DXP Enterprises: Earnings overreaction presents opportunity

• Buy DXPE around 33.30

Smartguystocks.com pick DXP Enterprises (Nasdaq: DXPE) released second quarter earnings last night. Sales increased 22% and net income grew 16% YoY. Yet the market was looking for more, and the stock is down almost 25% today.

According to CEO David Little, the company saw some unexplained order softness in June. Since then, sales have picked back up and the company is on track to meet its targets for the year. Little said that many orders have been coming in for the fourth quarter and backlog is very strong. He expects YoY top-line growth for the third and fourth quarters to exceed 30%.

The company also noted that the acquisition pipeline looks strong and it expects to use the cash from its recent share offering by the end of the year.

With the underlying business still strong and growing rapidly, and the stock trading for a .76 P/S and a 10 PE at last check, this is a great opportunity to take advantage of the short-term panic and load up for the long haul. While it’s painful to watch a core holding drop so much, it’s important to keep a long-term perspective and not be seduced by the day-to-day gyrations of the market.

Disclosure: SmartGuyAB is long DXPE

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.

Getting Wet: Long-term Profits in the Water Industry

• Buy PHO around 20.5 and PIO around 25.5 

I feel like Jack Nicholson in Chinatown: everywhere I turn, water issues arise. So, like a good grownup who grew up on Peter Lynch, my automated response is, “Which companies are succeeding in the water industry?”

Last April I started a position in an ETF called PowerShares Water Resources (AMEX: PHO). This water ETF corresponds generally to the Palisades Water Index, an index designed to track the performance of companies engaged in the global water industry such as pump and filter manufacturers, water utilities, and irrigation equipment manufacturers. I decided to invest in the ETF rather than individual companies in the water industry because I do not follow the industry close enough to safely say I am investing (Cf. gambling). In addition, I have subscribed to the ETF first because awareness of water industry equities has pushed up multiples and some of the best stocks are beyond my value target.

Like other water investors, I believe the industry will outperform because:

• water is a necessity which has become increasingly scarce in the face of growing demand;
• water will demand government spending and private investment no matter the status of the economy;
• water will fetch steadily increasing prices as supply remains limited while demand rises;
• water companies have virtual monopolies once they sign long-term contracts with goverment entities; and
• water, like oil and other natural resources, is an excellent way to invest in globalization.

Another play is the ETF called PowerShares Global Water (AMEX: PIO). This ETF corresponds generally to the Palisades Global Water Index. As the name implies, this ETF has more exposure to the international market. In my opinion, both ETFs are excellent long-term investments. A nice aspect of PIO is the ability to own companies that are not traded in US markets and, therefore, are not accessible as individual investments. I recommend purchasing a mix of both for a nice spectrum of exposure to an industry with earnings that will flow for lifetimes to come.

The top holdings in PHO are:

Valmont Industries Inc. (NYSE: VMI); Veolia Environnement SA (NYSE: VE); Tetra Tech Inc. (NasdaqGS: TTEK); URS Corp. (NYSE: URS); Itron Inc. (NasdaqGS: ITRI); Layne Christensen Co. (NasdaqGS: LAYN); IDEX Corp. (NYSE: IEX); Roper Industries Inc. (NYSE: ROP); Franklin Electric Co. Inc. (NasdaqGS: FELE).

The top US holdings in PIO are:

Valmont Industries Inc. (NYSE: VMI); Tetra Tech Inc. (NasdaqGS: TTEK); ITT Corporation (NYSE: ITT); Watts Water Technologies, Inc. (NYSE: WTS); Pentair Inc. (NYSE: PNR); Danaher Corp. (NYSE: DHR); General Electric Co. (NYSE: GE).

Disclosure: SmartGuyDH is long PHO.

Update on China 3C Group

• Sell CHCG.OB around 7.00

My timing could not have been worse on China 3C Group. A few days after I recommended purchasing shares of the company, it announced a private placement sale of $11.74M at $5.60/share. The issuing of new equity by itself didn’t bother me much, as China 3C Group is a small, fast-growing company looking to quickly build out its network of stores. What put me off was the price of the offering: before word of the private placement spread, shares were trading north of $8. They promptly dropped 10% following the announcement.

According to CEO Zhenggang Wang, I’m supposed to be happy about the price they received. Said Wang, “although the sale price of the shares was at a discount to the current trading price of the company’s common stock, we believe that management’s ability to act swiftly to negotiate this transaction without the assistance and associated fees of a placement agent demonstrates the company’s desire to maximize the benefits of the capital investment in light of a discounted sale price.”

A fast-growing company with bright prospects, and it needs to give a 30% discount for someone to buy 4% of its shares? This stinks to me, and I just can’t own the company after a move like this. The company does have a potentially bright future, and I will keep an eye on it to see if management decides to become a little more shareholder friendly, but for now I will move to the sidelines.

Disclosure: SmartGuyAB no longer owns shares of CHCG.OB

NASDAQ: The undervalued exchange

• Buy NDAQ around 33.80

The Nasdaq Stock Market (Nasdaq: NDAQ) is the second largest U.S. equities exchange, behind the New York Stock Exchange.

The rash of consolidation among exchanges in the past 2 years has driven their stock prices to stratospheric levels. NYSE Euronext, despite falling more than 20% in the last few months, still trades at a 51 PE and 11 P/S. The CME Group sports a 44 PE and 17 P/S, and the ICE has a dizzying 56 PE and 29 P/S. Compare this to Nasdaq, with its relatively meager 37 PE and 2 P/S. And its not as though Nasdaq isn’t growing like the others- last week the company posted excellent second quarter numbers, boosting revenue by 16% and tripling profits.

But the company has languished compared to its high-flying peers due to its unsuccessful bid last year for the London Stock Exchange. Investors soured on Nasdaq as they watched the NYSE grab Euronext and become an international juggernaut. Despite this, NDAQ has still managed to increase its market share of U.S. stock trading at the NYSE’s expense. And the growth should continue- the SEC recently announce that it would allow companies on the NYSE to switch to the Nasdaq and keep their three-letter symbols. The Nasdaq is lobbying to extend this ruling to include one and two-letter symbols as well. With annual listing fees on the NYSE up to 4x more than its electronic rival, I suspect some companies will be taking advantage of the opportunity to switch. The prestige long associated with being listed on the Big Board is steadily fading. As the NYSE completes its move to copy the Nasdaq and switch to an all-electronic trading platform, any differences between the two exchanges should disappear, and companies should gravitate to the lower-cost Nasdaq.

And Nasdaq is about to become an international power itself, with its pending aquisition of Nordic Exchange OMX. OMX recently reported a 53% increase in profits, and its purchase and resulting cost synergies should help drive Nasdaq’s growth and bottom line. There is still some uncertainty with what will happen with the LSE. Nasdaq owns a 30% stake in the exchange (worth over $1.5B), and is seeking to block the proposed merger between London and the Borsa Italiana. The speculation is that this may be in preparation for a second try at a takeover attempt. Regardless of what happens, Nasdaq will be the second largest international exchange and retain a major stake in another top five player.

I like NDAQ’s relative valuation, strong cash flow, and multiple growth catalysts. I’m also impressed by the current strength of the stock following earnings; it held its gains during Friday’s market sell-off. This is a good opportunity to buy into a company that looks to be on the path to becoming a global financial powerhouse.

Disclosure: SmartGuyAB is long NDAQ

lululemon: Hot IPO or Market Opportunists?

lululemon (Nasdaq: LULU) is a fast growing designer and retailer of athletic apparel in North America. The hot brand is well known for their women’s yoga apparel. The company was founded in 1998 in Canada, and expanded to the US in 2002. Currently, lululemon operates 52 stores.Financial performance is nothing less than impressive:

Our net revenue has increased from $40.7 million in fiscal 2004 to $148.9 million in fiscal 2006, representing a 91.1% compound annual growth rate. During fiscal 2006, our comparable store sales increased 25% and we reported income from operations of $16.2 million, which included a one-time $7.2 million litigation settlement charge. Over that same period, our stores opened at least one year averaged sales of approximately $1,400 per square foot, which we believe is among the best in the apparel retail sector. (Lululemon Corp. Form S-1.)

So, investors must be lining up to balance their investment-life portfolio with shares of LULU? Not so fast. Last Friday the company filed a revised prospectus to cut the number of IPO shares by nearly ten percent to 16.4 million. If demand is the key reason to get in early on an IPO, we may want to wait and see before clicking ‘buy’ in our online brokerage account.

In my opinion, the disappointing appetite for LULU stems from the use of proceeds from the IPO. Although I love nearly everything about this company (e.g., strong management, solid financials, excellent brand value, tremendous growth potential), like Warner Music Group (NYSE: WMG), the people benefiting most from this IPO are the founder and private equity investors: existing lululemon shareholders will account for nearly 14.1 million of the 16.4 million IPO shares. Yep. That means, as the Form S-1 so eloquently reads, “We expect to receive net proceeds from this offering of approximately $20.3 million.” That’s out of approximately $164M raised.

Wall Street may not be predictable all the time, but one thing most investors frown upon is market opportunists. Some companies like Blackstone (NYSE: BX) have the PR and hype to get over this issue, but little known niche companies do not. Such behavior is unfavorable because LULU will now use more money from cash flow, rather than IPO proceeds, to fund growth. This, in turn, eats into value metrics that support stock prices as well as premium values that a prospective buyout player may be willing to pay. In this case, during 2007-08, lululemon has budgeted $28.0 million to $34.0 million for new store openings. Tack on working capital and expanding G&A, and the proceeds from the IPO seem more like a windfall for existing shareholders than future shareholders.

Will LULU become another must have apparel stock like Abercrombie & Fitch (NYSE: ANF), Aeropastal (NYSE: ARO), American Eagle Outfitters (NYSE: AEO), and Urban Outfitters (Nasdaq: URBN)? Or, will the company’s founder and private equity investors take all the icing off the cake? As I wrote in my article about the EDA IPO, we will stay tuned …

Disclosure: SmartGuyDH does not own shares in any of the companies listed above.

China 3C Group: Best Buy deal establishes legitimacy

• Buy CHCG.OB around 7.96

China 3C Group (OTC: CHCG.OB) is a Chinese company that distributes electronics to retailers and operates 200-300 ft. “stores within a store” in major electronic retailers. The company has a market cap of just over $200M.
I’ve been tracking CHCG for several months, impressed with its low valuation (projected 2007 PE of under 16), clean balance sheet (over $5M in net cash) and enormous group prospects. As the Chinese middle class grows dramatically, so too is the population’s desire for the luxury items such as cell phones and MP3 players. At a recent investor presentation, the company promised to have 4,000 stores and $1B in revenue in 2010. In 2006, CHCG had revenue of $148M and ended the year with 800 stores. Its growth story is already off to a good start- the company turned in revenue of $84.5M and profit of $6.5M in the 2007 first quarter while opening over 100 new stores.

Despite the impressive numbers and prospects, I’m reluctant to dip into an OTC-traded foreign microcap. The company primarily operates in such stores as Gome, Carrefour, and Suning - perhaps household names in China, but nothing you’d expect to see at your local mall. Before investing in a company like this, I need to see some evidence of legitimacy- a profile in a major U.S. publication or contract with a major American company.

On June 15, I got the validation I needed, as the company announced that it would supply products and services to Best Buy’s first branded store in China, which opened earlier this year in Shanghai’s upscale Xujiahui district. Best Buy Int’l CEO Robert Willet recently commented, “the store is doing incredibly well. To say that it exceeded our expectations would be an understatement.” Based on this success, Best Buy plans to open another 10 stores around Shanghai in the next 18 months, providing even more opportunities for CHCG.

Another positive catalyst could hit later this year, as CEO Zhenggang Wang intends to list the stock on a major U.S. exchange.

The stock immediately jumped following the Best Buy announcement, only to fall back the remainder of June. July has brought increased volume and what looks to be a renewed up-trend, and I recommend getting in now on a ride to the double-digits.

Disclosure: SmartGuyAB is long CHCG.OB

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

Nintendo: Skeptics are sign stock will keep rolling

Today’s WSJ reports that Nintendo (OTC: NTDOY.PK) still has vocal skeptics:

“The Wii’s popularity is unbeatable at the moment, but it will be facing tough competition in the fall. Some skeptics also say that Wii’s popularity is short term, based largely on the strength of Wii Sports …” (Nintendo on a Roll With Wii, July 5, 2007.)

So long as a group of analysts continue to scare people away from Nintendo shares, the stock still has room to run as these naysayers are proven wrong and their congregation converts to owners of NTDOY.

The risks of competition in the fall and waning Wii Sports popularity are very weak assertions. Regarding competition, the Wii is by far the cheapest console and will continue to appeal to parents worldwide as a more affordable purchase - especially as fuel, food, and energy costs eat into family budgets. Parents are also well aware that once a console invades the household, demand for new games is as constant as dad’s need for fresh razors. Again, the Wii is more appealing than PS3 and Xbox360 because Wii games are cheaper. If you do not believe me, watch a pack of moms peruse the game isles at your local Target.

The Wii also has advantages over competition because the gameplay is revolutionary and unique. Thus, the Wii appeals to an enormous mainstream that would never consider purchasing another console because these consumers do not consider themselves video game players. Furthermore, based on price, unique gameplay, and brand loyalty from Nintendo DS, the Wii seems to be a much more appealing option for young teens and preteens. Therefore, analysts who work 100 hours a week in cubicles on Wall Street may talk about blanket business risks such as competition, but those of us who interact with society are well aware that Wii competition is a lot weaker than supposed in theory.

Insofar as Wii popularity somehow being completely dependent on Wii Sports, anyone who takes a moment to talk with an employee at GameStop, EB Games, or Best Buy knows this is nonsense. In fact, when I bought my Wii the salesperson immediately recommended two additional “must have” games that are super fun to play on the Wii.

Honestly, who thinks of these silly risks? I cannot seem to find any sales data that supports these unproven claims. Rather, all sales data objectively points to the contrary — not to mention that when friends congregate at my house, the Wii is the most popular person at the party.