Monday, December 18, 2006

Update on ASFI and IPS

I've had a couple letters asking about Finance Wonk Buys ASFI and IPS from people who have noted news articles and some negative stock action.

David Batten asks if I have "any new thoughts on asfi after the earnings announcement and correction"?

The answer is that i have been watching ASFI like a hawk and pored over the new annual report as soon as it was filed. There appear to be several things leading to stock sales:

1) Ryan, Beck & Co lowered ratings on ASFI from outperform to market perform. This does concern me a little since James O'Brien (the R,B & C analyst on ASFI) has been doing reasonably well predicting it. But in this case he's predicting a short term reduction in growth rate that is well within our buy window. This brings us to #2...

2) The recent annual report showed higher interest costs and administrative costs. This drew my attention so I rolled around in the details. It looks like management found a lot of troubled debt they thought was worth owning this year. Don't forget the business of ASFI is buying bad debt at 2.9 cents on the dollar and collecting an average of 4.3 cents on the dollar. Finding good debt to buy is the primary business and I'm glad management wasn't worried about smoothing earnings and took advantage of an opportunity to buy well priced debt. The increased inventory raised administrative costs and interest payments, which in turn will push down growth a little this year, but this is exactly what the company should be doing to keep the business healthy. If we still believe in the business and the management, we should be glad to see them working.

3) There has been a dark cloud over mortgage companies recently, and it has lowered the shares of many consumer lenders. Recent numbers suggest and amazing 30-40% of mortgages in the last year were "creative" option loans, and a tremendous number of those have so called "silent seconds" over them. Several prominent mortgage companies have gone out of business in the last few weeks and people are avoiding consumer debt companies. This is pretty much what I predicted in May (this post) where I observed that we would start to see increasing mortgage failures due to rising fed rates. Historically this also correlates with market corrections (at some point, not necessarily right now). But since we predicted the trend we stayed out of mortgages and stuck with ASFI - which takes advantage of direct consumer lending and the new bankruptcy laws.

Numbers 1&2 just adjust a small percentage of profit growth outward into the future a little farther in return for a stronger company, number 3 is irrelevant because we avoided that mess already. I'm holding on ASFI.

If you bought with me you are probably smarting from the 15% decline since then (versus much larger rises for FW buys AAPL, ARW, NOW, and LECO, so we're still solidly ahead).

The drop has been about $5 in the last week. Two reasons on this one:

1) Oil prices have trended lower. This includes a statement by OPEC that they intend to cut production (which may or may not happen, but needs months after an announcement to happen so they had to get in front of it). Since IPS sells mostly steel tubulars into the oil business the stock has declined along with the other oil support industries. Not to worry, the price is still plenty high enough to justify investment in the areas where IPS is strong and IPS is still sold out for the forseeable future. The cuts by OPEC are designed to keep prices elevated, which is to the advantage of IPS as their market is booming from high oil prices.

2) The US has lowered tariffs designed to keep foreign steelmakers from dumping steel into the US market. Specifically the auto makers lobbied congress to get them to eliminate tariffs that were costing detroit millions. This came as a surprise so the market went nuts and steel producers dropped like a rock recently. Now listen carefully: IT DOESN'T APPLY TO IPS. Yes, you heard me, energy tubulars are not effected by the legal change and defensive tariffs still apply there. If anything this will lower the costs for IPS' raw materials. The possibility always exists that congress may further alter the laws in a way that would hurt IPS, although it is doubtful that a powerful lobby is pushing for energy tubulars since it is a local business where tariffs don't have as much impact.

Now would be the wrong time to sell IPS. I am holding, with real money, so you know what I think.


In general both these companies are experiencing bumps that are within the range of what I envisioned when buying them. We don't expect a perfect ride, or for stocks to only go up. Keep in mind that we required a net present value discount of 15% before buying these stocks so even choppy news should not deter us. For example, the average 12 month analyst price target on ASFI is $53, an 85% gain from current pricing. Hardly a picture of a "bad stock".
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