Exceed Company - Take a Risk on China

While we focus more and more on the economic slowdown in China, let us pause and take a moment to see where we can make some money on the attempted soft landing in the Far East. Exceed Company Ltd (EDS) is a Chinese footwear and apparel company – based in Hong Kong – offering products under its flagship Xidelong brand name. Exceed produces the types of sports and leisure products targeting young adults, which you are used to seeing in a company like Dick’s Sporting Goods (DKS) – shoes, socks, pants, coats, etc.

Exceed, like many other Chinese stocks, has been a beat up stock in the past year – down nearly 70% from its 52-week high of $5.45 last fall. The chart looks like a "house of pain" if you were in at $5. Now is a chance to ride a potential reversal. EDS is trading up slightly today to $1.70 on nearly 10 times volume. 

Highlights of the most recent 2^nd Quarter, reported on August 13^th, include strong revenue:

Revenue – $88.3 million

Net Income – 4.7 million

Net Cash – $124.3 million

Debt - $1.6 million

Cash on hand has never been a problem – while the stock price has plummeted – leaving net cash per share (29.31 million shares outstanding) at around $4.24 today. Net Receivables increased 43% - something I would like them to use for a stock buyback in the near future. 

Founder and CEO, Shuipan Lin, commented after the quarter: “As anticipated, our results in the second quarter were impacted by weakening consumer demand in China, which was largely attributable to the domestic and global economic slowdown. As a result, overall sales volume across our main footwear and apparel product lines decreased, resulting in a decline in revenue.  In response to the prevailing market conditions, we began in the second quarter to proactively limit production and delivery of products to better manage inventory levels at our distributors. Despite the unfavorable operating environment, we managed to outperform our revenue guidance for the quarter, supported by our ongoing brand building and marketing initiatives which have continued to raise the degree of market recognition of the Xidelong brand name and the average selling prices of our products, especially in our footwear segment.”

Lin added that strategies are in place to manage inventory levels and strengthen brand awareness, a proactive strategy already implemented by slowing down deliveries to third-party merchants last quarter. Inventory turnover levels decreased year-over-year from 9 days to 7 days. He added they will continue their “Fitness for All” campaign sponsorship. Third quarter guidance of the net revenue range of $95.8 million to $102.1 million should be manageable and I expect to see a profitable year-end close.

Although overall demand for the product is slowing in China, take a look at comments from this 2010 Chinadaily.com article:

“According to UBS Securities, sports shoes priced between 170 and 250 Yuan (between $25 and 36.8) are best sellers in China's second- and third-tier cities.

Currently, most Nike sports shoes cost between 500 and 1,500 Yuan in China. They sell to mid- to high-end consumers in large cities. For an ordinary white-collar employee in Beijing, one pair of Nike shoes costing 1,500 Yuan would account for nearly half of his monthly wages.”

HALF his monthly wages! Exceed’s target market could very well be invading not just the white collar workers in second and third tier Chinese cities, but making its way up the income bracket as the economy slows and demand for high-end brands like Nike (NKE) and Adidas AG (ADDYY) decreases. Chinese population growth is not slowing down, and with more and more families struggling to make ends meet, they will turn to lower priced alternatives, especially for their children, who seem to outgrow everything in a few months anyway.

I was able to find some Xidelong shoes here, priced at a reasonable 239 Yuan (a bit over $40 dollars). Take a look for yourself:

Along with the fundamentals, I want to confirm with some technical indicators:

The RSI (14) of 35 indicates we are approaching oversold territory. I believe this has some to do with how thinly traded this stock is – along with the typical low-volume August we have seen in the broader market. Also, look for EDS to break out from touching its lower Bolligner Band and trend upwards from the $1.69 closing low. Remember to use limit orders here, the bid/ask spread on this small-cap company is often large- and one trading block could push the bid down over 10%. Stay patient.With Jackson Hole already priced in, I think we have seen the bottom in EDS and we are in store for a double in the next year.

Facebook Longs Getting Zuckered

Already down over 47% since the IPO, shares of Facebook (FB) had been trading lower ahead of the August 16th lockup expiration - and that trend continued on expiration day itself.

As Jon Najarian (who is even long the stock and looking for mid-twenties short-term) of OptionMonster.com pointed out: "The single biggest thing it might do is make it less expensive to be short Facebook."

I agree in the sense that many of the shorts were way ahead of the lockout and held short all the way down into the teens - so they'll cover now and on the way up as longs jump in on perceived value. So, yes, we could see a short term bump, but I worry about the rest of the year. The market doesn't care what your IPO was or what percentage hair-cut your stock has taken already - it will find a home. Take a look at the November at the money ($20) put options below:

               

A lot of volume. November options are extremely important because:

1. Oct. 25th earnings are reported right after October options expiration. Yes, Zuckerberg says he does not manage to please the street every quarter. But, the market does react to quarterly reporting. For example, Facebook's first quarter seemed OK on the surface: They met estimates, sure, but once investors combed over the details and language, the stock sold off 10%. An important issue raised in guidance was the outlook on mobile advertising strategy and revenue. I use the iPhone and have never used FB's mobile app. It is so important that by November, there is some sort of guidance about mobile. Who is going to click on ads? Probably the same people that buy eCoins on DrawSomething - no one!
2. The second lockup expiration of 1.2B shares is November 14th. Will Mark Zuckerberg sell any portion of his shares? Will other big institutions and partners like Zynga (ZNGA) sell? Their cost basis is plenty low enough to. I realize Microsoft (MSFT) already says they are holding their 25M shares here - but how long will Ballmer be content?
3. Some other obvious answers - The macroeconomic picture and general market sentiment, including QE3 prospects and the presidential election. I would say to simply look at the social media "sector" as a whole in the last three months, around the time of Facebook's IPO. Stocks like the aforementioned Zynga is down over 63% in the last three months, Groupon (GRPN) is off around 61% while Pandora (P) shrugged off about 14%. Each of these are now trading in single-digits. To avoid a similar fate, Facebook will have to figure out what LinkedIn (LNKD) is doing right and try to emulate certain things.

Are you truly bullish and contrarian? If you are willing to buy here, why not start writing those Nov $17 puts and collect a nice $1.25. What about the bears? You could definitely try a Bear-Put spread in a nice little range should FB not break $26-$27 on the upside, in my opinion.

My sentiment is slightly bearish, but with little conviction: I found today's news really interesting, but have no plans on going either way with this. Maybe if we fall below $10, Zuckerberg will use his own money and take it private again. Sidelines are OK for me and many others for the moment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

A Rick Santelli View...

The TED Spread, albeit still historically high, came down from the highs last week. I would be hard-pressed to call it a ‘rally’, but at least more faith is being shown that the government is doing the right thing.

What is the TED Spread? The TED Spread is defined as the yield difference between the [risk-free rate] United States three month Treasury Bill and the three month London Interbank Offered Rate (LIBOR).

What does it mean? The TED spread is a way of taking the pulse of global credit risk. The three month T-Bill is considered ‘risk-free’ because of the full faith and credit backing of the US Government (i.e. no default risk). To compare that to the LIBOR reflects the credit risk of unsecured lending between banks in the London interbank market. In a nutshell, a rising TED spread indicates what we have now- fear of the default risk. Low spreads indicate more of an appetite/tolerance for risk in a ‘safe’ economy.

What other data supports the TED Spread? Many economists argue that the LIBOR-OIS spread is the complement to the TED spread. The LIBOR-OIS spread measures the difference between LIBOR and the overnight index swap rate. The rate has been viewed as confirming the credit risk by “measuring the availability of funds in the market” ( Bloomberg ).

Bullbeartrader.com put out this paragraph that perfectly summarizes the spreads: “As discussed in a recent Bloomberg article, the spread between the 3-month Libor and the overnight index swap (OIS) rate, traded forward 3 months, is greater than similar expiring spreads. This recent movement in the spread is signaling that traders are concerned that banks will have difficulties obtaining cash to fund existing assets, as well as putting into question their ability to shore-up their balance sheets. In general, an increasing spread signals that funds are becoming less available. The recent activity appears to be driven more by traders leaving the short-term, closer to expire positions early over worries about Libor and its reliability” (BullBearTrader).

Back in May, MarketBeat’s David Gaffen also pointed out that the TED spread improved (fell) because of the T-Bill rates rising, not LIBOR rates decreasing. Now, we are seeing the complete opposite (TED rising). Investors are now flooding into T-Bills and thus sending prices higher and yields lower. To think - investors at one point in time were willing to put their money in 0% yield instruments.

Conclusion:
The scary part is that the U.S. three month T-Bill traded at either zero or even negative late last week. While it has recovered, the TED spread is still too high and I am sure the Federal Reserve is paying close attention to it, among other factors. After holding rates steady, the Fed will surely have the finger on the ‘ease-rate button’ should emergency intervention be needed pending Congress’ vote on the Paulson bailout plan.

Below:
The first chart shows the dramatic volatility in the TED itself. It has historically charted between only a few basis points, but the recent events in the U.S. have created a spike that finally broke out.

The second chart gives a closer view of what has been going on the past year. We finally got the biggest spike in the TED after a week that changed Wall Street forever. Although it has subsided from its highs, the TED is worth watching as a future indicator, pending the government's solution.

Charts are (c) of http://www.bloomberg.com

The Short Ban and ETF's

Since the SEC decided to follow the lead of the UK and ban short selling, this time on 799 select financial stocks, with others beginning to petition to be put on that list to protect their own shareholders. The transition into ETFs only seems logical.

For this purpose, we’ll look at the (SKF), which is the UltraShort Financials ProShares. The (SKF) managers don’t actually short the underlying stock directly; they enter into equity swap contracts with an intermediary – who goes out and shorts the stock. With the ban in place, there are less (if any) counter-parties to assume the risk on the other side of the swap contract.

ProShares made the following announcement this morning, while the ETF was halted: “Due to the emergency action announced by the Securities and Exchange Commission on September 18, 2008, temporarily prohibiting short sales of shares of certain financial companies, Short Financials ProShares (SEF) and UltraShort Financials ProShares (SKF) are not expected to accept orders from Authorized Participants to create shares until further notice. Unless notified otherwise, shares will be available for redemption by Authorized Participants as normal. The shares of these ProShares are expected to trade in the financial markets today, but may trade at prices that are not in line with their intraday indicative values.”

It has subsequently started trading again, down nearly 20% during mid-day action. Obviously, we see the inverse action on the 2x long ProShares (UYG). So, if bears really think Paulson & Company will be stuck holding a bad hand after this weekend, they can go ahead and short the UYG itself rather than even dealing with the SKF and the mess created by the ban. On the flip side, others will confide in the government and remain long the likes of the UYG and the Financial Sector SPDR (XLF).

Two questions: (1) Will hedge funds start piling in these ETFs [traditionally used by small-capital investors for the moderate-long term] with no shares of individual companies available to short? (2) Will the shorts go right back after the financials, specifically the likes of Morgan Stanley and Goldman Sachs on Oct. 2nd? We’ll wait and see- any unusual activity in the October 2008 options, as the plan from the Treasury and Congress becomes clearer, could signal the future of the financials come the 2nd of October.

Midday (2pm on 9/19/08) charts of the UYG and SKF, respectively:

I have no position in either ETF.

VeriFraud back to being VeriFone:

VeriFone Holdings (PAY), which manufactures the devices which enable debit/credit card transaction automation for merchants, is finally seeing a pop in their stock’s performance – months after an accounting debacle sagged PAY shares to a 52-week low of $10.10.

The San Jose based company was busy this past week, upping forecasts while naming a new CFO to the team- as a part of cleaning house. Veteran Clinton Knowles replaced Barry Zwarenstein after months of allegations and current SEC investigations into VeriFone’s books.

It looks like VeriFone is getting back on the right track after erasing $70 million in overstated profits from fiscal 2007. The company also beat earnings consensus of $0.28 per share [excluding books adjustment and other one-time expenses] and upped guidance for Q4 to $0.36-$0.39 from the original analyst forecast of $0.30 per share.

CEO Douglas Bergeron also pointed out the raised FY 2009 earnings guidance to $1.45/share versus the previous $1.21/share consensus.

The results prompted the following opposite reactions from analysts:

"The optimistic outlook prompted SunTrust Robinson Humphrey analyst Andrew Jeffrey to predict VeriFone's stock will rise to $30 within the next year, up from his previous target of $22.

'We are convinced that VeriFone's historical competitive advantage remains materially intact, even as its two primary competitors have probably used the company's recent travails as an opportunity to take market share,' Jeffrey wrote in a Wednesday research note titled 'Starting Over: Phoenix Rising.'


Other analysts, though, were more skeptical.

In a Wednesday research note Goldman Sachs & Co. analyst Julio Quinteros wrote that VeriFone still appears to be facing 'headwinds' because the company is selling less profitable products, particularly in international markets. VeriFone hopes to offset some of those pricing pressures by lowering its expenses." (AP via Yahoo! Finance)

The $64,000 question is: What now?

Here’s my take:

1. VeriFone has great secular growth potential (25% international, 40% latin America, 25% asia, as per the conference call)

2. The inherit nature of the industry- (i.e. an Oligopoly- I, personally have not seen debit keypads manufactured by any other company)

3. Note the huge pop in MasterCard (MA) over the past year and a half, the IPO buzz surrounding Visa (V) and the Warren Buffett apparent continued buying of American Express (AXP). All of these factors indicate higher margins for VeriFone.

4. Accounting mess cleaned up = takeover target for big tech? No one can rule that out.
This business just seems that it has such vast growth; had it not been for the account debacle, the stock could very well be hanging around in the $40/share range and threatening the 52-week high of $50/share.

Conclusion: Assuming the accounting mess is 100% straightened out- the stock is a bargain, assuming any multiple less than 1.5 times the growth rate. I often screen out stocks with high PEGs [very generally, for long term plays], but this stock really does looks cheap considering the 1.00 PEG ratio.

PAY added nearly 36% after-hours on Tuesday and finished the week at $18.79.

Disclosure: None

Buffett and Gates help bid up Canadian Natural Resources:

Warren Buffett and Bill Gates, ranked #1 and #3 richest in Forbes [respectively], took an unusual summer trip together - to northern Alberta on Wednesday to explore CNQ’s multi-billion dollar oil-sands project.

The Horizon project is an “open pit mining strategy [which] will consist of mobile equipment and bitumen extraction facilities to mine and separate the raw bitumen from the oil sands. Canadian Natural will further upgrade the bitumen to a sweet synthetic crude oil using proven delayed coking and hydro-treating technologies” (CNRL.)

The project comes with some drawbacks: Budgeted costs have risen to (est.) $8.5 billion and drilling in the oil sands is not as environmentally clean as the likes of Transocean’s (RIG) deep-water drilling. CNQ projects that the costs will be easily covered, though, with the 40 year project life-span. Drilling technology over the next few decades will undoubtedly advance, as well.

In all, the oil sands of Canada are the second largest such reserve for crude oil production – an estimated 175 Billion barrels- not a bad output to help curb the supply-curve while alternatives to fossil fuels are explored.

I think it is unlikely that Buffett and Gates will invest in CNQ or one of its competitors – a lot of investors, politicians, journalists and government officials take trips to explore the future of energy in North America and the world. "We were asked to come up and give a general overview on the oilsands and Canada's role in the world of energy in general, which we did," said Greg Stringham, CAPP's [Canadian Association of Petroleum Producers] vice-president. "They were exercising curiosity, basically saying, 'Wow, this is neat.' " (Calgary Herald)

Even if Buffett has a desire to invest here, history says he is always highly educated on both the sector and company he invests in (i.e. no tech companies). I’m sure the idea has crossed his mind, but unless he’s seen more than a small presentation about how the industry operates, I would not expect anything more than a flicker of hope for CNQ longs (who, not to mention, have had a nice ride with CNQ already).

So, whether it be an investing trip, sightseeing trip or both- one thing is certain: Both institutions and individuals follow every footstep of Buffett. If there is a remote chance he will put capital towards this form of oil harvesting, you bet your house that the money will follow.

Edward Jones analyst Lanny Pendil apparently did not get the memo that these billionaires really do move stocks: “The fact that people were up there kicking the tires means nothing from a financial standpoint and therefore really shouldn´t really play into what the price of these stocks is doing today.”

So, why did CNQ jumping the highest since 2005 on the day of the visit? Hmm. I’m still amazed how Buffett can materially move stocks, especially from my point of view as a young investor who has not had the privilege of following Buffett.

CNQ added 7% on Wednesday on the speculation and another 3% Thursday on higher oil.

Disclosure: None

A Currency Called the Oil/Dollar?

The old “Which came first: The chicken or the egg ?”debate has turned into “Does oil affect the U.S. Dollar or does the Dollar strength (or lack thereof) drive oil prices?”

Here’s both sides of the story:

Option A: Oil is driven by supply and demand – Economics 101. Sure, there are speculators floating around, but certainly not prominent enough to drive the price of oil more than a few dollars either way. Oil prices react to socioeconomic events, conflict premiums and EIA data, among others.

Therefore, as demand increases, other countries (namely, the BRIC: Brazil, Russia, India, China) bid up the price and force oil to be valued at X amount of dollars in the eyes of the U.S. citizen/investor. In terms of companies that use the oil, like airlines, the smartest ones have had a hedge on prices for years.

Solituons: The government needs to look for both alternative energy and drill offshore to create our own extra supply. Citizens should demand congress to enact legislation promoting the use of nuclear power. Democrats argue that leaving Iraq would help lower prices (probably true, but should not be considered before we win the war). Other, in my opinion, less effective arguments include Sen. Obama’s call for a bigger reliance on the mass transit system.

Conclusion: Oil drives the Dollar.

Option B: I could not think of a better way to put this, so I’m using a quote I found in this FOREX Blog: “In a nutshell, this inverse relationship exists because global oil prices are denominated in dollars. Thus, as the USD declines, oil producers are paid fewer 'units' of foreign currency in exchange for oil. They must compensate for this decline in real revenues by raising the price of oil (in dollars).”

To add to that, the price of physically importing the oil from foreign countries increases.

Solutions: Raise Federal Funds rates while growing the economy- the Fed’s dual mandate (FYI, the ECB has a single mandate). If China and others would float their currency, the USD would strengthen versus the EUR.

Conclusion: The Dollar drives oil prices.

Clearly, we see an inverse relationship from the weekly closing charts of the Dollar Index and Lt. Sweet Crude, respectively: