More Margin Treats

Louis Corrigan (TMF Seymor)

Atlanta, GA (November 3, 1998) -- Last week I modeled the way I typically use the margins screen to find good businesses worth further research. Using the weekly Rising Margins screen compiled by the fearless TMF Rockie, you can troll for potentially hot stocks every week.

While there's often a certain advantage to spotting these companies as soon as possible after they release their results, the weekly screen usually catches them in plenty of time even if you're looking to research and buy a stock in short order. Last week I profiled Department 56 <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DFS)") else Response.Write("(NYSE: DFS)") end if %>. It reported earnings after the close on Wednesday October 21. When I spotted the stock on the margins screen after the close on Friday, it was at $28 1/4. It's risen 12% from there in just seven trading days.

Of course, there's no need to rush into any investment. I often use the margins data from 2 to 3 months back to scan for companies whose earnings reports may be especially worth looking at this quarter. I tend to focus on the companies with stocks that have fallen the most in the interim, on the theory that these companies probably have a decent story but have been unfairly maligned. If the upcoming earnings report shows business is still strong, they may be real bargains.

This week I'm going to look at a few more stocks that appeared on the screen for the week ending October 23.

APAC Teleservices <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: APAC)") else Response.Write("(Nasdaq: APAC)") end if %> reported a 75% jump in EPS on 49% higher sales. As I noted in a Daily Trouble in July, APAC has been a disaster despite being one of the largest operators of customer service call centers. "Could APAC eventually deliver strong profits from its move toward value-added inbound services and long-sought improvements in capacity utilization?" I asked. "Possibly. But at this point, APAC has no credibility and the stock price reflects that," I answered.

The latest results reveal early signs of a potential turnaround. Earnings appear to have met the otherwise stale estimates. Revenue from inbound calls increased by 58% in the quarter versus a 41% gain for the lower-margin (classic/annoying telemarketing) outbound calls. Inbound revenues have now comfortably surpassed outbound. While a snapshot of the company's operating and financial health still looks relatively ugly, further signs of change came after the market closed last Wednesday, when APAC announced that Mark Remissong, former CFO of U.S Robotics before it was acquired by 3Com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COMS)") else Response.Write("(Nasdaq: COMS)") end if %>, has been appointed as the new CFO. This combination of events seems to have attracted buyers. The stock closed Monday at $7 3/8, up 37% since reporting earnings after the close two weeks ago.

Next up is Chili's restaurant operator and franchisor Brinker International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EAT)") else Response.Write("(NYSE: EAT)") end if %>, which reported EPS up 24% (beating estimates by two cents, or 7%) on a 15% increase in sales. I recently discovered the local Eatzi's, Brinker's new upscale market and bakery concept, which strikes me as a great one with vast room for expansion. The insider trading report isn't the strongest, but there have been at least a couple of buys in the $19 area. The profile shows a decent business, but nothing to get too excited about at the current price of $25.

But guess what? The stock was trading for just $20 1/4 after reporting earnings before the market opened on October 21. So it's up 23% in less than two weeks, thanks partly to an upgrade to "outperform" on October 22 from Morgan Stanley, which set a 6-12 month price target of $24. The stock traded at $22 11/16 by the time it appeared on our weekly margins list.

Supply chain management software company i2 Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ITWO)") else Response.Write("(Nasdaq: ITWO)") end if %> was another stock that immediately caught my eye. Given the massacre in the entire enterprise resource planning (ERP) software sector (detailed in a recent Fool Evening News column) and the specific pain felt by i2 and other supply chain management firms like Manugistics <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MANU)") else Response.Write("(Nasdaq: MANU)") end if %> and JDA Software <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: JDAS)") else Response.Write("(Nasdaq: JDAS)") end if %>, i2's latest results were impressive. EPS doubled on 62% revenue growth while all-important software sales rose a still strong 57%. The tax rate did come down, but is still at 40%, which is fine.

The profile doesn't do justice to how profitable this firm can be (excluding charges, i2 sports a 7.3% net profit margin year-to-date), but it does highlight the bundle of cash. The massive insider sales need investigating. Still, at the $15 1/4 price at which i2 traded following the October 22 earnings release, the stock was 64% off its high. Since then, it's risen 31% to Monday's close of around $20. The company appears to be pulling ahead in the supply chain management sector, given its relative business strength versus competitors. Anyone looking to research the firm should start with fellow Fool Greg Markus's conference call synopsis.

Of course, the overall market's been rallying like crazy since these companies reported earnings. Not every stock with rising margins will soar in the ensuing weeks.

While the stock of shoe and apparel manufacturer K Swiss <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KSWS)") else Response.Write("(Nasdaq: KSWS)") end if %> has enjoyed a strong year, it hasn't done much since October 22, when the company reported 77% higher EPS on 16% sales growth (EPS benefited from a decline in the tax rate from 48% to 38%, but that's still fine). The stock bounced from $24 to $27 1/4 the next day but quickly settled back to around $24.

The athletic shoe business has been in the doldrums for the last two years, but a number of smaller players have done much better than giants like Nike <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NKE)") else Response.Write("(NYSE: NKE)") end if %> and Reebok <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RBK)") else Response.Write("(NYSE: RBK)") end if %>. Looking at the company's profile, I see it's enjoyed a year-to-date net margin of 7.2% thanks to higher average selling prices on popular new styles. The price to sales ratio is just 0.93, which seems inexpensive in light of the net margins. Moreover, the firm has $8.17 per share in cash and an otherwise solid balance sheet. Backing out the cash, I calculate that it has a enterprise value ($90.9 million) to trailing twelve month sales ($144.2 million) ratio of just 0.63!

Only two analysts cover K Swiss, and either they had fallen asleep, or the company crushed estimates by 56%. In the last week, the FY98 consensus earnings estimate has jumped from $1.68 to $2.08 while FY99 estimates have risen from $2.19 to $2.92. That may be due to the fact that domestic future orders for the next six months are up 126% over the year-ago period to $106 million.

So net of cash, K Swiss now trades at just 5.5 times next year's earnings! This one definitely deserves further research. Either it's dirt cheap and has simply been ignored because of its tiny float and small market cap, or there's something else to the story.

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