Comtech looking good with big contract wins

When I made Comtech Telecommunications (Nasdaq: CMTL) my inaugural SGS pick on June 10, I cited the anticipated Movement Tracking System contract extension as a major reason for my recommendation. Last week, Comtech finally came through with the long-awaited news: a $605M contract that extends the MTS relationship with the Government through 2010. But the company actually did one better: it announced a brand new, $216M contract to supply the Government’s Blue Force Tracking program through 2011. Both these contracts are of the “indefinite delivery/indefinite quantity” nature, meaning that there is no pre-arranged timing for orders within the contract time period. However, Comtech will start to cash in immediately as it received a $53.3M order against the Blue Force contract several days after it was announced.

So how did the market respond to $821M in contract wins for a company with 2006 revenue of less than $400M? Pretty muted, as the stock rose only 3.4% on the day of the big announcement. It has since trickled up about 6% as the major indexes have rallied, but is still below its July highs.

I believe that the magnitude of these contracts is not being fully appreciated, and that the stock has more upside. Not only does Comtech have an impressive history of growth and exceeding earnings expectations, but it has a rock-solid balance sheet with over $7/share in cash. AG Edwards analyst Mark Jordan estimates that if the company spent that cash on acquisitions and “earned its typical return on sales,” it would bring in an additional 25 to 40 cents a share in annual earnings per share.

I continue to be a confident and optimistic holder of Comtech shares, and will look to pick up more on any dips.

Disclosure: SmartGuyAB is long CMTL.

Wii Parties will keep Nintendo shareholders having fun

At the risk of turning Smart Guy Stocks into the Nintendo Fun Club, I bring you yet more evidence of the Wii’s success and potential to drive NTDOY’s stock price even higher.

In another case of Nintendo reaching well beyond the traditional gamer crowd, recent reports have touted the growing trend of “Wii Parties.” An article from the Pittsburgh Tribune-Review describes a “Wii and Wine” party. I’ve actually been invited to one of these myself, an occasion where professional adults who would never in a million years play “Halo,” are instantly returned to their youths as they giddily return tennis balls or race cows.

Nintendo has taken notice of this trend and appears intent to capitalize on it as a marketing opportunity. The company has already partnered with Norwegian Cruise Lines and Erickson Retirement Communities to add Wii parties to their activity schedules, and has been talking to libraries about using Wiis for community-building. Nintendo is also trying to tap into the classic Tupperware model- giving Wiis to people in target groups in exchange for them hosting Wii parties. Last month, Nintendo partnered with Evite to launch a dedicated Wii party-planning page.

All this means that not only has the Wii started a unique video gaming trend, but Nintendo appears ready and willing to capitalize. With the stock down 5% today apparently on news that the Wii is “only” outselling PS3 3-1 in Japan, this is another chance to buy in to NTDOY before the holiday season.

Disclosure: SmartGuyAB is long NTDOY

DXP’s consolidation strategy takes a big step forward

When I originally recommended shares of DXP Enterprises (Nasdaq: DXPE) in June, I wrote how the company was undertaking a consolidation of its industrial supply industry. Most of the competing distributors are small and family-owned, and DXP spotted an opportunity to integrate these companies and become the dominant industry player. In writing last month about the market’s overreaction to DXP’s earnings miss, I noted that the underlying story hadn’t changed and the business and acquisition pipeline remained strong.

Well, last Sunday, DXP showed just how strong that pipeline was by announcing that it was buying Nebraska-based Precision Industries for $106M in cash. According to the press release, Precision has annualized sales of about $250M, which values the company at a bargain 0.42 P/S (DXP’s P/S is 0.70). There was no word on Precision’s net income, but according to an analyst at Dutton Associates, “this is because this acquisition requires a Hart-Scott-Rodino waiting period (likely two-to-four weeks) before consummation and, understandably, Precision, as a private company, has no interest in divulging this information before the deal closes.”

A little digging suggests that the Precision addition will be accretive to earnings. In Industrial Distribution’s 2007 Big 50, Precision’s President notes that “Once again, [2006] was a record sales and record profit year for us.” The magazine lists Precision’s 2006 sales at $297M vs. the aforementioned $250M, which initially led me to think that this was a company hitting a steep decline in 2007. However, Precision’s press release notes that the controlling Circo family will retain two of Precision’s software and technology subsidiaries, and I’m guessing this accounts for the difference in numbers.

Without too much information to go on at this point, the acquisition seems positive. DXPE (65 stocking locations in 14 states) gains access to Precision’s nationwide footprint (163 locations in 30 states). It also receives inroads to new markets and customers, as Precision appears to have relationships with some of the largest food and beverage companies.

Precision is a family-owned business that has been growing steadily in a sleepy industry for over 60 years. For them, joining up with DXP to create an industry powerhouse makes perfect sense. According to their press release: “Recently, Precision Industries was awarded several new supply chain service contracts and Precision Industries believes that the consummation of the sale will allow it to leverage DXP’s access to the public stock market and provide additional growth capital.”

It appears that my original thesis of DXP as a “consolidator of a boring industry” remains intact. The company remains my largest individual holding and I believe that we can expect big things over the long-term.

Disclosure: SmartGuyAB is long DXPE

Hurco: A reminder to stick with buy and hold

Over the last month, most of our portfolios have taken major beatings along with the rest of the market (The Smart Guy Stocks portfolio has dropped over 10% from its high). Friday’s rally notwithstanding, the huge negative swings of the market in July and August have been enough to test any investor’s resolve.

It’s heart-wrenching to watch one of your stocks drop 30% when it misses earnings by a few pennies, or see the market decide that a technology company is suddenly worth 20% less because of mortgage lenders making some bad sub-prime loans (I understand the potential for the sub-prime crisis to affect the entire economy, but the recent huge drops in totally unrelated companies seems overdone). During times like these, I find myself invariably questioning the buy and hold approach, and ruing the fact that I did not successfully “time” the market and take my profits.

I assume that many of you, like me, are guilty of second-guessing your investment strategy during these rough patches. So I wanted to give all of us some anecdotal reassurance that buy and hold works. When I say buy and hold, this doesn’t mean just purchasing a stock and closing your eyes for five years - every investment should be diligently tracked and regularly reevaluated. Buy and hold means that you don’t sell your shares in a company until the reasoning behind your fundamental thesis (why you invested in the company in the first place) changes. Ala Warren Buffet, the disciplined buy and hold investor shouldn’t get scared by often random-seeming day-to-day or weekly movements; the idea is that the true value of a strong, growing company will be realized at some future point.

The company I want to look at is Hurco (Nasdaq: HURC), a small manufacturer of machine tools. Hurco has been one of the most successful holdings in my personal portfolio to date in 2007, up 50% for the year based on today’s closing price. It has also been one of the most volatile stocks: on three occasions, once each in February, May, and July, Hurco lost over 10% of its value in a week.

The reasons I have (and do) like Hurco are simple: earnings and revenue have been growing rapidly as the company looks to feed the insatiable appetites of the growing manufacturing markets of China and India. The company has a history of consistently generating solid cash flow, yet has managed to trade at a very modest valuation relative to its growth (sub-20 PE). So did anything happen this year to change my thesis? No- sales and earnings both increased by ~15% in the 2nd quarter (which precipitated one of the 10% dips), and over 30% in the 3rd quarter results released last week. The company hasn’t released any other major news to speak of. So in Buffet-esque fashion, I’ve gritted my teeth and held on to the stock during the random 10% price drops.

I appreciate that not all stocks will recover as quickly from their price dips as Hurco has. In the case of another company, it may not be a week or even a couple months; but if the underlying thesis remains strong, the rewards will eventually be there. As for Hurco, I am still hanging onto my shares. I’m not making it an official SGS recommendation at this price, as I’m not convinced that margin for safety is quite what it used to be. But keep an eye on it and look to buy the next time the market decides to inflict another arbitrary 10% blow.

Disclosure: SmartGuyAB is long HURC

lululemon: will this be the next high-flying retail stock?

I’ve been counting down the days since I heard that hip yoga-wear retailer lululemon (Nasdaq: LULU) was going to IPO. This is exactly the kind of growth story I love to see - a foreign company whose initial foray into the US has been greeted with wild excitement by affluent urban tastemakers. Walk into any yoga class in Chicago or New York and you’ll see women and men of all ages going into downward dog adorned with lululemon’s distinct omega-esque logo. It’s just a matter of time before this sight spreads to the rest of the country.

I figured that lululemon would undoubtedly be the next in a recent run of hot clothing stocks to go on a tear. Despite recognizing their popularity early on, I largely sat on the sidelines as the stock prices of Zumiez, Under Armor, and Crocs (which I did hold briefly) soared. I was never able to pull the trigger as the stocks always seemed too richly valued. I vowed that I wouldn’t make the same mistake this time with lululemon.

It seems as though a lot of investors made the same promise and wanted to load up on lululemon at any price. In comparison to the IPOs of the aforementioned companies (and Citi Trends, another recently IPOed retailer), lululemon appears to give new meaning to the word “overvalued.”

Like LULU, all four of the other companies soared on their first day of trading. And all four of the companies have posted huge annual returns since that first day close (interestingly, each company also found its stock at a lower level 1 week after the initial IPO). But it seems as though investors may have learned their lessons and banked enormous future growth assumptions into lululemon’s initial valuation.

Let’s take a look at all four of these companies today.

How does lululemon’s valuation stack up? Not well. In terms of estimated growth rates, the closest comparison is Crocs. Despite an amazing track record as a public company and future growth estimates exceeding lululemon’s, Crocs is selling for a forward P/E that is 75% lower. While one can argue that this makes Crocs undervalued, I tend to see a 29 forward P/E as fair for a growth company. And unlike Crocs, lululemon’s growth is limited by the number of stores it can build. The company currently has 59 locations and plans to build another 20 to 25 this year. As Crocs’ popularity grew, it quickly able to scale up its distribution to thousands of retailers. For lululemon to ultimately fetch the same valuation as Crocs, which would not even triple the stock price, it would have to produce approximately 20x more profit than the $7.7M it earned last year. Furthermore, as SmartGuyDH wrote on July 16, it’s unclear whether lululemon’s primary purpose for going public was to fuel growth.

Don’t get me wrong- I would love to own shares of lululemon, just not at this price. This is a company with 25% same-store sales growth and $1400/sq. foot sales, which may be the best in all of retail. It capitalizes on the current yoga craze with desirable, high-priced products. But ultimately, this is a niche retailer whose “cool factor” has caused the market to get ahead of itself. Keep lululemon on your watch list, but don’t count on it to produce the same eye-popping returns as the hot retailers that came before it.

Disclosure: SmartGuyAB does not own shares in any of the companies mentioned.

Nintendo: Wii Fit will capture new market

Yesterday, at the annual E3 Show in Santa Monica, Nintendo unveiled its newest creation for its red-hot video game system: Wii Fit. Aside from being an unbelievably cool-looking game, Wii Fit is the breakthrough product that will truly establish the Wii as a must-have for the whole family.

Wii Fit utilizes a new balance board, perhaps inspired by the classic NES power pad (I remember even my parents trying this out). The pressure-sensitive board not only registers your movements and projects them on-screen, but also measures your BMI (body mass index) to let you track your fitness progress. Wii Fit features over 40 activities, including hula-hoop, push-ups, yoga, and step aerobics.

Wii has already proven to be a hit at parties and with kids, and now Nintendo looks poised to cash in on yoga moms and business professionals with little time to work out.

Although Wii Fit isn’t due to hit shelves until early 2008, Nintendo has announced other much-anticipated titles due out in late 2007 that will keep its momentum going: Super Smash Bros., Mario Kart, and Super Mario Galaxy. This is an exciting time to be a Nintendo shareholder, and although we originally recommended NTDOY.PK at a lower price, the stock shows no sign of slowing down even at these lofty levels.

Disclosure: SmartGuyAB is long NTDOY.PK

Comtech Telecommunications: Update on MTS Contract

On June 10, I recommended purchasing shares of Comtech Telecommunications (NASDAQ: CMTL) partially due to the anticipated announcement of a huge contract extension with the Army for its Movement Tracking System. In May, the Army published a pre-notification to extend Comtech’s existing contract an additional 3 years for $646M. The anticipated date of execution was June 15.

Anxious Comtech shareholders watched that date come and go with nothing more than a stream of small contract announcements. With no word from the company, we were left to speculate as to whether this was just a typical government delay or something more dire.

Finally, word came last night that Comtech has secured a short-term extension to August 31 for $45M, and would be using this period to negotiate and finalize the 3 year extension.

We can only speculate as to the eventual outcome of those negotiations, but the short-term extension has reinforced the importance of Comtech to the MTS. In addition, the government looks prepared to beef up its spending on the MTS - the $45M addition brings the amount left on the current contract to $65M, representing an annual run rate of ~$400M.

As expected, the market has responded positively, with shares up over 2% as of this writing. I anticipate even more upside, as shares should get another big pop whenever the final contract extension is announced. I don’t buy the assertion that the full upside of the contract is already baked into the stock price. While I usually agree with the efficient market theory, there are sometimes it just doesn’t seem to hold. Take the extreme example of the iPhone. After Apple had announced the imminent release of the iPhone, its stock soared on any subsequent, although expected, announcement such as the release date.

I don’t mean to assert the Comtech has anything close to the hype of Apple - nothing does. But when Wall Street analysts wake up to see their Bloomberg terminals showing news of a little-followed $1.1B company landing a $600M+ contract, even if it was expected, the money will flow in.

Even though the shares of Comtech have been on a nice run, I am holding my shares in the expectation of further upside.

Disclosure: SmartGuyAB is long CMTL

Digital River: Keep your eye on the tide

Digital River (NASDAQ: DRIV) provides comprehensive e-commerce solutions to retailers of software and other technology products. In other words, if you buy virus protection software from Symantec (Digital River’s largest client) over the internet, Digital River manages both the engine that delivers the software and the promotions that persuaded you to buy it. I’ve been following this stock for years, and have had pretty good success trading it - I bought shares between 27-35 in late 2005 and sold in the high 50s earlier this year on valuation concerns.

Last week, Digital River slashed revenue and profit guidance for the 2nd quarter and remainder of the year, citing delays in new initiatives for Symantec and Microsoft. The company tried to soften the blow by announcing an increased share buyback and new deal with Microsoft. Yet the market didn’t take kindly, dropping the stock over 10% to under 45.

While this latest development was a disappointing contrast to Digital River’s history of underpromising and overdelivering, I’m inclined to give management a pass this one time. I believe that the underlying business of digital delivery is still strong, as content providers across all industries move away from traditional brick and mortar sales.

Digital River is the number one player in e-commerce management, and its biggest competition is companies’ internal operations. Naysayers need only to look at ADP in payroll processing and Amdocs in customer billing to realize that specialized service outsourcing is a much-needed and lucrative business.

Digital River should get back on track once Symantec fully transfers its global subscriptions business and Microsoft ramps up its Vista sales. There’s also been rumors of Digital River making a big mark in the fast-growing video game market through a major deal with Electronic Arts.

Although I believe Digital River is a solid company whose shares should be much higher 2 or 3 years from now, I think there may be some more downside to the current share price. The current P/E of 30+ seems pricey for a company whose updated guidance calls for only 12% top-line growth this year. I suggest keeping a close eye on this one, but staying on the sidelines until we see a more compelling price or new positive development.

Disclosure: SmartGuyAB does not own shares of DRIV