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Glenn Rogers is a longtime contributor for BuildingWealth.ca (http://www.buildingwealth.ca). His background is in Media and Publishing and has held a number of senior positions in major magazine and newspaper organizations. He has also successfully partnered with private equity firms to... More
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  • There Are Ways To Profit From Cyber Security

    Unless you have been living in a cave these past couple of years you will doubtless be aware that the subject of cyber security has become a hot topic both domestically and internationally. The recent attack by North Korea on Sony was just the latest and most headline-grabbing example.

    The Sony attack was exacerbated by the fact that this may be the first time that a national government has singled out and attacked an individual corporation. This raises the bar in terms of what we could be facing down the road. Prior to the Sony incursion, both Target and Home Depot were hacked causing considerable damage to the reputation of both corporations and it's hard to imagine more will not follow. However, as far as we know, a foreign government did not orchestrate those attacks.

    Doubtless there have been numerous country-to-country attacks, some of them widely reported. U.S. officials have pointed to China in particular, claiming it mounted repeated attacks against U.S. facilities. But the United States has been active as well. It was widely reported that the U.S. managed to attack and damage Iran's nuclear facilities by placing viruses in their centrifuge servers, causing the entire facility to grind to a halt.

    Last week President Obama and British Prime Minister David Cameron agreed to a series of cyber war games to test our readiness to repel enhanced attacks from other countries. The Joint Chiefs of Staff has identified cyber security as one of America's major vulnerabilities as a nation and I'm sure that Canadian officials are deeply concerned as well.

    In the light of all this, there's no doubt that in corporate boardrooms worldwide and throughout defense sectors around the globe experts are doing complete reviews of the vulnerabilities and capabilities against this very real threat. You can easily imagine that the phones are ringing off the hook at the consulting firms and software companies that provide security services to both corporations and governments. For this reason we decided this month to look at the ways you can play what is likely to be a multi-year rush to secure our computer and Internet systems worldwide.

    Back in the early years of the Internet, companies like McAfee (since acquired by Intel) would sell inexpensive software to protect our laptops and home computers. Windows computers were considered the most vulnerable and Macintosh users seldom bothered with security software at all. As Wi-Fi use proliferated, identity theft and password hacking to get financial information seemed to be everywhere. As a result, a number of companies have produced enterprise-level security systems that have come to be relied upon by corporations and governments everywhere.

    Recently, the ever-vigilant ETF community launched a product to give investors exposure to this area. It's called the PureFunds ISE Cyber Security ETF and the symbol is, appropriately enough, HACK. This fund is run by a small provider called PureFunds (pureetfs.com/index.html). The company only has two funds, the second one being an ETF that invests in junior silver miners.

    HACK has only been trading for a couple of months so there is no real track record to work with and of course the market has been extremely volatile so it's difficult to assess how this fund will do. However, it is up roughly 6% since it was launched. It is helpful, though, to run through their top 10 holdings as of the middle of January. Most of the names are the ones you should research to increase exposure to this important sector. I intend to look at two of them but investors can simply buy the ETF or cherry pick one or two of the issues on their list and add them to your portfolio.

    Palo Alto Networks

    First, I want to look at Palo Alto Networks Inc. (NYSE: PANW), which is trading near its all-time high of $129.42 (figures in U.S. dollars). This is a very stable stock and the chart looks beautiful. Nearly every analyst that covers it has a buy rating on the stock.

    Palo Alto provides sophisticated firewall systems through their security platform and they are the fastest-growing cyber security company that I'm aware of. They have over 21,000 customers in 120 countries around the world and 75 of the Fortune top 100 companies use Palo Alto as their cyber security provider.

    Revenue is growing quickly. For example, for the first quarter of fiscal 2015 (to Oct. 31), the company grew revenue by 50% to a record $192.3 million and they should be able to continue that high growth rate for some time to come. In fact, the company has projected second-quarter 2015 revenue will come in between $200 million and $204 million, which would be a year-over-year growth rate of 42%-45%.

    However, and here is where I want to inject a note of caution, Palo Alto is not profitable. It reported a first-quarter loss of $30.1 million ($0.38 a share, fully diluted, based on GAAP standards). That was worse than the previous year's loss of $7.9 million ($0.11 per share). The company says it is profitable on a non-GAAP basis, which defines non-GAAP net income as net income (loss) plus share-based compensation expense and related payroll taxes, acquisition related costs, amortization expense of acquired intangible assets, litigation related charges including legal settlements, and non-cash interest expense related to the company's convertible senior notes.

    "Palo Alto Networks believes that excluding these items from non-GAAP net income and non-GAAP diluted net income per share provides management and investors with greater visibility into the underlying performance of the company's core business operating results, meaning its operating performance excluding these items and, from time to time, other discrete charges that are infrequent in nature, over multiple periods," a note to the financial statements said.

    On a non-GAAP basis, Palo Alto management projects a profit of between $0.16 and $0.17 a share in the current quarter.

    The company has over 1,900 employees around the world and they have added over 1,000 customers every quarter for the last 12 consecutive quarters. The company has also been making acquisitions, recently acquiring Cyvera, a privately held cyber security company located in Israel.

    I believe this should be a core holding for any forward-looking portfolio, however the stock is not cheap. According to Capital IQ, the forward p/e ratio for fiscal 2016 is a bloated 85.62. Cautious investors may want to watch for a price pullback although based on recent performance and the growing demand for these services, that seems unlikely.

    Action now: Buy with a target of $150. The shares closed Friday at $126.81.

    FireEye Inc.

    The second company I want to draw your attention to is FireEye Inc. (NDQ: FEYE) which is far more volatile than Palo Alto. It went public last year and since then the stock has been pummeled and is currently trading 66% below its high of $97.35.

    So why look at it? It's been trading sideways for some time and continues to have issues with lawsuits brought by disgruntled investors who watched their market position get destroyed. But I have a feeling that once things settle down the stock could easily double based on the company's strong revenue growth. But be warned, this is not a stock for the faint of heart.

    FireEye provides real-time threat assessment for its customers based on a virtual machine platform that they invented. The system is well-regarded and from their website we are told that they protect five out of the six major telecom companies, five of the top ten financial institutions, seven of the top energy companies, seven of the top ten high-tech companies, and five of the top ten aerospace defense contractors. It was FireEye that Sony called to help them figure out who it was that attacked them and how they could shore up their defenses.

    If you go to the FireEye website at fireeye.com/ you will see an alarming cyber threat map that as I write this column is reporting over 24,000 attacks on this day alone.

    Financially, the company is growing quickly on the top line but still losing money. Third-quarter revenue (to Sept. 30) came in at $114.2 million, up 168% year-over-year. However, the GAAP net loss was $120 million ($0.83 per share) while the non-GAAP loss was $73.9 million ($0.51 per share).

    For the fourth quarter of 2014 (results to be released next month) the company projected billings in the range of $195 million to $210 million with losses of between $0.46 and $0.50 a share.

    Cautious investors may want to wait and see the fourth-quarter results before establishing a position. More aggressive investors may want to take a small stake now and add more later, depending on how the quarterly report goes.

    Action now: Buy with a target of $40. The shares closed Friday at $34.93.

    Interestingly, one of the things that Sony did while they were going through the attack was to shut down all their iPhones and reactivate some old BlackBerries that they found in the basement. So an outside beneficiary of all the cyber security concerns, ironically, might be BlackBerry, which has been trying to remake itself into a security software provider. Their handhelds still provide the best email security in the market.

    Feb 17 12:26 PM | Link | Comment!
  • American Water Works Is A Safe Play In A Frothy Market

    "Water, water everywhere and nor any drop to drink." - Samuel Taylor Coleridge, The Rime of the Ancient Mariner

    Truer words were never spoken, particularly here in California where we are in the middle of a five-year drought, which is threatening agriculture and recreational activities throughout the state and has led to some of the worst wildfires we've ever seen. If this continues there will be profound effects on virtually every aspect of our lives here and elsewhere in the Southwest. This got me thinking about what companies will benefit and could play a part in helping to solve what is a global problem and a significant threat to our national well being.

    The idea of water being the new oil is not new. Water related investments, broadly speaking, have mostly just tracked the S&P 500 for the past few years but going forward this looks like a mega trend that's not going away.

    The U.S. water utility business is a $130 billion industry that is growing at 4% per year. The capital demands are high so there are relatively few players that can afford to be in this sector on a large-scale basis. There has been massive consolidation in the industry over the last number of years, further reducing the number of companies who can serve this important segment.

    We have recommended Flowserve in the past (NYSE: FLS) and did very well with it. I still like it although it seems fully priced for now. Another way to get exposure to this sector is by using the PowerShares Water Resources Portfolio ETF (NYSE: PHO) that contains Flowserve and American Water Works (NYSE: AWK), which I am recommending in this column.

    AWK is also a significant component of the Canadian-based iShares Global Water Index ETF (TSX: CWW), which was recommended by my colleague Gavin Graham in our companion Income Investor newsletter in July 2013 at $19.65. It was trading at $24.71 at the time of writing.

    So let's take a closer look at AWK. The company was founded in 1886, is based in New Jersey and has 6,600 employees. It is essentially a U.S.-based utility, which serves 14 million people in 40 American states and parts of Canada. In 16 states, the company is a regulated business similar to an electric or gas utility. This status subjects the company to oversight that includes how much it can charge for water and wastewater services. The regulated part of the business is asset based and offers water and wastewater services to approximately 1,500 communities in 16 states. It operates approximately 80 surface water treatment plants, 500 groundwater treatment plants, 1,000 groundwater wells, 100 wastewater treatment facilities, 1,200 treated water storage facilities, 1,300 pumping stations, 87 dams, and 47,000 miles of mains and collection pipes.

    However, the company also has a significant market-based business that can charge whatever the traffic will bear. The non-regulated part of the business is essentially service based, with the company operating and providing maintenance, financing, and waste disposal services to municipalities, armed services, and private homeowners.

    In total, American Water Works serves approximately 14 million people with drinking water, wastewater, and other water-related services

    Recently the company announced first-quarter earnings that grew by 25% with net operating cash flow increasing by 63.65%, driven by revenue increases of 7.2%. This resulted in an increase in earnings to $68.1 million ($0.38 per share, fully diluted, figures in U.S. dollars). That compared to $57.6 million ($0.32 per share) for an increase of about 19% over the prior year on a per share basis. The company also recently announced an 11% increase in its dividend to $0.31 per quarter ($1.24 annually) and is now yielding 2.57% based on its Friday closing price of $48.16. It marked the seventh straight year since 2008 that the company has increased its payout.

    I like the fact that this a relatively unexciting company with solid earnings, a decent dividend, and a customer base of Canadians and Americans, which reduces the risk of global craziness such as we are seeing now in Ukraine, Iraq, etc. When rates begin to rise we will have to have another look but for now AWK offers growth and stability.

    If you want more reassurance, take a look at the stock's five-year chart. No scary peaks and valleys here - just a nice steady upward climb.

    Action now: Buy with a target of $55. The shares closed on Friday at $48.16.

    Disclosure: The author is long AWK.

    Jun 30 6:40 PM | Link | Comment!
  • Recent Updates
    Covidien Ltd. (NYSE: COV)

    Originally recommended on April 19/10 (#20115) at $51.09. Closed Friday at $90.11. (All figures in U.S. dollars.)

    In a surprise move that is having repercussions all the way to the U.S. Congress, Minneapolis-based Medtronic Inc. has made a $42.9 billion bid to buy Dublin-based Covidien in a cash and stock transaction that values COV at $93.22 per share. That's a premium of 29.4% to Covidien's closing price on June 13, the day before the announcement.

    Both companies are in the medical technology business and once the transaction is complete - if it isn't blocked - Medtronic will have a comprehensive product portfolio, a diversified growth profile, and broad geographic reach, with 87,000 employees in more than 150 countries.

    In a joint statement, the companies said the deal is expected to result in at least $850 million of annual pre-tax cost synergies by the end of fiscal 2018. "These synergies include the benefits of optimizing global back-office, manufacturing and supply-chain infrastructure, as well as the elimination of redundant public company costs," the statement said.

    But here's the kicker. In what is known as an inversion arrangement, Medtronic plans to move its head office to Ireland, where it will operate under the name Medtronic plc. The reason: tax avoidance. By taking over Covidien and shifting its executive offices to Ireland, Medtronic will be able to take advantage of low Irish tax rates. That prompted U.S. Deputy Treasury Secretary Sarah Bloom Raskin to comment that the deal should put pressure on Congress and the administration to overhaul tax laws.

    This is a signal that some kind of business tax reform should be taken quite seriously," Reuters quoted her as telling a business forum. "Something is probably wrong with our tax system."

    There have been several inversion transactions recently, prompted in part by U.S. laws that heavily tax offshore profits once they are repatriated to the country. With billions of dollars at stake, major international corporations have been exploiting tax loopholes, enraging some lawmakers in the process.

    There are two schools of thought on how to proceed. One is to introduce lower tax rates for foreign earnings brought back to the U.S., thereby encouraging companies to bring home their overseas earnings. The other is to take a tough line and ban deals such as this one.

    Given the controversy, there is no guarantee this plan will go forward. It is subject to regulatory approval not only in the U.S. but also in the European Union, China, and some other countries.

    My advice at this point is not to wait around until the smoke clears. Let's take the money and run.

    Action now: Sell. Including dividends of $3.58, we have a total return of 83.4%.

    Realogy Holdings Corp. (NYSE: RLGY)

    Originally recommended on March 18/13 (#21311) at $47.70. Closed Friday at $35.20. (All figures in U.S. dollars.)

    I recommended this stock in March 2013 when it was trading at $47.70. Initially it did well but in the last few months it has been hammered.

    As a reminder, Realogy Holdings is brokerage firm for domestic and foreign real estate, principally residential. The company was involved in nearly 30% of all the real estate transactions in America last year and showed signs of recovery when the real estate business was finally picking up after being in the doldrums for several years. It differs from other businesses in the sector in that it simply makes a fee per transaction and doesn't have to worry about inventory or risk tying up capital by actually constructing homes like the homebuilders who hire the firm.

    Individual agents taking a larger share of the commissions than was historically the case have challenged the model in recent years but it's still a compelling business when times are good.

    First-quarter results were so-so with revenue up 5% year-over-year but profits were negatively impacted by a reduction in mortgage refinancing. However, Realogy did reduce its corporate debt by nearly $400 million and refinanced its own notes to take advantage of lower interest rates.

    Compared to where we were three or four years ago, times are good indeed even given the terrible winter weather we had and factoring in that the market got ahead of itself last year. Overall, we still are in a relatively good real estate market, one that is likely to get better over the next couple years.

    I think this recent pullback is a buying opportunity and I will be establishing a new position this week.

    Action now: Buy with a target of $45.

    Nutrisystem Inc. (NDQ: NTRI)

    Originally recommended on Aug. 26/13 (#21331) at $12.80. Closed Friday at $17.05. (All figures in U.S. dollars.)

    I recommended this stock last August when it was trading at $12.80 and we've done really well with it. The shares closed this Friday at $17.05 for a gain of 33% and that's down 17% from its high of $20.54, which we touched last November.

    Even with all the new smart phone apps and wearable technologies counting steps and calories, Nutrisystem still helps its clients lose weight and that remains a national problem that is not going away anytime soon.

    There is a large short interest in the stock, which could propel a covering rally. Earnings for the first quarter of 2014 were strong with revenue increasing 16% year-over-year and gross profits up by 13%. The company has no outstanding debt. The company also raised its revenue guidance for the full year.

    The stock pays a quarterly dividend of $0.175 per share ($0.70 a year) to yield 4.1% at the current price. The bad news is that the dividend has not been increased since 2008.

    I still like this one.

    Action now: Hold.

    Broadcom Corp. (NDQ: BRCM)

    Originally recommended on Aug. 23/08 (#2820) at $27.42. Closed Friday at $38.28. (All figures in U.S. dollars.)

    It has been more than two years since I last updated Broadcom, at which time it was trading at $34.77, up more than $7 from the original recommended price of $27.42. Since then the stock mostly traded sideways until very recently when it spiked up 25% in the past month giving us a profit of almost 40%, not including dividends.

    Recently, the company announced it was selling its cellular baseband business and some analysts have downgraded the stock because of that. Recent financial results have been decent but uninspiring with revenue growing at only 3.9% over the previous quarter but flat compared to the first quarter of last year. Net income was also flat.

    I don't expect to see much more progress on this one so let's take profits on the recent jump and move on. Including dividends of $1.76 per share, we have a total return of 46%.

    Action now: Sell.

    - end Glenn Rogers

    Jun 30 6:38 PM | Link | Comment!
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