Vera’s Margins Fuel 20% Stock Gain

Vera Bradley (NSDQ: VRA) took the critical fourth quarter home in the bag. The purveyor of cotton quilted bags and accessories soothed nervous investors with earnings of 41 cents per share, in line with analyst estimates, and guidance for a better-than-hoped-for fiscal 2017 (ends January 2017). Management now forecasts 90 cents to 98 cents in earnings versus analyst estimates of 82 cents.

vera bradleyAt the high end of that range, Vera will increase earnings 20% for the year. However, the first half of the year will grow significantly faster, 53% versus only 12% in the second half.

The stock, which had been quietly inching up before the news, jumped 11% and at $19.50 is getting close to my $23 target. I had already incorporated an estimate higher than analysts’ when developing my target, but I am considering increasing my buy limit price as I tweak my model. I will post immediately if I change that price.

As I mentioned, it was imperative that Vera showcase improving gross product margins. Indeed it did. These margins, which measure product revenue less cost of goods, increased from 52.4% to 58.2%. And importantly, management moved up the range for gross product margins for this year as well.

After a major product transition last year, almost half of Vera’s product sold is coming from its new designs and materials. Microfiber, single-color bags in smaller shapes are popular and appealing to younger customers.

While Vera brags that it serves customers ages 8 to 80, the company was losing many between the ages of 24 and 40. The new sleek bags are bringing those customers back across the threshold, and the bags are higher-priced and more profitable.

Vera’s balance sheet is clean. Inventories are higher than at this point last year, but management said it missed sales last year because it ran out of popular items. I will keep a sharp eye on this number. Cash flow was $43 million, down from last year’s number due to the inventory build. The company has $98 million or $2.50 per share in cash and no debt.

Brunswick Hits the Gyms

Brunswick (NYSE: BC) stock is up nicely since last month—about 7%—buoyed by the overall market and by improving consumer demand. I will reiterate that the reason I like Brunswick so much is the company’s declining dependence on consumer whims, but that doesn’t mean the market won’t swing the stock in response to these bursts of emotion.

brunswickAs expected, the company named Mark Schwabero its new CEO. He has been COO and president since 2004 and is the natural successor for Dustan McCoy, who is retiring after 11 years. Schwabero was instrumental in the company’s recent acquisition of Cybex, the maker of commercial gym equipment.

At a recent investor conference, Schwabero said Cybex would reduce the cyclicality of the company. Few of Cybex sales are to individuals. As anyone who has been to gyms at upscale hotels or at college campuses can tell you, the fitness areas of these institutions rival the gyms of most professional sports teams. Brunswick is happy to fill these commercial gyms with its cardio and weight-training equipment. The Cybex acquisition allows Brunswick to sell the Arc Trainer, a low-impact cardio product, to its customers.

Planet Fitness, one of Brunswick’s largest fitness customers, continues to grow in leaps and bounds. It opened 209 new locations in 2015 and on its recent conference call noted it will open 215 in 2016, with 500 stores expected to open over the next three years.

Not only does Brunswick get a huge boost in orders for equipment when a new fitness facility is opened (have you seen the sea of treadmills and bikes in one of these places?) but it also requires franchisees to replace equipment every 5.5 years on average.

Brunswick added $300 million to its three-year stock buyback plan. If the company bought $100 million worth of stock at current levels this fiscal year, it would boost earnings per share 2%. In addition the company issued its quarterly 15 cent dividend.

Brunswick is looking in better shape than ever. With the stock trading at 11 times 2017 estimates, growing earnings 16% and offering a 1.3% dividend yield, investors would be wise to add a healthy dose of this stock to their portfolios.

Charles River Nails Fourth Quarter

As we reviewed in the February issue, Charles River Labs (NYSE: CRL) reported a striking fourth quarter on Feb. 10.

Earnings rose 23% and beat estimates by 6 cents per share. Management increased guidance for revenue, excluding the acquisition of WIL Research, and held fast on assumptions for WIL’s contribution. Both actions should give investors increased comfort in the stock.

charles riverThe basic business will grow 9% to 11%, faster than previously expected because of the company’s ability to ingrain itself as a partner in early-stage drug research. Once firms become comfortable with Charles River and understand its expertise, most choose to continue or expand the services under contract. The inclusion of WIL, which brings novel experience in agricultural and chemical research, broadens Charles River’s portfolio of services significantly.

At an analysts’ conference last week management pointed out that biotech funding has remained healthy. Although the company has plenty of big pharma companies as customers, smaller shops and biotech firms rely almost exclusively on contract research organizations like Charles River to handle research and development.

Funding certainly seems solid, as eight of the 13 initial public offerings fortunate enough to be priced this year have been biotechs. After a small increase post-earnings, the stock trades at 14 times 2017 estimates, much lower than my expected 20% growth.

Photronics: Not Yet in the Chips

Although Photronics (NSDQ: PLAB) has been a dismal stock since my recommendation, I am keeping it on my list. A conversation with the company’s investor relations manager highlighted the temporary issues beleaguering Photronics. Continued strong performance in high-end photomasks, an inherently lumpy demand cycle for mainstream photomasks, and indications that the dip for mainstream chips is bottoming all point to the stock moving higher from here.

After warning that first-quarter results would be less than expected on Feb. 11, Photronics released its results on Feb. 24.

photronicsRevenue for the quarter came in at $130 million and earnings per share at 17 cents, both at the high end of the newly lowered numbers and roughly 8% below original estimates. This would have likely been acceptable to investors if future numbers were kept in place. Unfortunately the company lowered numbers for the second quarter (ends April) as well.

The real kicker for the second quarter is that both revenue and earnings will be down slightly from last year. Obviously I recommended Photronics on the grounds that revenue and earnings were expanding at a rapid rate. Estimates per share for the full year are now 66 cents, flat from 2015, and up 24% to 82 cents for 2017.

Analysts have conservatively penciled in a decline in earnings for the second half of the year, a decline that seems unlikely based on management’s indications that they are actively working with customers on new photomask designs. In the perverse manner of Wall Street, once a stock has missed numbers I prefer the estimates to be low and see the company beat them. Management issues guidance only for the next quarter out, not for the full year.

Like most analysts, I spend much of my time circling back to the problem stock. I’ve dug through Photronics’ quarterly report, read through many industry articles and spoken with Troy Dewar, head of investor relations. All of these leave me with a better understanding of the earnings miss and the company’s potential.

The basis for my original recommendation was that demand for high-end photomasks, tools that help create the smallest, most sophisticated chips (35 nanometers or smaller), was building up rapidly. This is still true. In the first quarter revenue for high-end chip photomasks was up 13% and high-end flat-panel-display photomasks up 56%. These high-end masks generate much higher profits and helped boost product margins.

The Achilles heel for Photronics is the mainstream chip sector. According to Dewar, mainstream chips are not terrifically smart or sophisticated. Many of these chips are used in simple devices like Fitbits or handle the most rudimentary electronic function in your car. These mainstream chips account for almost half of Photronics’ revenue, and while they are not super high margin, the volume helps cover the fixed cost of production and boosts overall profitability. This business was down 10%. The segment represents almost half of revenue, so its behavior has a large influence on overall growth.

These mainstream photomasks are typically sold not directly to the end user but  to a foundry, or a factory, in Asia. Thanks to this two-tier distribution, Photronics does not always know who the end customer is so it’s difficult to point to one end product as the reason for the slowness.

CEO Peter Kirlin noted on the company’s quarterly call that his customers are optimistic about the second half of the year, and although Photronics operates with just a two-week backlog, his sense is that this is the bottom of demand for these mainstream chip photomasks. As he notes, innovation has just temporarily slowed, not disappeared.

It is no secret that demand for semiconductor chips hit a speed bump in the last quarter of the year. Intel and Micron have both cautioned about slower demand for smartphones and PCs. According to Gartner Group, global smartphone sales rose just 9.7% in the fourth quarter, the slowest rate since 2008.

Although slowing demand in units does not hit Photronics directly, designs for new photomasks in the mainstream market could be held off as manufacturers weigh which innovations they will make in this segment of the market.

The company should be a big beneficiary of 3D NAND Crosspoint, a revolutionary memory product designed by Micron and Intel. Photronics is already qualified for this product, which will boost numbers late this year and into 2017.

Photronics currently trades for 12 times 2017 earnings, which are expected to grow 24%. Clearly the market is discounting the growth incorporated into that estimate. With $1.25 in net cash (cash less debt) per share, significant cash flow and a strong position to enjoy growth, we’re sticking it out with Photronics but keeping it on a short leash. We expect improvement in guidance coincident with the second quarter and will likely remove the stock if it does not see higher revenue trends by that time.

SolarEdge Strong, but Its Sector Wavers

My favorite solar stock appears to be taking a nap in the sun while the rest of the market rallies. To be fair, there hasn’t been much specific news on SolarEdge (NSDQ: SEDG) since our last update.

solaredgeCertainly industry daredevil SunEdison continues to create drama for the solar group. This highly leveraged player hit the wall last week as bankers backed out of financing its most recently planned acquisition of Vivint Solar. Yet this deal has no impact on SolarEdge outside of depressing investor sentiment for the whole sector.

The Solar Energy Industries Association reported that U.S. solar installations hit a record 7.3 gigawatts in 2015 and represented almost 30% of all new electric-generating capacity. This is a remarkable number. The extension of the investment tax credit on solar panels into 2020 will continue to stoke demand.

SolarEdge’s chart certainly doesn’t look like one of a company that reported 70% revenue growth and 400% earnings growth in early February. Current estimates for fiscal 2016 (ends June 2016) predict that earnings will more than double. Fiscal 2017 is expected to follow with 35% growth.

As they say, make hay while the sun shines. I believe that means buying SolarEdge stock by the bale.

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