Tuesday, October 13, 2009

On Sale Now!

The current market, tentative as it is, requires careful scrutiny of companies before taking long positions. Investors in this market, as opposed to speculators who are simply looking to turn a quick return on price momentum, need to make certain they are buying a good value.

This is more than simply looking at companies with low price multiples. We went looking for deep value off the beaten trail so to speak. We looked at companies that have been struggling and have just returned to profitability. This approach requires an admission that equity markets are not perfect and that knowledge and awareness about a company’s re-emerging strength spreads sporadically. These leaves a period of time during which the company is not fairly valued, i.e. the stock is undervalued.

How about MCG Capital Corp. (MCGC: Nasdaq)? This is a commercial finance company that provides both debt and equity financing to middle market companies. MCG had been profitable until about a year ago when the housing crisis brought the capital market to its knees. The company has been successful in de-leveraging and bringing liquidity to its balance sheet. Management has become upbeat in their guidance and there is reason to expect a reinstatement of the company’s dividend. While the trailing price/earning ratio is negative the forward multiple is 7.6 times the consensus estimate.

The same screening strategy also produced the name Xyratex Ltd. (XRTX: Nasdaq) which provides modular enterprise class data storage solutions and storage process technology. Sales have slipped in the last three quarters as enterprise tightened the purse-strings as a way to cope with the uncertainty of the economic recession. The worst may be over for Xyratex. The company returned to profitability in the September 2009 quarter. We also note that cash flows had been positive since the beginning of 2009. The balance sheet has no debt and cash has been built back up to $38.3 million. At 12.0 times the consensus earnings estimate of $1.01 for FY2010, the stock looks interesting.

Its multiples are higher than average so most investors would not call PMFG, Inc. (PMFG: Nasdaq) a value stock. However, the consensus among analysts with published estimates for the company expects a sharp increase in earnings this year and the forward multiple on PMFG shares is less than half the trailing PE. The company makes custom-engineered infrastructure for the power generation, natural gas, refining and petrochemical industries. Its pollution abatement systems using selective catalysts reduction (SCR) technology are in demand as the power and industrial complex continues to grapple with reducing carbon emissions. Last month PMFG announced a shelf offering for a $60 million equity raise, which suggests plans for major strategic moves if the share price moves higher and the capital raise is triggered.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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