As the GeoTeam® continues to adapt its research methodologies to the ever-changing market landscape our ultimate goal is to discover equities that can prosper through this unprecedented period.
Although it seems like every company succumbs to the ebb and flow of the short term market performance, we have come across several companies that may be able to buck the trend.
Navigating Through the Turbulence
Gulfstream International Group Inc. (GIA)
Due to the airline industry’s competitive nature and exposure to unpredictable energy prices, it is not one in which the GeoTeam® typically prefers to invest. However, Gulfstream has still piqued our interest as its stock has ‘flown under the radar’ so to speak.
The recent decline in energy prices has obviously relieved the entire transportation industry of some of the burdens associated with the cost of operations. When oil was $20 per barrel, fuel comprised between 10 to 20 percent of airlines’ operating costs. At $100 per barrel, that number was between 30 to 40 percent, exceeding the amount spent on labor. (Flying on Empty, by Zubin Jelveh.)
While Gulfstream should enjoy a short-term boost in profit margins, it still has developed clever ways to adjust to fluctuating energy costs. We believe this can potentially engender a confidence that investors need to substantiate investing in an industry that is typically susceptible to erratic market environments.
- During the high price environment, Gulfstream restructured its route network and eliminated city pairs that were no longer profitable.
- As some of the larger competitors have opted to leave some of Gulfstream’s market, it has been monopolizing on this by further expanding into strategic market niches:
Our most significant market opportunity relates to the fact that we currently operate in and have targeted future expansion in unserved and underserved short haul markets, which is a growing opportunity for two principal reasons. Many smaller markets are being abandoned by major carriers, as they shift their focus increasingly to international markets and reduce capacity in domestic markets and hubs in response to higher fuel costs and a weakening economy. In addition, many smaller markets are also being abandoned by regional airlines, as they continue to gravitate toward larger jet aircraft in the 70-100 seat range, and away from smaller regional jets and turboprop aircraft." (Pg. 12, 3rd Qtr 2008 10Q.)
- The revision of its business plan was in response to the weakening economy. The third quarter of 2008 was a key transitional period for the company during which important decisions were made to affect overall cost reductions:
The quarter was primarily characterized by an immediate and substantial reduction in capacity and a corresponding decrease in operating costs. The rate of overall cost reductions during the quarter was not as immediate as our capacity and related revenue reductions, because of the complexities and delays associated with implementing extensive schedule changes and related staff reductions and retraining.” (Pg. 13, 3rd Qtr 2008 10Q.)
Other recent activities have helped to put Gulfstream on our radar. It has resolved outstanding liquidity issues through the sale of certain assets, the issuance of debentures and the restructuring of $6 million in creditor obligations.
Potential Valuation Scenarios (Under Review)
The GeoTeam® still needs to monitor the GIA story to see if the recent developments are bearing fruit. After all, the company has been losing money for several quarters. The fourth quarter 2008 ended December and first quarter 2009 ending March should shed some light into the GIA story and potential various valuation scenarios.
Wiping Away Wall Street’s Tears
Orchids Paper Products Co. (TIS)
The following statement generally provides the GeoTeam with more than enough impetus to begin the due diligence process regarding the analysis of a company:
Changes in the national economy, in general, do not materially affect the market for our products.
The GeoTeam® likes Orchids Paper for its aggressive efforts to expand its operations and become more productive. Orchids Paper manufactures bulk paper products for the private label industry and to a lesser extent markets its own brand name products.
The company might be able to benefit from a soft economy as consumers opt to buy cheaper private label brand names. Orchids Paper sells its products to a wide variety of customers ranging from dollar stores to recession resistant discount retailers such as Wal-Mart (WMT), all of whom exhibit consistent ordering patterns due to the nature of the consumer’s demand for paper towels, bathroom tissue and paper napkins.
Orchids Paper is also benefitting from reduced operational costs with the decline in natural gas prices. Natural gas is largely used to drive its current plant operations and is being used to power their new paper machine added in 2006 to boost production.
Understanding Orchids Paper Products
The Company has two main product lines:
- The production of Bulk Tissue (parent rolls): These products are sold to customers who then convert the rolls into finished products such as tissue paper.
- The conversion of Bulk Tissue into finished products (paper towels, bathroom tissue and paper napkins).
Margins should improve going forward because:
- The company is focusing on selling all of its parent roll capacity as converted products, which have higher margins than parent rolls. Currently, Orchids Paper's sales are comprised of over 85% converted paper products and less than 15% as parent rolls.
- The company recently improved its conversion process by identifying and addressing the root issues that impair production. As a result of these efforts, conversion productivity from the beginning of September through mid-October improved approximately 20% compared with the run rate experienced in the first eight months of 2008.
- The company can manufacture 100% of its paper roll needs due to the purchase of a new paper machine in 2006. Previously, the company had to purchase some of its paper roll inventory from the open market.
The GeoTeam® is constantly searching for confidence in company press releases. Orchid Paper’s recent third quarter report had plenty of it. Mr. Robert Snyder, President & CEO, stated:
We are very encouraged with the results of the third quarter, which included record sales and earnings. We achieved the record earnings despite a $274,000 consulting expense and unusually high maintenance and repair costs. Our program on continuous improvement in the converting operation is beginning to yield results as production levels in September and October have exceeded the prior eight month's trend by 20%. By the end of the quarter, we were able to implement our previously discussed product content and pricing changes. The tissue market remains strong with several opportunities available to sell our additional converting production. We believe we are well positioned to take advantage of these opportunities... The current economic and credit crisis has had profound effects on many industries, however our current order backlog remains strong and we expect that situation to continue. While world-wide virgin pulp prices have seen significant decreases in recent months, the grades of waste paper we use to produce paper have not experienced price decreases to date.
Orchids Paper Products is fully taxed and has shown impressive EPS growth rates in 2007 and 2008. It has had only two down quarters in the past eight quarters. Analyst estimates show 2009 EPS growing 84% to $1.40, assuming the company meets 2008 estimates.
Potential Valuation Scenarios
Data Inputs: (As of February 12, 2009)
2009 EPS analyst estimates.
Future EPS growth based on 2009 analyst estimates
Trailing P/E Ratio
Short Term Scenarios
Price based on P/E of 25 on four quarters trailing EPS
Price based on P/E of 20 on four quarters trailing EPS
Price based on P/E of 15 on 2009 analyst EPS estimates
Long Term (12 Months Forward) Scenario
Price based on P/E of 25 on 2009 analyst EPS estimates
Price based on P/E of 20 on 2009 analyst EPS estimates
Peg Ratio Analysis (Aggressive): Common rule of thumb that the P/E should equal the future EPS growth rate:
PEG Ratio less than 1?
Price based on Current Price/PEG
Disclosure: The GeoTeam is long GIA and TIS and does not have any partnership or financial obligations to either.
These scenarios are not intended to be investment advice, but are scenarios based on some commonly used investment guidelines. They are provided to aid investors in making their own investment decisions.