Port Notes: BLD@1.37, Buy

Buy this one for some short-term profits.

Baldwin Technology manufactures cleaning, fluid & temperature management hardware for the printing industry. It’s a global company—50% sales in Europe, 25% America, 25% Asia and Australia. It usually earns $6 or 7 million before the recession. In 2009, it lost $12 million. After a restructuring, it turned profitable again for the first nine months in 2010, earning $3 million.

Now the industry it serves is declining, since printing media is being replaced by the online. Still the stock is cheap—at $21 million in market cap, or 6X earnings—and its cost cutting has worked, at least for the short term.

Buy it at current price of $1.37 per share and sell at $1.7 later, for a crispy 30% gain in what could be several months. It may as well go down to $1—if so, hold on to it.

Port Notes: ACY@14.72, Buy

Here’s a good one.

AeroCentury is a leasing company that purchases aircrafts and aircraft engines and leases them to international regional airlines. It’s $125 million portfolio includes Fokker/de Havilland/Saab aircrafts, and some GE engines.

I used Net Income + Depreciation as a proxy for operating cash flow, and it leads to 8-10% return on leasing assets. After levering up with $72 million debt, the rate of return is around 30%.

The company has zero employees—it’s a first—since it outsourced the management to JMC.

It trades at about half book value and it’s profitable.

There’s some complexity in financing schemes.

Before buying, you need to figure out what would happen if there is an interest rate hike.

Port Notes: ADUS@$4.94, Don’t Buy

I’ve come across several “corporate pensioners,” whose sole providers are the government. Some are with the military industrial complex, others produce vaccines for stock-piling.

Here’s another one, taking care of the elderly and infirm on S&L budget and Medicare, putting the tax payers money into good use.

Out of the $259 million in revenue – the hourly rate for community center is around $16 – it profited a meager $5 million. It seems that the company doesn’t manage its SG&A cost very well.

It trades at $50 million market value. If you believe in P/S (price to sales), it’s a good pick.

How well will the company do? Hard to know, largely depending on federal and state budget, which is not at their best for the moment.

Port Notes: ACMR @$2, Don’t Buy

A. C. Moore is an art & crafts specialty retailers operating 135 stores on the east coast. It sells all kinds of materials and tools for scrapbooking, painting, sewing and quilting, needle works, knitting and crocheting mainly to middle aged women. The sales of 2007 was $560 million, or $4 million per store. The company earned $4 million that year.

When the Great Recession hit, sales dipped 5% in 2008, then another 16% in 2009. Consequently, it lost $26 million in both years.

The stock is very cheap right now, at $2, with a market value of $51 million. The balance sheet is quite healthy. With $31 million in cash, $19 million short-term debt, and $41 million in land and buildings, it seems a Ben Graham stock. In other words, the company is worth at least 20% more than the trading value and then some if liquidated immediately.

The problem is, of course, how to turn it profitable again. Lacking necessary information, I would not be able to judge the level of difficulty of doing so.

The gross margin is 40% though, meaning it has an unusually big overhead. Maybe it would help you make some sense of the operational efficiency. Is it a scale issue, or cost management, or any other standard retail problems? I have no idea.

However, if you are a customer who thinks the price in A. C. Moore’s store is reasonable, its product quality superior, store staff are helpful and knowledgeable, and the economy is getting better, you may consider buy some of its shares.

There is margin of safety. You cannot be far off.

Portfolio Note: Buy EUFN @$21, A Trade on the EU Stress Test

This is a note of a trade on the European banks on the ensuing EU bank stress test result, an event-based trade, if you will.

The rationale behind the trade is that uncertainty is the nemesis of the market, and more so in the banking business where the asset values float in line with the macro. A stress test, which puts into light the prospectus of safety and soundness of the financial institutions, would hopefully clear the cloud over the investors and increase the market valuation of the tested along the way by diminishing perceived risks.

The idea came to me earlier this week when the news of the EU stress test was all over the business media. The result set to come to the open Friday, I have since been contemplating buying EUFN (iShares MSCI Europe Financials Index) throughout the week. A delay of action has cost me, when EUFN’s suddenly jumped 5% from $20 to $21 Thursday. Standing behind my expectation on what the stress test could do, however, I decided to put significant weight into EUFN in my portfolio, purchasing at $21.

The U.S. Stress Test and its Market Impact

What inspired me into such a trade is the bank stress test conducted by the Fed in the U.S. last year— in my opinion a highlight stroke out of the arsenal in the all-out war against the financial crisis by the regulators.

In February 2009, still lingering deep in the woods of the crisis, the Fed organized the bank stress test, called Supervisory Capital Assessment Program (SCAP), in an effort to gauge the collective health, and in some cases the viability, of the top 19 big U.S. banks, which consisted aggregately of 60% north of all U.S. bank assets. The test simulated under two what-if scenarios—one normal and the other more adverse, with more dire macroeconomic assumptions—the credit losses and the subsequent capital adequacy of the tested for 2009 and 2010. Those who failed would set out to raise capitals.

As the result showed by the Fed on May 7, 2009, the accumulative credit losses under the more adverse scenario would hit $599.2 billion for the 19 towards the end of 2010, on a basis of risked weighted assets (I don’t know what it means) of $7.8 trillion. After offsets by earnings and government support, $74.6 billion of additional capital needed be raised—$33.9 billion for BofA alone, and another $13.7 billion for Wells.

I was puzzled, however, looking into the market movement in the two-week span on both sides of the May 7 publication of the stress test result.

• During the trading week before, May 1 - May 8: S&P500 +2.42%, IYG (Dow Jones U.S. Financial Services Index Fund) +9.93%, BofA +36.51%, Citi +25.62%, Wells +16.21%;
• The week after, from May 11 – May 15: S&P500 -2.9%, IYG -6.47%, BofA -17.54%, Citi -9.84%, Wells -6.26%.

If you stretch the time zone back from the March-9-2009 low till today, IYG’s +116.91% beat by miles SP500’s 61.66%. BofA was up 264%, and Citi 298%.

If the time frame started from the May 7 result publication, however, S&P500’s +20.28% outperformed huge of IYG’s +10.33%. BofA gained a meager 5.6%, 6% for Citi.

All these wild swings mean different things to different people. What is clear is that my thesis of a short-term trade on the EU stress test breaks down, according to what I observed in the U.S. theatre. There was no observed correlation between the stress test result and the market performance—if anything, the market tumbled upon it.

The Reading of the EU Stress Test

The Committee of European Banking Supervisors (CEBS), mandated by the ECOFIN of the European Council, in cooperation with the European Central Bank (ECB), the European Commission and the EU national supervisory authorities, conducted a bank test similar to the U.S. one in 2009 on 22 cross-border European banks.

The EU bank stress test of 2010 is a second-run, only on a larger-scale, expanding into all banks whose assets should cover at least 50% of total bank assets in every of the 27 EU member states. Such a new rule drew in total 91 banks with total assets of €28 trillion, or 65% of the EU banking system.

The 50% coverage rule also resulted in an even distribution of number of banks from different countries. On the two ends of the extremes, there is only one bank from Poland, but 28 from Spain. Although the names of 20 countries on the list seem familiar (7 are inexplicably missing), skimming through all the 91 names of the banks, I found myself not knowing most of them.

The methodology of the test stayed more or less the same: the estimation of capital adequacy under one base-line scenario, one adverse scenario, with an additional sovereign shock in light of the recent sovereign debt crisis in Europe.

The Friday result showed that 7 banks from the 91—five Spanish, one Germany, and one Greek—failed under the worst case scenario the threshold of 6% tier 1 capital ratio, a standard seemingly lower than the U.S. one. In all, a mere €3.5 billion needs to be replenished. It is a result better than expected, as it should have been. The final estimate, also under the worst case scenario, is €565.9 billion in total credit and trading losses until 2011.

What is more striking than the outcomes is the property price assumption used. Even in the base-line case, property prices run flat in all countries, with those in Spain and Ireland down 5-15%, commercial doing much worse. Under the adverse one, property prices are assumed to be down 10% across the board.

The Trade

I have to say that I made the purchase Thursday on EUFN intuitively, with more an intention for a short-term ride on the momentum.

Now with the stress test result refresh at hand and the time for after thoughts, I believe there is value in the medium term nonetheless. Despite of the complexity of the issue (United States of Europe, macroeconomic forecast, FX, housing, banks, ETF) and information deficiency, I see on the iShare website that EUFN trades at 1X book value, while its U.S. equivalent IYG trades at 1.6X, and EMFN (MSCI Emerging Markets Financials Sector Index Fund) at 2.5X. I may be comparing apples to oranges here—think aggregated asset books kept on quite different accounting standards and you lose all sense of accuracy—but the valuation gap is stark and in my personal opinion more than reasonable, despite the sovereign debt crisis, deteriorating real estate market and decelerating growth in Europe.

At any rate, the game is on.