What Next?

Written by GSCR Staff   
Wednesday, 30 April 2014 08:26

Do we outright sell big winners, take profit, or just hold on thus turning picks from trades to investments.  We took a look at our three biggest Market Monitor winners from three big small-cap sectors; biotechnology (LCI), technology (RMBS), and Consumer Goods (RAD), to illustrate the possibilities.  The chart below summarizes the price level increases.  Initial Price is stock price at the previous day’s close before featured in the Market Monitor.

Price Level Summary for 3 Biggest Market Monitor Winners

Stock drivers vary depending upon the corresponding industry segment and include quantitative and qualitative measures for the company itself and its industry, along with intangibles such as the value of the brand.

For Rite Aid Corporation (NYSE – RAD) we took a look at profitability and operating margin since they have had a big hand in the RAD turnaround over the past year.  The chart below illustrates the gross profit margin and operating margin over the last four years for RAD

Rite Aid Corporation Gross Profit Margin and Operating Margin FY2011-FY2014

We note that larger peers Walgreen Company (NYSE – WAG) and CVS (NYSE – CVS) have generated very different profit margins despite the similar business lines. For FY 2013 CVS gross profit margin was 18.8% and operating margin of 6.3%, while WAG had 2.9% for gross profit margin and operating margin of 5.4%.  Comparatively speaking, RAD looks attractive when one considers the 5-year PEG ratio of 0.43.  On a technical basis, the stock remains bullish as evidenced by the 50-day Daily Moving Average technical metric.  Based on valuations and the shift in the age demographic that drives business, we believe that RAD is a keeper.

For Rambus, Inc. (NASDAQ – RMBS) a hardware and semiconductor supplier, we reviewed a couple of balance sheet ratios as indicators of general health.  Good utilization of assets and use of debt can provide a glimpse of the survivability of a firm as well as its status as an M&A target.  The chart below illustrates the 4-year annual data for RMBS in two solvency ratios and one liquidity ratio.

Current, Debt/Equity, Leverage Ratios 2010 – 2013 for RMBS

The current ratio of under 2 is low and has been trending down over the last few years is cause for concern.  Additionally, the rising long term debt to equity is alarming.  The take away, short term and long term debt is becoming an issue for Rambus, Inc.  As a reference, Intel (NASDAQ – INTC) had an equity multiplier of 1.65 for 2013.  On the bright side Rambus is forecast for a 10% growth in top line revenue for 2014 to $300 million, even with a recent downgrade for 2Q14 revenue.  Additionally, on the technical side, the stock is one of the few that remain very bullish in the DMA.  We think some profit taking is probably in order for RMBS with a target price of $6.00 for remaining shares.

Lannett Company, Inc. (NASDAQ – LCI) has skyrocketed over the last year and a half as the multi-platform firm has had great news with respect to clinical updates and approvals domestically and abroad. These include a recent green light as the first bioequivalent Diazepam, which is used to treat anxiety, an Oral Solution product approved by the FDA.  Lannett has 16 products pending FDA approval and another 55 in clinical trials. 

LCI is also one of the few favorable biotechs on the technical side. . At current levels, the stock carries a 5-year PEG of 1.25, and a reduction from 58 on the trailing 12-month P/E to 16 on the FY P/E based on growth estimates from the expected cash flow from the numerous products in the pipeline on the simple valuation front.  The chart below illustrates the four year trends in two common cash flow metrics.  CFO is cash flow from operations.

Cash Flow Ratio for LCI 2010-2013

With the exception of 2011, the trends for positive (the higher the better for both) indicate potential upside for Lannett.  In essence there is more cash coming in for the investors and greater coverage on long term debt with the increased cash flow over this time.  This combined with the factors above still make LCI attractive.  Again, a little profit taking is probably in order for the stock based on what you can stomach for the rest of 2014.  We think LCI can get back to the $40-45 range this year.

Disclosure: Goldman Small Cap Research analysts are neither long nor short these shares but may elect to purchase the stock within the next 48 hours.

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