Saturday, April 19, 2008

Research in Motion (RIMM): Trading at a discount to its growth rate (even at a whopping 50 p/e)

Buy: RIMM, Target Price: $140, Time Frame: 6 months.

Apart from RIMM being a strong tech player and mobile e-mail dominator, it has a few things working for it this time of year. Even amongst the credit crunch and sub-prime mortgage mess this summer, Tech has slowly but surely led people out of the trenches in the early stages and then got some help with aid from the fed. There was a massive influx of cash into tech names (institutional money/hedge funds, etc) as they realized the beaten down names represented good value.

Reasons for RIMM to head higher: Firstly, earnings guidance is a major one. Next year's earnings per share (EPS) estimates have been raised from from $6.15 to $7.68. This obviously signals a general consensus that RIMM and its armada of Blackberries will continue to perform. And, rightly so. Practically every businessman/woman walking around has a Blackberry, it really is amazing. Most of these people receive them through their companies, which is where RIMM derives its major consumer base. Corporations and even small businesses outfit their employees with Blackberries in order to stay in touch with their business and e-mail 24 hours a day. And it is not like they just buy one set of Blackberries and call it good. Nope, they upgrade every time a new Blackberry comes out, constantly fueling sales for the company. In fact, even though the company is supplying the employee with the device, the employees seemingly fall in love with the device and can't live without it, which explains why the device has been nicknamed a Crackberry, due to it's addictive nature. Now, with a loyal consumer base and constant sales due to corporate orders, RIMM seemingly has it made. But what about it's competitors. Exactly, what about them? Where are they? Palm has seemingly fallen off the planet. Their stock has been doing nothing compared to RIMM and continues to decline. Apple iPhone? Sure, it's a great device, but it targets a totally different consumer. There is no way iPhones will invade the corporate workplace for numerous reasons, among them: possible security and compatibility issues, no physical keyboard, etc. Basically, it is a multimedia/communication device, while Blackberries focus mainly on what they do the best, e-mail. With a loyal consumer base, RIMM will always be able to sell future products. Sure, they can sustain market share, but can they continue to grow it? I believe so. As mentioned earlier, corporate sales are a major driver for RIMM. However, you are starting to see small businesses and even people who don't receive a Blackberry for work are purchasing them, diversifying their consumer base a little bit more. Smartphones are penetrating the personal cell phone market by becoming people's personal phones as well, rather than just a business phone. Not to mention, corporations always go through upgrade cycles to upgrade their employees hardware and thus RIMM sees big bulk orders. Now, RIMM trades with a trailing PE ratio of 52 which is obviously high due to its anticipated growth. It has a PEG ratio (price to earnings growth) of 0.94, signaling that the stock is still slightly under-priced and has room to grow. (PEG ratio of 2 indicates that the stock is valued fairly based on growth estimates). So, RIMM still has room to grow based on estimates. Thus, I am recommending a shorter term trade/investment for 6 months, to extract the full value determined in the PEG ratio. And, as pointed out earlier, estimates have already been raised for the next fiscal year. It has a return on equity (ROE) of nearly 40% (and this number has accelerated over the past few quarters), which is definitely a solid number as well. Additionally, they have strong margins of 28% and quarterly revenue growth of 102% and quarterly earnings growth of 123%. These numbers are massive and are not sustainable in the long term. But, this is after all a growth name and you have to play it for its growth while it lasts. The second they start showing signs of growth get out of this name because it will plummet and will need a lower multiple. In the mean time though, RIMM is easily trading at a big discount to its growth rate (thank you big tech sell off earlier this year). With quarterly earnings growth of 123% and a PE of (only) 52, RIMM is trading at a very substantial discount to its growth rate. You are basically getting RIMM here at half price to its growth rate, amazing. This is one of the main reasons to buy this name.

Last, but not least, Blackberry has been pumping out international ready versions of it's smart phones in order to serve the truly international businessman/woman. Now, in addition to this being a positive for American users of the device who go on business trips abroad, it opens the door for further international exposure, possibly growing the brand even more by selling them in additional international markets. After all, Blackberry is already growing this fast with the majority of its business coming from America. Once it taps into more markets, its growth could even accelerate, or at the very least remain consistent.

RIMM is a growth name and thus needs to be evaluated as one. Its PE seems high at first glance, but it is trading at a discount to its growth rate and needs to be bought for this reason. Simply put, RIMM has a quality product with both a sustainable and growing consumer base, and constantly has new Blackberries in the product pipeline. They are growing fast and their PE reflects that. It will be hard to sustain this growth further down the road, but in the nearer term (6 mos- 1 year) I see RIMM continuing to grow and lead the tech sector. That is why I have selected a time frame of 6 months. Keep an eye on earnings if you wish to hold longer term simply because this is a growth name trading at a high multiple because it is experiencing high growth. Once this growth slows or contracts, RIMM will sell off because it will need to trade a lower multiple that reflects its slowing growth. Until then, ride the wave.

Buy: RIMM, Target Price: $140, Time Frame: 6 months.

Nike (NKE): The quintessential international company

Buy: NKE, Target Price: $73, Time Frame: 6 months

Nike (NKE) is one of the first stocks that comes to mind when you think of big, bluechip names. They consistently seem to perform and offer the slow, boring, yet consistent returns on your investment. Even though that might be the case with most bluechip names, NKE is far from that. Over the past year, NKE is up 32.6%. Over the past 5 years, NKE is up 200%. So, as you can see, NKE might be a boring blue chip name, but they certainly don't come with the typical 10-15% bluechip returns. In fact, NKE is performing at a rate that is nearly double that of most boring blue chip large cap names. The point of this analysis is to point out that obviously, NKE is a buy on any dip. If you pull up a chart of Nike, no matter what time frame, you will see a nice uptrending chart. Stocks that trade like this are simply buys on the dips, and NKE is just that. They are seeing huge growth internationally and so in addition to playing a great company, you're gaining a lot of international exposure as well.

Fundamentally, it should come as no surprise that NKE is just dominant in their industry. With a PE of 18.6, they are slightly cheaper than the industry average of 20. Their price to sales ratio of 1.82 implies that they are very cheap on valuation. Any equity with a PS ratio of less than 5 can be deemed undervalued, and NKE definitely falls into that category. They also have operating margins of 13.6% and a return on equity of 25.3% (slightly accelerating too), both very solid numbers that exemplify NKE's solid fundamental drivers. So, overall, NKE is pretty fundamentally sound, but we already knew that. They are seeing quarterly revenue growth of 15.7% and quarterly earnings growth of 32%, both great numbers, even with a slowing US environment. This just goes to show how much international exposure Nike has, and how beneficial it is to them.

Analyst sentiment: There are currently 2 strong buys, 3 moderate buys, and 3 holds on Nike. So, 5 overall buys and 3 holds is pretty bullish. The 'hold' analysts are obviously telling us to hold for the long term as they see continued, consistent blue-chip like growth ahead for NKE. In addition, both UBS and Merrill Lynch rate NKE 5 stars, while Citigroup rates NKE 4 stars. This information is also bullish for NKE. Overall, analysts expect NKE to significantly outperform the market over the next six months with very little risk. Earnings growth over the past year has held steady when compared to earnings growth over the past 3 years. And, one or more analysts have modestly increased their quarterly earnings estimates for NKE. Turning to the institutional ownership aspect of NKE, we see that Fidelity, Barclays, State Street, Vanguard, Janus, Dodge & Cox, and Berkshire Hathaway are all major shareholders. Each of the above has invested at least $448 million into NKE, with Fidelity investing as much as $993 million. Not to mention, behemoth hedge fund Renaissance Technologies has a very large stake in NKE, which provides investors with that much more confidence. Anytime a consistent hedge fund performer like Renaissance is in a name you're looking at, its always comforting. They all expect NKE to continue to perform with relatively low risk.

Lastly, NKE's earnings reports just reaffirm what we already know. Nike is showing a 10% increase in profit, mainly fueled by international growth. These results all exceeded analysts expectations as well. Quarterly revenue has been up 14% and with all their international exposure, Nike certainly benefited from currency discrepancies (especially the weaker Dollar). Revenue growth in the Americas was up 19% and 18% in Europe and 17% in the Asia Pacific region. Growth in Europe and Asia was notably much stronger than what analysts were anticipating. CEO Mark Parker said that their quarter "illustrates the ability of our portfolio to deliver consistent, profitable growth." And, what more can you ask for from a company? (Especially a huge company like NKE). Lastly, Nike also saw an increase in cash, gaining $3.1 billion by quarter's end. They are making several notable changes by selling Nike Bauer Hockey up for sale and having recently acquired Umbro PLC, a soccer company. This is definitely a move in the right direction for Nike as soccer continues to grow as the "world's favorite sport." By picking up Umbro, Nike has essentially picked up a solid soccer presence to add to their already large European soccer market share. But, at the same time, Nike will see dividends paid from this investment worldwide, not just in Europe. And, they sold off their presence in the dwindling hockey market.

Nike is a solid company with solid fundamentals and solid growth. If you were to use one word to describe Nike, it would have to be: solid. They simply continue to perform in that boring, blue chip fashion. But, instead of offering the typical modest blue chip gains, Nike is tearing it up. And, the best part is, they will continue to do so. Nike is a buy on any dip.

Buy: NKE, Target Price: $73, Time Frame: 6 months

Potash (POT): Fertilizer Companies Have Pricing Power

Buy: POT, Target Price: $250, Time Frame: 6 months

It's pretty obvious that agriculture has been one of the hottest sectors over the past 6 months. Having ripped through all my previous price targets, the fertilizer names continue to trend higher and it's time to re-evaluate them. Just like my previous analysis of the sector, this analysis is a three part agriculture series in which I'll be covering Agrium (AGU), Potash (POT), and Mosaic (MOS). These three companies specialize in fertilizer (potash, nitrogens, & phosphates) and currently there is a shortage in supply of fertilizer and thus these companies are ripe for success. All three of these companies are compelling because they are in the agriculture sector, and more importantly, the fertilizer sub-sector. But, they are all appealing investments for different reasons: valuation, growth, and market share, respectively. Instead of just picking one of these names to own, pick all three and spread the money you would have spent on one stock across all three names. That way, you diversify yourself away from company specific risk while still gaining exposure to the sub-sector secular growth. Fertilizer is in the midst of a secular bull market due to the pricing power that these companies have.

Commodity prices are sky high and this only benefits the fertilizer producers. This is mainly due to an issue I've touched on previously: there is simply not enough crop supply to meet crop demand. There are not enough farmers, there is not enough farmland, and there's simply too much demand. When a scenario like this plays out, the suppliers of such a product cannot lose. The makers of fertilizers and seeds are seeing huge demand from farmers who are struggling to meet the robust crop demand. So, the producers of these products, who are facing this robust demand, then see a shortage of their supply of fertilizer and the like. And, that's exactly what we're seeing right now. POT, AGU, and MOS all have pricing power because there is insane demand for their product and their product is in very short supply. This issue will not be solved for some time either because demand for crops (especially corn) is not going anywhere and thus the producers have to find a way to step up their supply of fertilizer. But, any outcome is a victory for companies like Potash, Agrium, and Mosaic simply because they're raking in cash. This analysis focuses on Potash (POT) but I will be doing a series of 3 analyses on the 3 main fertilizer companies: Potash, Agrium, and Mosaic. POT is my favorite of the bunch simply because they have a dominant market share of around 75% of the potash sold.

Potash is a Canadian company who produces integrated fertilizer and various other feed products. A year ago, they represented 55% of global potash excess capacity. And, nowadays, with the supply issues at hand, you can bet that Potash (POT) is raking in the cash on their reserves.

POT's strong suit is not its valuation. And, this is because it trades at a premium to other fertilizer names due to its 'best of breed' status. AGU is the cheapest on valuation, while MOS is second. With a trailing PE of 56 and a forward PE of 17, POT is richer than both AGU and MOS. Note, though, that POT's forward PE has been declining substantially on a quarterly basis, based on future earnings forecasts. And, I strongly believe that analysts are underestimating the earnings potential POT has with their strong market share and pricing power due to the inability by all parties to bring new Potash to market until year 2012 and beyond. (It takes years to bring a potash mine online). So, I believe you will see the real numbers continue to blow away estimates (as they report earnings here soon) and then eventually you will find that POT is actually trading at a lower multiple than everyone thinks. The fundamental story here is very real and people aren't grasping that these suppliers just can't "grow" or "discover" more potash all of a sudden. It takes years to bring more potash to market. Thus, the prices of the limited capacity will skyrocket and their earnings potential will continue to grow. Estimates will be continually smashed until the analysts realize what is happening and adjust their estimates accordingly. But, when it comes down to it, POT is not your value play in the fertilizer sub-sector of agriculture. AGU would be your value play (check that analysis to see why). Potash (POT) is actually my pick for the dominant company of a sector, i.e. best of breed. In any sector, there is usually a growth story, a value story, and a best of breed story. And, within fertilizer, POT is best of breed and here's why. POT's operating margins and return on equity absolutely crush their competitors. And, these are the real bread and butter numbers of any business. Firstly, looking at operating margins, we see that AGU is slightly weak in this area with margins of only 11% (due to their smaller company size). Mosaic (MOS), a larger company, has margins of 24%. POT's operating margins dwarf that of both these companies. POT's margins come in at 32%, tripling that of AGU. So, this is one of the main reasons POT is best of breed: their ability to crank up huge margins in their business. Additionally, POT has returns on equity higher than AGU as well. AGU has returns of 20%, which is respectable. POT trumps them with a return on equity of nearly 25%. So, you want best of breed? You got it. POT dominates the industry with their huge margins and solid return on equity. Like I said earlier, there are typically 3 types of names within any industry: a growth name, a value name, and a dominant name. POT is the dominant name in the fertilizer sub-sector of the agricultural industry.

As if you needed another good reason to own POT, they are also seeing very strong quarterly revenue growth of 42%. And, that number is accelerating on a quarterly basis. Additionally, they're seeing strong quarterly earnings growth of 102%, a number which is also accelerating. Also, POT was rumored to be a possible takeover target or merger participant back in early December. Although these rumors have died down, you never know. POT could still see an additional boost from any mergers and acquisitions activity that might pop up. Analysts covering the situation cited that POT might either be taken out by a company or merge with a peer where the newly created entity would then use leverage. So, this is something else to watch out for as time goes by.

AGU, POT, and MOS are the 3 main players within the fertilizer space and each is compelling as a buy for a different reason. POT, for instance, has superior operating margins and returns on equity when directly compared to its competitors and is thus the 'best of breed' play of the group. Additionally, they have the largest market share in terms of potash, the fertilizer nutrient in the shortest supply and highest demand. Play the increasing demand for crops, play the increasing demand for fertilizer, and play the pricing power fertilizer producers have gained by playing AGU, POT, or MOS. In this case, play POT because it is performing extremely well in terms of the 'bread and butter' aspects of the business.

One last thing I wanted to point out is to wait for a slight pullback because the stock is overextended and due for consolidation before the next leg higher. After they all report earnings, look for continued strength in the names and get in on any weakness that you can. I'm simply writing this analysis before any pullback occurs because I wanted to get the information out there beforehand. Watch the chart and the moving averages that act as support lines to help guide you with an entry point. Buy on any weakness and continue to watch the fertilizer story play out. This is pricing power at its finest. POT keeps raising prices (as they just did again this week) and they simply continue to dominate.

Buy: POT, Target Price: $250, Time Frame: 6 months

Mosaic (MOS): Fertilizer producers have pricing power

Buy: MOS, Target Price: $167, Time Frame: 6 months

All the fertilizer names continue to rock and thus its time to re-evaluate them. Just like my last analyses of the fertilizer plays, this analysis is a part of a 3 part agriculture series in which I'll be covering Agrium, Potash, and Mosaic. These three companies specialize in fertilizer and currently there is a fertilizer shortage in supply and thus these companies are ripe for success through 2008. All three of these companies are compelling because they are in the agriculture sector and more importantly the fertilizer sub-sector, but they are all appealing investments for different reasons (valuation, growth, dominance). Instead of just picking one of these names to own, pick all three and spread the money you would have spent on 1 across all 3 names. Fertilizer is seeing a secular bull market due to the pricing power that these companies have.

Potash, Agrium, Mosaic and the like are gaining pricing power due to supply issues of fertilizer. Additionally, they are seeing very strong demand. So, not only were their prices high due to short supply, but when you add in big demand, prices exponentially increase. Not to mention, agricultural commodity prices are sky high (and so are the futures prices) and there looks to be no end in sight. This is mainly due to an issue I've touched on in a few analyses over the months. And, that issue is the reality that there is simply not enough crop supply to meet crop demand. There are not enough farmers, there is not enough farmland, and there's simply too much demand. When a scenario like this plays out, the suppliers to the farmers simply cannot lose. The makers of fertilizers and seeds are seeing huge demand from farmers who are struggling to meet the robust crop demand. So, the producers of these products, who are facing this robust demand, then see a shortage of their supply of fertilizer and the like. And, that's exactly what we're seeing right now. POT, AGU, and MOS all have pricing power because there is insane demand for their product and their product is in very short supply. This issue will not be solved for some time either because demand for crops (especially corn) is not going anywhere and thus the producers have to find a way to step up their supply of fertilizer. But, any outcome is a victory for companies like Potash, Agrium, and Mosaic simply because they're raking in cash. This analysis focuses on Mosaic (MOS) but I will be doing a series of 3 analyses on the 3 main fertilizer companies out there that all are attractive as buys each for a different reason.

MOS produces phosphate and potash and animal feed ingredients. Basically, they are involved in the agricultural sector in terms of providing nutrients so that various crops can grow. And, as I've just detailed above, there's a lot of demand for crops. When looking into an industry you'll typically see a value play, a growth play, and a best of breed play. In the agriculture sector, the fertilizer plays are where you want to be right now just due to their supply situation. Within this sub-sector, AGU is the value play, POT is the best of breed, and MOS is the growth play. Now, why is MOS a growth play if it has a market cap of 58 billion? Well, I'll tell you why. MOS is seeing faster growth than that of POT (who is best in breed in this space). MOS is seeing quarterly revenue growth of 67% which is greater than POT's 42%. Also, MOS is seeing big gains in terms of quarterly earnings growth. They are seeing a 1134% growth year over year. POT, on the other hand, is only seeing year over year quarterly earnings growth of 102%. So, even though POT and MOS are similar in terms of market cap, MOS seems to be growing at a faster rate than POT and based on their last year's performance, this growth is pretty sustainable. And, the best part is, MOS isn't even trading at a premium to its peers for this growth. POT is the richest in valuation and yet it is growing slower than MOS. You are paying for MOS' great growth, and even then you are hardly paying a premium for it. As long as MOS continues to grow at around this pace (as they have), then these valuations would be worth paying for and would be warranted. But, there is a caveat with this pick. If MOS' growth slows for any reason, then their rich valuations will no longer be warranted and thus the shares would see a pretty good sized sell-off, seeing as they are trading at a premium currently. So, that's the only cautionary measure with this pick. Make sure to monitor their quarterly earnings with care to ensure that growth is being sustained or increasing. So, from this we see that MOS is the growth play of the sector based on consistent earnings growth that outpaces their competitors and at the same time is sustainable. Also, keep a watch on analyst estimates for this name. I have a feeling that their estimates are extremely weak and that MOS is being underestimated by analysts. Then, in reality, based on forward earnings, MOS would be trading at an even lower multiple, making it a screaming buy. Plus, strong operating margins of 24.8% and a return on equity of 30% just add to an already great fundamental picture.

Additionally, MOS recently had a big positive development that provides yet another reason to own this name. MOS is going to be prepaying $150 million of their long-term debt (principal amount). The ability for the company to pay ahead of schedule like this is a positive sign in that it shows they are pro-actively servicing their debt, as well as making an active effort to increase shareholder value. Debt is obviously never really a good thing, and the fact that MOS can shed $150 million of debt way ahead of schedule is very encouraging. Also, they have already prepaid $1 billion worth of long-term debt over the course of the past year. MOS has clearly seen a big increase in their amount of cash from the high crop prices and thus high fertilizer prices. This cashflow perfectly illustrates just how real the problem in the agriculture sector is. Demand is out of control and thus supply companies like MOS are raking in cash trying to meet all the demand. MOS has then used the excess cash they've received to constructively payoff their debt. This company and its management are definitely taking big steps in the right direction and this is a very encouraging sign for investors. Management's effort to strengthen their balance sheet and improve their credit ratings should provide investors with yet another good reason to invest in MOS. Lastly, as if we needed another reason to own MOS, it should just briefly be pointed out that MOS was one of the top performers of 2007 in terms of % gainers, locking in a 289% gain for the year, which is 8th out of all non-penny stocks. So, MOS has performed extremely well and will continue to perform well given the advantageous environment they are working in currently. Again, the story in their industry is real and they have pricing power. Easy money.

Agriculture will be a big story for all of 2008 and into early 2009. AGU, POT, and MOS are the 3 main players within the fertilizer sub-sector and each is compelling as a buy for a different reason. MOS, for instance, has seen the largest, most consistent, and sustainable growth when directly compared to its competitors and is thus the growth play of the group. Play the increasing demand for crops, play the increasing demand for fertilizer, and play the pricing power fertilizer producers have gained by playing AGU, POT, or MOS. In this case, play MOS because it is seeing high, sustainable growth and because management is actively enhancing shareholder value by paying off debt and cleaning up the company's balance sheet. And, keep an eye on estimates as I believe analysts are underestimating MOS growth and thus it should be trading at a lower multiple and becomes even more of a bargain. One last thing I wanted to point out is to wait for a slight pullback because they are overextended and due for consolidation before their next leg higher. After they all report earnings, look for continued strength in the names and get in on any weakness that you can. I'm simply writing this analysis before any pullback occurs because I wanted to get the information out there beforehand. If I wait to write this all up right when these names start to dip it will be too late. As you can see from the chart, they take massive violent downswings that only last a few days and then are right back to their winning ways. Watch the chart and the moving averages/Bollinger bands that act as support lines. Buy on any weakness and continue to watch the fertilizer story play out. MOS has the momentum to compete right up there with the best (POT) and so watch out as their growth continues to accelerate. This whole sector is booming and MOS is doing all they can to trump the competition.

Buy: MOS, Target Price: $167, Time Frame: 6 months

CSX Corp (CSX): Rails still red hot

CSX: Buy, Target Price: $64, Time Frame: 6 months

Typically I don't like to recommend names that are just hitting 52 week highs because they usually pull back and consolidate after their big run. However, in CSX's case, the industry is simply seeing too much strength and thus the name should have continued momentum. It took out my last price target of $51 in no time. After re-evaluating things, its still a strong play. If you thought that in a 'weak US environment' that the rails would succumb to poor performance, then think again. If you've noticed the earnings reports from all the major US rails recently, you'd notice a distinct pattern: they're all beating estimates. No matter what kind of economy we are in, CSX keeps on chugging. CSX provides rail, intermodal, and rail-to-truck services in the railroad industry. As oil prices sky higher every day, planes and 18 wheelers are looking more expensive and less attractive to transport items with. Therefore, look to the rails. As the media has hyped the last few months or so, Warren Buffett has taken a large position in the railroads recently, and rightly so. He was a little early to the railroad party, as he experienced some downside in the late summer, but nevertheless it was the right call. And, in this recent downturn, Buffett has again added to his rails position, signaling his strong belief in the core business. Rails will be a solid form of transportation whether we continue to see great global growth or whether we experience a recession. How is this possible though? Rails can sustain current profitability in a recession? Well, yes they can and its because of two things: agriculture and coal. Prices of coal and ag related commodities have skyrocketed. Thus, these products are in high demand and need to be transported constantly. These two commodities are seemingly recession proof as well, as record earnings from Potash, Mosaic and others indicate. So, even if a recession is among us or headed our way, the rails will still profit. And, as CSX's most recent earnings indicate, the rails see continued strength due to commodities demand.

Fundamentals: With a trailing PE of 19 and a forward PE of 14.5, CSX shows its increasingly rich valuation due to share price appreciation. But, this move is a fundamental move and thus allows CSX to trade at a higher multiple. Its PEG of 1.01 is decent but nothing spectacular either. Its price to sales ratio of 2.4 indicates that it is undervalued, as any PS ratio under 5 deems this. Also, its price to book of only 2.8 shows that CSX is indeed undervalued by this metric as well. Buffett likes to see PB ratios of as close to 1 as possible, and CSX is right there. The rails core business is also strong with solid operating margins of 22.2% and a return on equity of 13.9%. This ROE is slightly low when compared to Buffett's typical standard, but he makes an exception seeing as all the rails have typically lower ROE. So, as you can see, it has some decent valuation (rising multiples due to industry strength) and is even deemed undervalued by certain metrics. CSX will continue to grow and beat estimates as long as the commodity race continues. Agriculture's secular growth is a key component of CSX's ability to withstand any recessionary pressures. And, we all know this secular growth will continue as commodities demand and prices sky higher every month.

Taking a look at a 1 year chart of CSX reveals a strong uptrend with noticeable dips for buying opportunities. If you don't want to hold this one long term, you could technically flip it each time it hits the dips, as the trend is very distinct. Be warned that there might be some near term downside, but it should be limited. After all, consolidation after big moves is necessary and healthy. As mentioned earlier, the rails are being fueled by strong commodity demand and are constantly transporting agricultural products. Strong fundamental strength here is why the chart looks so bullish.

Institutional Ownership: I've been following hedge fund activity as you can really see what sectors prominent funds are heavily weighted in. I could take all the research I do on all my stocks combined and it would still be less than what some of these funds do with their research and trading teams for this one stock alone. So, why not take their lead as an indicator of where to head. After all, if you follow the prominent hedge funds (ones that return greater than 30%) you are in good hands. So, hedge funds are currently heavily weighted in rails. Like I said earlier, Buffett got into rails early, and I think even some of the hedge funds are piggybacking Buffett's idea for longterm value. So, prominent hedge funds are heavily invested in rails and in particular in UNP, and more importantly, CSX. Taking a look reveals that Atticus Capital and Tudor Investments are two majority owners of CSX. In fact, CSX makes up 4% of Atticus' portfolio. And that actually says a lot, as hedge funds hold so many different positions at any given time. They are betting big time on long term growth for CSX. Also, Carl Icahn's fund Icahn Management and Daniel Loeb's fund, Third Point are big holders of CSX. In fact, BOTH recently upped their ownership to 2.9 million shares and 2.0 million shares respectively. Both increased their positions by at least 300,000 shares each. There are many other hedge fund holders of CSX which shows an overwhelming majority, and I have only chosen to highlight the most prominent names in the space. Point is, big hedge funds are throwing big money into CSX for the long term based on its cheap valuation and their bullish outlook on the transports and particularly the rails. It should also be noted that activists Icahn and Loeb (just mentioned above) who own large stakes in CSX are calling for a split up of the company in order to extract most value. Basically, think MO (Altria) and apply it to the rails. Altria spun off Kraft foods first, and then recently just announced they plan to spin off Philip Morris International as well in order to enhance shareholder value. The same technique can be applied to CSX as Icahn's and Loeb's research points to a stronger valuation for CSX if it is broken up. So, look for that catalyst to move the stock sometime within the next year as well. Rumors are already surfacing that Icahn and Loeb have begun their activist quest. So, there you have it. CSX and the rails in general are being picked up left and right by institutional and hedge fund money.

I'm not going to cut and paste the recent earnings numbers because they're readily available on Yahoo/Google finance. If you pay any attention at all to this sector you know that it is seeing underlying strength and that's all there is to it. There are simply way too many reasons to own the railroad sector, and CSX in particular. The stock is pegged for future growth. CSX benefits from any future rise in oil prices as other forms of transportation become extremely expensive. Also, the rails will continue to drive profits from transporting the heavily desired agricultural goods. Warren Buffett staked himself in the rails earlier last summer ahead of the crowd, and numerous prominent hedge funds also have taken large positions in CSX. Buffett even added to his rails position in BNI again over this most recent sell-off. Lastly, activist investors amongst those hedge funds will also look to split up CSX to extract the most shareholder value possible. Look for CSX and the rails in general to see continued slow and steady growth. The secular growth from agriculture and other commodities is simply too great to be ignored. While we may be in a recession, you can still find solid places to put your money to work: secular bull markets. And, the rails are in one with their strong tie to commodities.

CSX: Buy, Target Price: $64, Time Frame: 6 months

Burlington Northern (BNI): Rails seeing continued strength

BNI: Buy, Target Price: $110, Time Frame: 6 months

In recent weeks, we have seen a clear shift in energy prices. Oil has primarily moved upwards due to fundamental reasons (weak US dollar). Oil is cruising higher. And, if you believe in T. Boone Pickens Peak Oil Theory, then the rails are just the play for you. Wait, but if energy prices are high, why would we look to transportation? Don't they get hit hard by these high costs? That's exactly the point. This will affect every single type of transport company (rails, trucks, planes). Rails, however, will be affected the least. We recently saw weak earnings results from trucking companies who cited slowing demand and rising fuel costs. This is all the more reason to be bullish on rails. If it becomes so expensive to ship things via trucks and planes due to high fuel costs, where will suppliers turn? To the rails, of course. Sure, the rails still have to face energy costs. However, the severity of the impact of energy prices on rails is much less than that of trucking companies or planes. It seems that transport has shifted from airplanes and trucks to good old-fashioned railroads. And, to sweeten the deal, this favors rails for the long term as well. As oil is consumed heavily all over the world on a daily basis, Peak Oil Theory will only become that much more evident. This means that airplanes and trucks will become that much more expensive to operate, and the rails will continue to see a shift in their favor. Buffett is undoubtedly playing the rails for the long-term, and he has the perfect thesis to back up his investment: Peak Oil Theory. Not to mention, the rails are the form of transport for some of the hottest commodities out there right now: soft commodities/agriculture. These crops are rising in price due to strong demand and weak supply. The rails are the principal form of transport and this secular bull market spills over right into the rails.

Since we know the fundamental story behind the industry, lets make it easy and invest in the name that Buffett keeps piling into whenever it dips down low: BNI. Fundamentally, BNI offers a compelling story and its clear why Buffett initially made his investment. Besides having strong fundamentals in the underlying sector, this specific company is strong fundamentally as well. With a trailing PE of 19 and a forward PE of 14, BNI has become slightly rich in valuation over the past few months. But, this is due to the fact that they are seeing industry strength which allows them to trade at a higher multiple. With a PEG around 1.19, there is still room for earnings growth as well. Price to sales ratio of 2.19 deems BNI undervalued as any PS of under 5 is very bullish in terms of valuation. Additionally, BNI has a price to book of 3.1 which is decent, but nothing spectacular (it was much cheaper when Buffett first got in, that's for sure). BNI cleans up compared to other rails in terms of operating margins and returns on equity. Every little edge counts and with operating margins of 22% and a return on equity of 16.8%, BNI comes in slightly ahead of its competitors in the "bread and butter" of profitability in their business. Additionally, they are seeing 9.4% quarterly revenue growth. And, that is in the rails? think about that. Such an old fashioned form of transportation is seeing slow and steady growth at this day and age is almost amazing. It all boils down to the underlying sector strength due to the commodity bull market and secular growth in agriculture. There is a negative associated with BNI and that would be their debt. They have $330 million in cash, but more than $8 billion in debt. Seeing as they are raking in the profits, look for them to spend some of that cash to pay down some debt to get their debt/equity level to more comfortable levels.

This piece merely serves to reiterate which name is the best of the pack. BNI recently reported better than expected quarterly profit. In recent quarters, the company cited increased volume from the agricultural business. This fact also benefits BNI as agriculture is seen to continue to be strong through 2008. In my recent analyses of agriculture giants Potash (POT), Mosaic (MOS), and Agrium (MOS) I cited how top management saw agricultural demand as very strong throughout 2008. With energy prices so high, suppliers and farmers will continue to send and receive products by rail. This agricultural bull market adds yet another positive catalyst for BNI and the rail stocks. So now we've got high oil prices and an agricultural bull market working in favor of the rails. The long-term outlook for these names is definitely bright.

Institutional Ownership: As an investor or a potential investor, you like to see this kind of positive outlook, but you also look for reassurance that other great minds are thinking the way you are. And, as a matter of fact, BNI's shareholders include some of the great names in terms of investors. First off, as mentioned earlier, Warren Buffett has recently acquired stakes in BNI and UNP, betting big on rails for the long term. Buffett's Berkshire Hathaway has taken a greater than 16% stake in BNI, and it is one of Berkshire's largest investments in a long time. His vote of confidence in these names alone should give other investors even more confidence. Secondly, besides receiving a seal of approval from Warren Buffett himself, BNI has also received a stamp of approval from one of the most successful and well respected hedge funds on Wall Street: Atticus Capital. 3% of Atticus' portfolio resides in shares of BNI. Now, some of you might be thinking, 3%?! That's not that impressive. Well, it immediately becomes impressive when you find out that Atticus is a $13 Billion Hedge Fund. 3% of $13 Billion? You do the math. Lastly, BNI also has seen BlackStone take a heavy stake in their company through their Kailix Advisors Hedge Fund arm of their organization. 5.1% of Blackstone's hedge fund portfolio is secured in shares of BNI. As you can see, 3 major names in the world of Wall Street have bet on BNI and the rails for the long term. Not to mention, they have bet with very large amounts of money. When you have this many smart minds investing in one name, it's definitely worth checking out. Collectively, they've done more research than all of us could do combined. If there ever was a vote of confidence in a stock, this is it. This provides just an additional reason to like BNI. With Buffett, Atticus, and BlackStone all backing this name, it's hard to bet against them.

BNI: Buy, Target Price: $110, Time Frame: 6 months

Friday, April 18, 2008

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"Profit from folly rather than participate in it." ~ Warren Buffett tracks prominent hedge funds and successful investors and provides daily updates on what they've been buying/selling and why.  The site covers SEC filings, hedge fund letters, buyside investment conferences, market commentary, and articles on refining investment process. The author is an analyst at a long/short equity hedge fund, has been investing for over a decade, and earned degrees in both Economics and Communications.

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