Taipan Online: Hotline

Well, what a week. I’m sure many folks are glad of the Labor Day weekend after a topsy-turvy week on the markets in the devastating aftermath of Hurricane Katrina.

That’s reflected in the performance of my own Taipan portfolio, where some stocks like JetBlue have struggled along with the rest of the beleaguered airline industry amid a potential disastrous shortage of jet fuel that could force some airports to close.

All told, the sector has lost almost 15% of its fuel supply because of the storm, with a grim report stating that airports in the east and south (including major hubs like Atlanta, Washington-Dulles, Orlando, Charlotte and Tampa) could run out of jet fuel as soon as this week if the refineries and pipelines aren’t working again.

Jet fuel costs bounced up 20% last week alone, with many planes bound for these airports carrying more fuel than usual in order to save refuelling supplies.

On the bright side, my energy plays (and hopefully yours, too!) are enjoying a very strong spell.

Having started the week at US$57.75, Canadian oil sands miner Suncor Energy (SU:NYSE), my pick from the September 2004 issue, climbed to US$59 a share at Friday’s close and has produced a total gain of 112% from the official entry price of US$27.80 on August 31, 2004.

Texas-based oil and natural gas company Patterson-Energy (PTEN:NYSE), a joint-play between myself and WaveStrength’s Sara Nunnally, started the week at US$32.80 and has edged up to US$33.22 since. We entered this position (featured in the June 2005 Taipan issue) on June 7 at a price of US$26.94 and have gains around 23% so far.

Finally, BG Group (BRG:NYSE), a natural gas company based just up the road from me in Reading, England. This was my recommendation in the July 2005 Taipan issue, getting in at US$39.93 on July 20. Nothing but upward momentum since, as the stock has forced its way US$46.80 for gains around 17%.

RETAIL TUMBLE

Unfortunately, those good vibes haven’t spread to the retail sector. Teen retailer Pacific Sunwear of California (PSUN:NASDAQ) has been all over the place last week, recording both hefty gains and losses. This despite posting healthy August sales gains of 10.9% to US$175.7 million. But same-store sales only climbed 2.6%, short of the 3.6% the precious Wall Street analysts had expected and the stock dived down US$1.68 (7%) on Thursday before wrapping up the week at US$21.96.

And then there’s Abercrombie & Fitch (ANF:NYSE).

A brief recap: This is my recommendation from the December 2003 Taipan issue (entry date of November 24, 2003 at US$28.83). Having sold half the position for 46% gains on November 4, 2004, the second half is still going strong, up around 87.5%.

However, on August 17, I recommended you pick up the September 60 call options (ANFIL) in response to a crazy selloff, despite blowout second quarter earnings and an increase in the dividend.

In just two days, the calls bounded up from my entry price between US$1.30 and US$1.40 to US$2.15. At that point, I advised you to cash out on half the position for gains around 77%. Thanks to those of you who e-mailed me with your profit stories.

OK, now for the bad news: Unfortunately, the second half of this options play isn’t faring so well. As I write, the calls are selling for around 10 cents. Why?

Well, a lot of it has to do with some boardroom unrest at Abercrombie – a row that saw president and chief operating officer Robert Singer quit after just 15 months in the job. The dispute centred on “a difference in approach to the timing and extent of our expansion into certain international markets,” according to CEO Mike Jeffries, with Singer’s more aggressive approach snubbed by the other executives.

As it stands, the company is pressing forward with plans to expand at a speedy pace in Canada and here in the UK, but with slower progress elsewhere. However, the news also comes as the company announced a very strong 24% rise in same-store sales in August, thanks to a rash of back-to-school purchases.

So while the company is still faring pretty well, its stock is a fickle beast, shrugging off good news, but getting slapped by any shred of bad news. The second half of the ANFIL September 60 calls will expire on September 16, so we’ll hold out for some upside until then.

FARO FALLING

Now on to Faro Technologies (FARO:NASDAQ) – a small-cap technology company that makes portable software and computerized measurement systems for the engineering and manufacturing sectors. I recommended it back on April 12, 2005, ahead of its earnings guidance and strategic outlook conference call (it’s also featured in your May Taipan issue).

Because of that, it required you to act fast in order to maximize profits. Having entered the position at US$25.09, it quickly raced up to a shade under US$30 just one day later. It hovered in the upper-US$20’s for the next month before finally cracking the US$30 mark on May 10.

Boasting the only portable 3D computerized measuring equipment in the industry and almost half its market’s total US$200 million value, the company continued to cruise until it suffered from a bout of heatstroke in mid-July.

Despite announcing that second quarter sales jumped 28.2% to US$30.9 million from US$24.1 million in Q2 2004 and new orders leapt 57.5% to US$34.5 million, with a lucrative new order from Boeing on tap, FARO said operating expenses that ballooned 52% caused it to miss earnings badly. Profit sank from US$4.1 million to US$1.9 million in Q2 2004 – or 13 cents-per-share, compared with 29 cents. Ouch.

Because FARO prefers to issue annual earnings guidance, rather than quarterly updates, a miss can shock investors. And naturally, many bailed on the stock. But many more forgot all about FARO’s solid financials and healthy future upside potential. One earnings miss has not suddenly made FARO a bad company. In fact, a large chunk of the increase in operating expenses was due to its US$1.7 million expansion plans. As Chairman and CEO Simon Raab, “One of the reasons that we give only annual guidance is that we expect to have quarters where we take initiatives which may lower earnings in the short term, but result in long-term growth.”

I don’t know about you, but I like that strategy. Net profit margin sits at 12% - double its industry average, while return-on-equity is a healthy 15%, again almost double its industry average.

As Raab puts it: ““We continued to invest in growth-related initiatives, which will impact our second quarter earnings, but these initiatives are already paying off in terms of the growth in new orders” (as evidenced in that whopping second quarter orders growth). The company is also set to open a new facility in Singapore later this year.

Although its second half is traditionally stronger than its first, I’m not convinced that with that big earnings miss, whether FARO can achieve its stated full-year earnings growth of US$1.15 to US$1.45 per share (it has said earnings will be at the low end of this range). But FARO is merely doing what a lot of companies do at some point – sacrificing some short-term earnings in favour of long-term growth gain. And with the rash of new orders, its long-term outlook still seems pretty robust.

Since getting in at US$25.09, the stock closed last Friday at US$21.07 – down 16%. As you know, the Taipan investment philosophy is to apply a 20% stop-loss to minimize risk. So do that, but hold for now, as we look for a rebound. I think most of the bad news is priced in by now. Insiders still hold almost one-quarter of the stock, too, which is a pretty good indication that things aren’t that bad. Raab himself owns almost 10%. I’ll keep you posted.

Just before I go, my colleague Ian Cooper tells me that Televisa (TV:NYSE) is up marginally, but could receive a near-term catalyst from Scotia Inverlat, which just upped its 2006 price target on the company, “citing recent strong results and expected better advertising revenues from presidential elections next year.” So continue holding. In addition, he’s looking for further upside from Henry Bros. Electronics (HBE:AMEX), whose CEO is presenting the Roth Capital Partners Conference in New York this Wednesday and Thursday. Continue holding for the long haul.

Enjoy the rest of your Labor Day weekend.

Martin Denholm

Executive Editor, Taipan

MMM

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