Value Portfolio

Diamond Hill Investment Group released excellent third-quarter financials, with  revenues up 32 percent, earnings up 16 percent, and assets under management up 31 percent. Value investing really works! For the seventh consecutive year, the company announced a special dividend. The amount is $4.00 per share, which is $1.00 more than last year. The ex-dividend date is December 3rd.

Exactech issued an earnings and revenue warning on October 13th after the market close, one week prior to its third-quarter financial report:

The company said it expects that revenue for the third quarter will be at the lower end of its previously announced guidance and that net income will be below guidance due to softer than expected sales and adverse currency impacts.

The stock dropped 16.6% in a single day. When third-quarter earnings were actually released on October 21st, the results weren’t that bad and the stock has actually risen ever since, never again hitting the low point of October 14th. Although earnings dropped 6% and revenues were up only 4%, the reasons for the shortfall are not company-specific but simply based on macroeconomic issues such as foreign currency effects (7% to 8% depreciation in the Euro and the Japanese yen relative to the U.S. dollar during the quarter) and weak demand for knee replacements and spine biologics in Europe and Japan.  Furthermore, operating profit margins actually increased, reflecting efficient operations. The company’s cash balance is higher year-over-year and its debit load is less. The balance sheet is getting stronger.

In the conference call, CFO Jody Phillips said the the entire reason the company missed analyst estimates was foreign currency and that earnings may have actually beaten the estimates if exchange rates had remained constant during the quarter. As Phillips put it: “I am not happy with the currency losses, but I think the business is still pretty strong and we are delivering the [operating profit margin] leverage we are looking for.” Recently-promoted CEO David Petty (son of founder and doctor Bill Petty) said that recent weakness in knee replacements was related to an overburdened sales force, not an inferior product (although a revised state-of-the-art “porous” knee system will be introduced in 2015), and that the company plans to increase its sales force to get the knee division back on track. In addition, Petty explained that sales growth can quickly improve for small companies like Exactech; all it takes is a few customer orders:

Our market share numbers for hips and knees, for us to grow, it should not matter whether it was relatively a softer quarter compared to the prior quarter, because it just simply doesn’t take that many customers, new customers for us, for hip and for knee to really move the needle, so that’s a philosophical statement.

 Petty remains very upbeat about the future:

I think our story has remained the same along the way, which is we have really focused on trying to understand what the unmet clinical needs for patients with should problems, and then to design solutions, they will meet those needs, and I think the surgeons have responded and have often selected those solutions. So when we started with — our solutions with primary and reverse shoulders, we have now in succession followed that with multiple new products that solve difficult problems for surgeons.

We have also developed perhaps the strongest competency in the industry, and providing really good medical education programs to help surgeons understand the benefits of these solutions that we have provided, and I think our team — I’d take our team over any team in the industry for both the product developments, and the marketing and medical education that goes with creating business success, and we are going to continue doing all of the above.

I’m really excited about Exactech’s Guided Personalized Surgery (GPS) system, which catapults the company’s products above its competitors. The company’s problems are temporary and actually provides an excellent entry point into the stock. As the recent investor presentation (slide no. 3) points out, over the long term the company has enjoyed “consistent long term growth 2x as fast as the overall market.” This stock is a keeper.

Gentex reported third-quarter revenues jumped 22% to $350.9 million compared to the third quarter of 2013. Management attributed the strong revenues to its acquisition of HomeLink in late 2013, its product mix, and cost savings it’s seeing from its purchasing department.

Earnings were up 30% from the prior year due to stronger gross profit margin which improved to 39.5% from 36.7%. Earnings per diluted share for the quarter rose 29% to $0.49 per share, beating Wall Street estimates of $0.47 per share.  

Automotive net sales for the third quarter rose 22% to $341.8 million.

We continue to demonstrate double digit unit and revenue growth thanks to the performance of our SmartBeam and driver assist camera systems, the addition of the HomeLink acquisition, and the continued penetration of our inside and outside electrochromic mirrors,” said Gentex Chairman of the Board and Chief Executive Officer, Fred Bauer, “which, in this relatively flat, worldwide, light-vehicle production environment, represents solid performance and the goal of our many growth initiatives.

Gentex estimates that revenues in the fourth quarter will increase about 10% to 15% compared to 2013. Following its earnings release on October 22, 2014, shares jumped 8.1% and is currently up 77% from when we recommended it in January of 2013.

Gulf Island Fabrication reported third-quarter earnings of $0.52 per share, up from $0.23 per share in the same quarter of 2013. Revenues, however, came in at $118 million, compared to $168.2 million in the same quarter of 2013 as the company continues to weather a weakened deepwater industry and lower oil prices.

Revenue backlog for the period rose 16% to $252.9 million showing increased demand for the company’s services.

Analysts at EVA Dimensions raised their recommendation from “Hold” to “Buy”, bringing the list of company’s covering GIFI to two Buys and one neutral. Shares of GIFI have surged 18% in October but are still down 11% year to date.

Sanderson Farms hosted its analyst day on Thursday October 16th and its presentation sounded bullish to me. See slide nos. 102 and 144, where the company said that retail chicken prices were at “record levels” and “the future looks bright.”

Curiously, the stock fell 9.8 percent after the presentation, its largest one-day loss in almost six years (December 2008). Other poultry stocks also fell hard (PPC and TSN), which suggests that the negative sentiment was based on a debatable interpretation of industry-wide dynamics and not anything negative about Sanderson Farms specifically. I agree with analysts that called the industry-wide selloff “overdone.” JP Morgan went further, characterizing the negative investor reaction as misguided:

After talking with SAFM management, we are confident it did not intend to send a negative signal. We spoke with CFO Mike Cockrell; our impression is that a) the company was surprised by the stock’s reaction, b) it intended to send a generally constructive message to the Street yesterday, and c) Mr. Sanderson did not mean to imply he was becoming incrementally negative in any way. Indeed Mr. Sanderson tried to say his stock was worth more than the current price and that current supply boosts were transitory. We are not certain when the company is or is not allowed to buy back shares, but we would not be surprised if it became more aggressive with repurchases as soon as possible.

Chicken is a commodity that can suffer declines in price per pound if industry production increases (which Sanderson’s comments at its analyst-day presentation suggested was occurring), but as long as consumer demand remains strong and feed costs remain low (as Sanderson’s comments also suggested was occurring), dollar profits and margins can remain high even if unit prices fall. A hedge-fund manager recently wrote about Sanderson Farms in  Seeking Alpha after the stock plunge and is very bullish on the stock, valuing it in a range of between $105 and $123 based on the company’s expansion plans and current undervaluation relative to peers.

Stewart Information Systems reported third-quarter net earnings of $0.97 per diluted share, up from $0.63 per diluted share in the same period last year.

Revenues fell 5% to $508 million but stayed ahead of the consensus estimates of $459.2 million. The company’s title revenues are benefiting from the level of activity in the real estate markets in the US as existing home sales rose to the highest level this year at an annualized pace of 5.2 million. Median home prices rose 4.7 percent from last year. Mortgage revenues rose 80.8 percent compared to the prior year, and 57.8% sequentially.

However, overall revenues from its other segments were down. STC’s  title segment revenues fell 12.6% to $40.5 million compared to the prior year, but showed signs of improvement as it was up 8.5% sequentially from the second quarter of 2014.

Our third quarter 2014 financial results were a solid improvement over both second quarter 2014 and third quarter 2013,” said Matthew W. Morris, chief executive officer. “Although the residential housing market continues to be somewhat lackluster, we are seeing the beneficial results from executing on our strategic initiatives.

Overall during the third quarter, the housing market continued the trend from the second quarter 2014, experiencing a reasonably consistent flow of refinancing transactions, and resale transactions showing steady, if modest, improvement,” Morris continued. “By quarter end, the effect of refinancing transactions on year-over-year comparisons was largely over, and we saw a small improvement in opened title orders per day while the mix continued to shift to more residential resale and commercial orders.

During the quarter, the company acquired 400,000 shares of its stock for $13.4 million. Management remains committed to its $70 million stock repurchase program by 2015 using its operating cash.

United Therapeutics announced third-quarter revenues were up 9.2% year-over-year. The company recorded a net loss of $0.53 per share compared to a profit of $1.25 per share in the same quarter last year, but this year’s loss was due entirely to the non-cash accounting expense involving equity-based executive compensation and had nothing to do with  operational issues. On an adjusted basis, EPS for the quarter came in at $3.91, up 31.2 percent from the $2.98 earned in the same quarter last year.

Sales of its leading  pulmonary arterial hypertension (PAH) drug  Remodulin rose 8% to $142.9 million offsetting decreased revenue from its inhalable PAH drug Tyvaso, which  fell 0.5% to $119.7 million. Most of the revenue growth can be credited to its recently-launched oral PAH drug Orenitram, which contributed $14.5 million to the top line.

The company now enjoys a consensus “Buy” rating from the 13 analysts covering the company. One physician-turned-investor recently wrote a very bullish article on United Therapeutics, speculating that the stock could be worth upwards of $200 a share in a takeover by Amgen or some other large drug company. He respects the entrepreneurial spirit and management expertise of CEO Martine Rothblatt, who was portrayed in a positive light in a New York Magazine article, and he noted some recent bullish corporate developments:

1. Joint venture with Medtronic for dosing Remodulin via an implantable pump, which is “massively good news” because it increases the number of patients who will use the drug.

2. In the third-quarter conference call, CEO Rothblatt projected peak annual sales of oral-based Orenitram at $1 billion, which requires only 4,000 users since Orenitram treatment costs $250,000 per year. If Orenitram works well, the number of users could end up much larger than 4,000.

3. The 10-percent royalty that GlaxoSmithKline has been collecting on Remodulin sales ends in 2014, so the profit margins United Therapeutics will receive for Remodulin sales in future years will be much higher than in the past.

W.R. Berkley reported strong  earnings for the third quarter, rising 37.7% as all areas of its business saw significant improvement. Earnings per share jumped 46.4% and revenues rose 12.6%, topping Zacks consensus estimates.

The insurer reported net premiums written for the quarter grew 7.1% and net investment gains surged 64.7 percent. Return on equity was a strong 17.4% compared to 12.7% last year. Its consolidated combined ratio, which is used to evaluate profitability (expenses dividend by premiums, so lower is better), fell 40 basis points to 93.5% compared to 93.9% last year.

We are pleased with our third-quarter results. Our underwriting continued to perform well, while investment income and capital gains were especially strong as a result of our long-term investment strategy.

 

Momentum Portfolio

VipShop Holdings experienced a 10-for-1 stock split on November 4th, so don’t be alarmed by the stock’s much-lower price, which in reality is hitting all-time highs. I have adjusted — and raised — the buy limit to $20.75, which takes into account the stock split. IBD recently noted that the company has enjoyed triple-digit earnings and sales growth and technically the stock has experienced a bullish technical breakout above prior resistance.