been around for more than a decade, a revolutionary new application – the implantable pump – promises to make the drug an even-bigger winner going forward:

I’m extremely pleased with the results of the third quarter. Our medicines are now prescribed for more PAH patients in the U.S.A. than any other company. United Therapeutics’ revenues are clearly on an upward trajectory. And when I take a look at our, at our leading revenue generator, Remodulin, I’m kind of reminded of this quotation back from the 20th century. I believe it was Winston Churchill, World War II, but don’t hold me to this and don’t hold it against me if I didn’t know for sure that it was Winston Churchill, for our English holders. But I believe he said something along the lines of, “This is not the beginning of the end, but the end of the beginning.” And he was speaking with reference to World War II. But for me, I’m speaking with reference to Remodulin. It’s kind of extraordinary for a drug that was launched in 2002 to 13 years — 11 years later, still have striking revenue growth quarter-over-quarter, year after year. And somebody might say, “Well, is this the beginning of the end?” I mean, that’s a long run for a drug, especially in an orphan market. But in fact, I feel very confident that it’s actually only the end of the beginning and nowhere near the beginning of the end.

And the reason it is just the end of the beginning is because we are now moving into an inflection period, where our Remodulin revenues are driven predominantly by parenteral delivery via subcutaneous or intravenous infusion attached to a pump that is carried outside of the patient’s body. And among the patients and the doctors and the nurses in the pulmonary hypertension community, this is referred to as being on “the pump.” And it’s always said with kind of scary music in the background, that people are frightened that they have to go on “the pump.” And it is, of course, something that any of us who are healthy enough not to need that, should really have a world of respect for those who do have to walk around 24 hours a day, 365 days a year with a catheter winding outside of their skin connected to a mechanical pump that is literally pumping medicine into their body with the full knowledge — they all know that if that pump was to stop for any number of hours, they could face instant death. And people have died instantly from rebound hypertension due to an interference with parenteral prostacyclin delivery. So the pump is scary. Now despite that, as I just mentioned, we’ve grown revenues of Remodulin and are now — actually have $0.5 billion a year revenue run rate within our eyesight. We’re not there yet, but it’s something that seems to be visible on the near horizon.

But I really believe that this is just the end of the beginning because there is a revolutionary new product in our pipeline, which is the implantable Remodulin. And as I travel around the country and talk with physicians, I’ve not met one who is not tremendously excited and believes it will be transformative for their Remodulin patients.

Despite promising future growth and strong price appreciation, United Therapeutics continues to trade at a reasonable EV-to-EBITDA ratio of 8.6. And don’t forget that oral Remodulin could still receive FDA approval, with the next  FDA response scheduled for February 16, 2014.

US Ecology (Nasdaq: ECOL) skyrocketed more than 13% on October 29^th after releasing a superb third-quarter financial report.  The company generated record operating income (up 25%) and record adjusted EBITDA (up 20%). Earnings per share and revenue both easily surpassed analyst estimates. Even better, the company raised its earnings and adjusted EBITDA guidance for full-year 2013. CEO Jeff Feeler spoke very confidently about 2014:

Strong Event Business combined with steady Base Business and continued operational excellence across all of our facilities produced a second consecutive quarter of record financial results. Growth in our Event Business was driven by a combination of solid new project demand and accelerated shipments on longer-term projects. Our underlying Base Business is performing as expected and demand for our thermal recycling services remains strong.

With a healthy pipeline of business that runs into 2014 and a solid fourth quarter outlook, we now expect full year earnings for 2013 to range from $1.68 to $1.73 per diluted share, up from our previous range of $1.45 to $1.55 per share. Adjusted EBITDA is expected to range from $67 million to $69 million, up from our previous guidance of $62 million to $65 million.

In the conference call, Feeler emphasized the company’s focus on profitable growth, stating:

Our key financial metrics that we track remain at or near industry-leading levels, with us delivering almost a 17% return on invested capital, 13% return on total assets and 24% return on shareholders’ equity. Overall, I continue to be pleased with our execution, companywide. Our end markets continue to be healthy and our project pipeline remained solid moving into the fourth quarter, which should translate into a strong finish for the year.

Wunderlich Securities issued a research report after the earnings release entitled “Wow! Can FY14 Maintain a Solid Growth Rate? Yes!” The analyst reiterated his buy rating on the stock and raised his price target to $38 from $33.

Bottom line: the U.S. is producing a lot of waste and US Ecology is the one cleaning up (literally and figuratively). 

Momentum Portfolio

LeapFrog Enterprises (NYSE: LF) reported third-quarter financials that saw GAAP earnings per share beat analyst estimates and adjusted earnings grow by 19%. Revenue growth of 4% was little light of expectations. The real news, however, was lowered guidance for the all-important fourth-quarter holiday season. Retail stocks have been hit by weak consumer spending and LeapFrog is not immune to such macroeconomic forces.

In the Nov. 4th conference call, CEO John Barbour said that the company is well positioned despite the macroeconomic softness and LeapFrog products are flying off the shelves:

We are well-positioned for the holidays with our best product lineup, significant off-shelf promotions and a strong marketing plan for Q4. I personally store checked 8 stores yesterday morning and found substantial out-of-stocks in our key items despite stronger retail inventories than last year.

There’s no question the market is tougher going into this holiday season. When you add to that the 6 fewer days, which does have an impact the tighter the market becomes, that’s why we have some caution going into this quarter.

On September 3^rd, a director purchased 25,000 shares of LF at 9.10, which is a nice endorsement for the company’s long-term business prospects!

LeapFrog is a real bargain below $9. Even with reduced guidance, analysts still expect the company to grow earnings by 17.5% annually over the next five years and the forecast for 2014 earnings of $0.57 are 32.5% higher than this year’s $0.43. As the global economy becomes more knowledge-based, early childhood education will increasingly become a necessity for U.S. competitiveness. LeapFrog is perfectly positioned to benefit from this education megatrend. I continue to believe that LeapFrog — the company with the best products — will eventually succeed and the stock is super-cheap at an EV-to-EBIDTA ratio of only 5 with no debt!

Ocwen Financial (NYSE: OCN) reported third-quarter financials that missed analyst estimates for both earnings and revenues, but Chairman Bill Erbey convincingly explained the shortfalls as due mainly to a timing issue:

Notwithstanding our record revenues, revenues were suppressed due to delays that have now been resolved in boarding the OneWest transaction. As expected, margins were below historical levels due to the timing involved in transitioning ResCap and OneWest.

Analysts were divided on the importance of the earnings miss, with two brokers downgrading the stock to market perform and two brokers raising price targets to $58 and $65, respectively. The downgrades are unpersuasive and appear to be knee-jerk reactions to both the earnings miss and a mistaken belief that the stock’s outperformance can’t continue. On November 12^th, Standard & Poor’s sided with the optimists and raised Ocwen’s credit rating to B+ from B, stating:

Following a year of large acquisitions of mortgage servicing rights portfolios, Ocwen Financial appears to have successfully added about 2 million mortgages to its servicing platforms–significantly boosting its EBITDA and alleviating some of our concern about its rapid balance sheet expansion.

Even though Ocwen missed estimates, revenue shot up by more than double (128 percent) and earnings rose 19 percent. Looking forward, earnings are expected to rise 88.7 percent in the fourth quarter, 43.7 percent in the first quarter of 2014, 57.6 percent for fiscal 2013, and 135.9 percent for fiscal 2014.

Further growth appears assured by the fact that all of the large banks continue to sell off mortgage-servicing rights (MSRs) in order to comply with stricter capital requirements. For example, Citigroup recently announced plans to sell off MSRs on $63 billion of its mortgage loans, or about 21 percent of its total contracts. Ocwen is sure to be one of the largest acquirers of these MSRs. As I’ve stated before, the more MSRs Ocwen owns, the more fees it collects and the higher its earnings.

Couple that amazingly strong growth with a trailing 12-month P/E ratio of 31, and you get a PEG ratio far below 1.0. It’s no surprise that Steve Eisman (who made millions in the 2008 sub-prime mortgage crisis) continues to tout Ocwen as one of his favorite stocks with 50% more upside.

Western Refining (NYSE: WNR) skyrocketed 9.5% on November 12^th thanks to news that it was acquiring 100% of the general partnership interest and 38.7% of the limited partnership interests in Northern Tier Energy for $775 million in cash. The purchase price is only 4.5 times 2014 EBITDA estimates, which is a bargain price representing a 16% discount to the EBITDA multiples of peer companies. The merger is expected create $20 million worth of cost-saving synergies per year and will be immediately earnings accretive to Western.

Northern Tier is a variable-rate MLP and UBS upgraded Western on news of the acquisition with a $41 price target based on its belief that Western will transfer its refinery assets to Northern Tier’s tax-advantaged MLP structure. MLP-structured refiners have higher valuations than C-corp. refiners like Western.

Northern operates a Minnesota refinery with an 89,500 barrel-per-day capacity, as well as more than 230 SuperAmerica convenience stores/gas stations and a 17% interest in a crude oil pipeline. Since Western’s El Paso and Gallup refineries combined have a daily capacity of 151,000 barrels per day, adding Northern Tier’s refinery increases Western’s refinery capacity by a very-substantial 59%.  Furthermore, Northern Tier’s refinery is in close proximity to cost-advantaged Canadian crude oil that is much cheaper than Western Texas Intermediate (WTI) crude oil — $36.75 per barrel cheaper. This low feedstock price means high profit margins for Northern Tier’s refinery. Combined with a widening WTI discount to European Brent (7-month high),Western Refining’s profit margins should soar in 2014. 

Third-quarter financials suffered from declining profit margins and missed estimates, but I believe the third quarter will mark the trough. CEO Jeff Stevens stated:

In the fourth quarter, we are seeing improved refining margins as the Brent/WTI crude oil price differential has widened from the levels we saw in the third quarter. The Midland/Cushing price differential has also widened, which is having a positive impact on our El Paso crude oil acquisition costs.

Perhaps in anticipation of better times ahead, the company increased its quarterly dividend by 22% to $0.22 per share.