This article covers our analysis of the top movers amid Tuesday’s market action. Of the 4,600 stocks that were tracked, 17 top movers that closed above $1 at market-close on August 16th and gained or lost at least 10% were analyzed to determine if they would continue going up or down, or if they would reverse their moves going forward. The following are some ideas based on that analysis (You can access the rest of our daily, weekly and quarterly mover series from our author page):
Sell Vanceinfo Tech ADS (VIT): VIT is a leading Chinese provider of outsourced software research and development, maintenance, testing, BPO and IT services to corporations headquartered in the U.S., Europe, Japan and greater China. Its shares plunged 26.9% on Tuesday after the company reported its June quarter results in which earnings missed estimates (21c versus 23c) and it guided down earnings for the September quarter (19c-21c versus 25c) and for the FY 2011 (84c-90c versus 96c), while reporting and guiding revenues in-line.
Gross margin compression resulting from wage inflation in China and its effect on profits and forward P/E multiples is the culprit here. In fact, gross margins declined sequentially to 36.4% from 37.4% in the preceding March quarter and it fell sharply from 39.7% reported in the prior year June quarter. Furthermore, SG&A for the latest six month period rose year-over-year from 24.4% to 26.8%, partly due to higher share-based compensation costs. As a result, while revenue has continued growing at a very healthy 30%-35%, earnings have flat-lined between 20c & 22c for the last five quarters in a row. The fall yesterday is justified as gross margin compression and wage inflation concerns, coupled with near-term uncertainty of outlook should lead to a compression in forward P/E ratios.
Currently, even after Tuesday’s fall, the company still sells at a premium forward 15-17 P/E based on the company’s guidance for 2011. Among its peers in China, ISoftstone Holdings Ltd. Ads (ISS) sells at a forward 19 P/E while earnings are projected to grow almost 50% in 2011 and Camelot Info Systems Ads (CIS) sells at forward 10 P/E while earnings are still growing at better than 50%. We believe that shares are likely to remain under pressure until the company can translate the wage inflation into price increases to its customers instead of letting it affect its gross and operating margins. At present, it isn’t clear whether and to what extent the company has the ability to do that and also to what extent this is a company-specific or an industry-wide phenomenon.
Sell Marshall Edwards Inc. (MSHL) and Novogen Ltd. Adr (NVGN): MSHL is an Australian developer of drugs that targets components in cancer-cell survival and proliferation to treat various cancers. It is majority owned by NVGN, an Australian developer of pharmaceuticals targeting degenerative diseases and disorders via dietary supplements based on plant compounds known as isoflavones. MSHL shares surged 38.4% , and its parent NVGN shares surged 25.5%, after MSHL announced that the FDA had accepted the Investigational New Drug application for its experimental cancer molecule ME-143, and that it would initiate phase 1 trials next month.
ME-143 is a small molecule that inhibits the enzyme complex nicotinamide adenine dinucleotide phosphate (NADH) oxidase inhibitor that is found in the membranes of tumor cells. It has shown promise in several types of tumor lines in pre-clinical trials, including breast, colorectal and ovarian cancers, and it has also shown an ability to enhance the cytotoxic effects of chemotherapy. MSHL shares popped earlier last month when the company announced the publication of a pre-clinical study of NV-128 in chemotherapy-resistant ovarian cancer stem cells, that illustrated that NV-128 can specifically target certain ovarian cancer stem cells that are resistant to chemotherapy and induce cell death in a pre-clinical setting, thereby providing sufficient proof of concept to warrant further study beyond the pre-clinical setting and on ovarian cancer patients.
With the stock having closed at $2.75 the prior day, we issued a call to sell MSHL and NVGN on July 28th based on our conviction that the surge was a one-day pop and over-reaction to an early stage development; the price subsequently over the next two weeks fell over 60% below $1. We believe that this surge on Tuesday is also an over-reaction to an early stage development, as explained in detail in our prior article. We would be sellers here and into any rally above the $2.20s.
Buy E-commerce China Dangdang Ads (DANG): DANG is a Chinese online retailer offering books and other media, personal care and general merchandise via Dangdang.com. Often called as the Amazon of China, DANG is the #2 e-Commerce player in China, behind TaoBao. Its business model is similar to AMZN except that it employs a courier-based delivery system that collects cash on delivery. Its shares fell 14.0% on Tuesday after the company reported that in the June quarter, it missed earnings estimates (6c losses versus 1c earnings), but beat current quarter revenue estimates ($122.3 million and $120.6 million) and guided September revenue higher (RMB 916-928 million versus RMB 895 million).
DANG missed estimates on account of a steep reduction in gross margins to 14.3% from 19.8% in the year-ago quarter, which at least in part can be explained by a change in its revenue mix to higher-ticket price general merchandise items as actual gross margin amounts in RMB did go up 10.1% year-over-year. Furthermore, operating expenses fell to 20.9% from 23.2% year-over-year, but actual operating losses surged to RMB 52 million from RMB 17 million year-over-year. This means that the gross margin contraction was just too severe to support the business infrastructure needed for the company to sell its general merchandise, and they will have to either raise prices or lower supply and operating costs to improve operating performance.
We believe that this is part of a growing pains challenge as the company ventures into the general merchandise category and strengthens its fulfillment capabilities. Overall, we continue to believe (as detailed in our prior article) that DANG is a good buy here based on a comparison of its revenues, growth and market-cap to Amazon (AMZN) in the late 90s when it was at a similar stage in which DANG finds itself now.
Credit: Historical fundamentals including operating metrics and stock ownership information were derived using SEC filings data, I-Metrix® by Edgar Online®, Zacks Investment Research, Thomson Reuters and Briefing.com. The information and data is believed to be accurate, but no guarantees or representations are made.
Disclaimer: Material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion. Further, these are our ‘opinions’ and we may be wrong. We may have positions in securities mentioned in this article. You should take this into consideration before acting on any advice given in this article. If this makes you uncomfortable, then do not listen to our thoughts and opinions. The contents of this article do not take into consideration your individual investment objectives so consult with your own financial adviser before making an investment decision. Investing includes certain risks including loss of principal.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.