A few weeks ago, ZachStocks covered FCStone (FCSX) in the wake of a fear-based selloff. Disruptions in the financial markets caused the stock to lose up to half of its value at one point, and yet at first blush, it appeared that the company was relatively insulated from the issues that were plaguing stocks like Bear Stearns (NYSE:BSC) and MF Global (MF).
This week investors got a chance to pull back the curtain and look a bit deeper into the operations of the company in the form of the second quarter earnings report (the company operates on a fiscal year ending in August). As a whole, the information disclosed was comforting to those holding the stock and was good for a 20% increase as the stock makes up its lost ground.
The raw numbers were very impressive. Revenues were $91.2 million up 52% from last year. Earnings (ex items) were $0.61 per share which nearly doubles the 32 cents earned in the same quarter last year. The company actually took a one time write down but it was not related to the same financial and liquidity issues expected.
In fact, management decided to shutter a biodiesel plant it had been working on bringing online. After considerable investment, it became clear that the plant could not be used in a profitable manner and so management took the difficult but wise step of cutting off further investment in this venture and instead will look at the possibility of selling the property to another party. While the failure is a bit of a disappointment, this was not a core part of the company’s business and we applaud the discipline in cutting losses and moving on.
The positive results were driven by higher activity in trading and consultancy services as volatility in the commodities markets continues to drive demand for risk management. FCStone has very little exposure to the actual direction of prices, but benefits from increases in trading volumes through its commission generating trading arm.
In addition to commissions on exchange and over the counter [OTC] trades, the company also makes consulting fees by working with clients to establish a comprehensive solution to their risk management needs. Management stated that it has witnessed no change to its operational business model over the last 90 days, so while it is continually monitoring its own risk associated with standard business, the overall environment is strong.
Despite having the majority of revenue come from the United States, FCStone is quickly establishing a more international presence. On the production side, the company is especially active in Brazil, where it covers a significant number of grain producers. While the region is known for its grain production, FCStone is also making strides in the sugar, ethanol, coffee and foreign exchange markets.
On the other side of the spectrum, China is one of the largest and growing consumers of commodities, and FCStone is active in this country as well. Management noted that it operates in China, helping to hedge risks in grain, metals, energy, cotton and foreign exchange markets. The continual growth of the Chinese population and the opening of markets for more active trade should continue to drive demand for goods. In fact, China trade figures released this week point to increasing trade statistics, which should provide a fertile ground for new FCSX business.
The company’s growth strategy makes use of both organic growth as well as acquisitions. Over the past year, FCStone has acquired Downes O’Neil, The Jernigan Group, and Globecott. Each company operates in a different niche of the risk management universe and gives FCStone better expertise in that particular field.
In addition, the expanded customer base allows FCStone to cross sell additional services that the customers may not have had access to in their previous relationship. Management was clear that it will continue to pursue additional acquisitions when it finds target companies that are immediately accretive. This gives the company an opportunity to branch out into new avenues of serving customers.
One such avenue is a new carbon initiative which is under development. The idea is that an exchange will be launched which allows companies to trade carbon or emission credits on a standardized market. The initiative should create more awareness and incentive for all companies to operate in a responsible manner with regard to pollution as the market increases incentives for all parties to reduce emissions in order to capture the economic value of such strategic decisions.
In addition, FCStone should benefit through its ability to consult with clients as to the best strategic moves to take along with commissions for facilitating trades within this new market.
Finally, interest rates have had an effect on the net interest income the company earns. At this point the total number in terms of earnings has grown, but that is more a function of higher customer balances than the overall interest rate environment. The trend at this time is for clients to hold higher balances with the company as margin requirements are increased due to the volatility in the markets.
At the same time, lower interest spreads mean that each dollar held for customers is less profitable than the same dollar would have been a year ago. In order to keep interest income steady, the company will have to attract a growing level of balances from customers, which it appears to be doing successfully.
In closing, the market is beginning to understand the risks associated with FCStone are not as fierce as originally believed. The stock is trading well after its sharp drop and I expect that as investors become more comfortable with the earnings visibility, the stock will be pushed higher.
Analyst expectations appear to be very conservative at this time as the company has actually already earned more than 2/3 of consensus expectations for the fiscal year with two quarters to go. As analysts ratchet their forecasts higher, it would not surprise me to see the stock move up in similar fashion.
Disclosure: Author has a long position in FCSX.