Margin Goodies

by Louis Corrigan (TMF Seymor)

Atlanta, GA (November 10, 1998) -- Today I'm going to survey a handful of stocks that appeared on last week's rising margins screen. I'm looking for promising stories that might prove worthy investments after further research.

Last Monday, Resmed <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RESM)") else Response.Write("(Nasdaq: RESM)") end if %>, a manufacturer of respiratory products for diagnosing and managing sleep disorders, reported a 45% increase in EPS to $0.42, five cents ahead of estimates. That came on 38% higher sales, led by 70% growth in the U.S. A shift to higher margin products plus a devaluation of the Australian dollar helped push gross margins to 68% from 61.1%. Investors immediately embraced the news, pumping the stock up $6 1/2 to $57 1/2 for the week.

This recent Daily Double had looked promising but for its rising receivables in the June quarter. While revenue was sequentially flat, accounts receivable declined by 7.8% over the last three months -- a small but encouraging sign. Moreover, results would have looked even better without a $1.1 million negative swing in "other" income. Resmed's 16% net margins allow it to support its price to sales ratio of 6.3, but at a P/E of 37, it's priced at a premium to its estimated 27% long-term growth rate. Still, Resmed looks like a viable research candidate: a highly profitable business delivering terrific growth.

Next on our list is MapInfo <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MAPS)") else Response.Write("(Nasdaq: MAPS)") end if %>, a leading provider of mapping solutions and spatial technologies for use on desktop PCs, servers, and the Internet. September period sales jumped 33% to $17.1 million as a 69% revenue gain in Europe more than made up for a 15% dip in Asia-Pacific sales. EPS doubled to $0.22, beating the lone estimate by two cents despite a slight drop in gross margins to 77.1% as operating expenses remained in check. For FY98, revenue increased 28% to $47.4 million as MapInfo recorded EPS of $0.54, versus a breakeven FY97.

Investors liked the news, pushing the stock up 19% to a new 52-week high of $14 7/8 on Friday. The earnings release includes a balance sheet showing nearly $5 a share in cash and no long-term debt. While the lone earnings estimate of $0.62 for FY99 suggests 15% EPS growth in the year ahead, the stock now carries a P/E of 27.5. Backing out the cash, though, it's trading at 16 times the FY99 estimate, or at an enterprise value to sales ratio of 0.95.

While MapInfo delivered a poor 7.7% return on average shareholder equity during FY98, the strong fourth quarter saw net margins rise to 7.5% and could signal a turnaround. Though insiders haven't been buying, the board repurchased 69,600 shares during the September period at an average cost of $10.76. Maybe the board should have been more aggressive. This one looks like a "maybe" for more research. The major concern is that accounts receivable soared by 64%, double the sales jump.

Next up, J&J Snack Foods <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: JJSF)") else Response.Write("(Nasdaq: JJSF)") end if %>, a New Jersey-based maker of Superpretzel soft pretzels, Arctic Blast frozen carbonated beverages, Luigi's Italian ices, and (since December) those frozen ICEE drinks (think Slurpee) available at a convenience store near you. For Q4, sales rose 24% while EPS increased a cool 47%. Sales rose for the 27th consecutive year, with FY98 revenue up 19% to $262 million and EPS up 45% to $1.26. These great numbers resulted from strong ICEE sales during the big summer season and improved operations at the food service and bakery groups.

Still, one of the two analysts following the stock downgraded it from "buy" to "neutral" two days before these numbers came out. The current consensus calls for earnings to increase just 15% in FY99 to $1.45 (the current P/E is around 16). The profile shows a so-so 9.9% return on equity thanks to a considerable amount of debt to leverage the results. The price to sales of 0.73 would be around 0.89 once you add in debt net of cash to get an enterprise value (EV) of $237 million.

With 4.5% net margins for FY98, that EV/sales ratio suggests a modest bargain. The insider sales show Chair Gerald Shreiber liked the stock at $15 1/2. Given that the peak sales season is over, though, this thinly traded stock could just melt for a while, especially considering that a debt to equity ratio of 0.41 doesn't leave J&J a huge amount of room for more debt-financed growth. Investors can probably find better snack food.

Global Sports <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GSPT)") else Response.Write("(Nasdaq: GSPT)") end if %> designs footwear under the Ryka, Yukon and Apex brand names and distributes off-price athletic footwear. In May it acquired Gen-X Holdings, a firm that sells off-price sporting goods and winter sports equipment, in-line skates, sunglasses, skateboards, and specialty footwear. September period sales soared 85% to $43.6 million while EPS increased 122% to $0.20, which crushed the lone analyst estimate of $0.15 and brought year-to-date EPS to $0.42. Company chair Michael Rubin mentioned strong sell-through and order flow for its branded product, indicating the company expects a "strong 1999." If that proves true, then the stock could be interesting at just $6 a share.

On the other hand, this is another thinly traded small-cap. It's also recently been through a reorganization, which included a 1-for-20 reverse split (never a good sign). Though the earnings release didn't include a balance sheet, as of June 30 the firm sported an ugly debt to equity ratio of 1.74. Though the company also has 4.8% net margins for the first nine months of the year and a price to sales ratio well below 1, I think it's tough for such a highly leveraged company to cut it in these competitive markets.

Which goes to show that some prospects pulled up by the rising margins screen may not pan out. Yet the screen will highlight bigger names moving on news that you might have missed. Tommy Hilfiger <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TOM)") else Response.Write("(NYSE: TOM)") end if %> reported a 56% rise in EPS to $1.10, a dime ahead of estimates, on 39% higher sales. This highly profitable business relies on a fair amount of leverage, reflected by its debt to equity ratio of 0.67.

Even so, growth like that attracted investors' attention, especially since Ralph Lauren's Polo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RL)") else Response.Write("(NYSE: RL)") end if %> hasn't fared well of late. Tommy shares closed the week up 16% from the $46 1/2 closing price prior to the earnings. Yet Tommy trades at just 14.4 times the $3.77 consensus earnings estimate for the fiscal year that ends in March. Analysts put the clothier's long-term growth at 23%. Probably worth a look.

So, we've got two highly profitable businesses that deserve further attention, one maybe, and two that don't look especially exciting. Not bad.

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