SPECIAL SITUATIONS
Enterra Energy (NASDAQ: EENC) $3.12
One of the factors we evaluate when selecting Special Situation stocks is how a company performs when a sector experiences a downturn. It is our view that if a company can outperform its peers during tough times, then it is likely to become a stellar performer when the sector returns to favor. We initially profiled the company in November when it was called Westlinks Resources and the stock was trading at $1.85. Since then, the company has changed its name, reflecting its combination with Big Horn Resources.
Enterra Energy is a Canadian based oil and gas producer. Despite the tough second half of last year that exploration and production companies experienced, Enterra increased production by 65% and exited last year by producing more than twice the amount of production it had for the previous year. It also increased cash flow, a key factor in valuing energy companies, by 67%, to $9.8 million Canadian. It improved cash flow per share to $1.40 Canadian. All this in an environment where energy prices declined sharply.
Another factor in determining the viability of an energy company is its operating costs. While commodity prices, which have steadily been increasing, play a major role in the fortunes of these companies, costs are just as relevant. The company reduced its drilling costs from $8 per boe to less than $4 per boe in less than one year, saving the company millions of dollars. This is why, although oil prices dropped 23% in 2001 and gas prices plunged 40%, Enterra was able to report strong results.
The company continues its aggressive exploration activities, most recently at Gordondale, in Alberta, Canada. The discovery well, encountered gas potential in four separate formations. Enterra has identified 15 or more additional potential drilling locations ranging from 200 m (650 ft) to 2,450 m (8,000 ft) in depth. The area has multi-zone potential with more than 10 different producing formations. The company has demonstrated the ability to increase reserves, a leading indicator regarding its future prospects. Last year, it grew reserves by 181%, indicating that its prospects should be strong for years to come. Its target of reaching 10,000 boe/day of production by the end of 2003 appears possible, which would give the company a valuation that is substantially higher than it is today.
Energy prices have begun to increase significantly, and for companies like Enterra, with strong management and low operating costs, it creates an opportunity for dramatic upside. The company is expected to report first quarter results on May 16th, and we believe that there exists a strong potential that the stock could break-out to a new 52-week high on the news. If the company is able to post excellent results in an environment where prices are depressed, what will they be since prices have rebounded?
Investors have already begun to bid up the price of the stock, as it is up 60% this year. However, we believe that the upcoming warrant expiration on May 17th could be a further near-term catalyst for a price increase this week. The energy sector has recently seen improved fundamentals, and we believe that Enterra Energy, with its low operating costs, strong management and solid reserve position should outperform the sector in the near-term. We feel that investors should buy the stock this week ahead of Thursday’s earnings announcement.
Universal Automotive (NASDAQ: UVSL) $2.20
Another area that has been one of the top performers this year has been the automotive sector. General Motors (NYSE: GM), for example, is up 36% this year alone. We believe that Universal Automotive is another company that is well-positioned to capitalize on the improving fundamentals in the area. The company specializes in the distribution and manufacture of brake rotors and other brake parts in the United States and Canada.
The company recently reported record first-quarter results for the period ended March 31st. It reported revenues of $17.5 million, a 10% increase from the same period last year, and earnings of $0.02 per share, which reflects the sharp improvement in its operations from the same period in 2001. Last year, it lost $0.15 per share. However, the company completed a number of operational, management and financial initiatives that are now paying off. We feel these steps will be the catalyst for the company to achieve its announced guidance of $0.08 to $0.10 per share, the first time it has forecast results. Typically, when a company announces results for the first time it is cautious in its guidance. We believe that it could beat these estimates. It already earned $0.02 during what is typically one of its slowest quarters.
So what has fueled the turnaround? The company moved its manufacturing plant from Laredo, Texas, to Cuba, Missouri, which is expected to generate substantial savings, including a reduction in freight costs. In addition, it made certain personnel changes, which were designed to improve operations. In the financial area, it significantly improved its balance sheet. It paid down $3 million of its FINOVA indebtedness, reducing it to $1.5 million. It also improved its cash position, receiving a $2.8 million strategic investment from The Wanxiang Group. The company now has the ability, through this relationship, to reduce costs by importing product from China. We believe that the sale of its Hungarian foundry operations in December will allow it to further concentrate on its core business.
We feel that micro-cap companies will never save themselves to prosperity, and that value is created through growth. Universal Automotive has taken a number of steps to grow revenues. It expects the majority of its growth to come from the higher margin friction line. It also anticipates the introduction of new premium friction products. For example, it is expected to launch a new line of high performance ceramic disc brake pads. Currently, Brake Parts account for 92% of the company’s revenues.
Industry trends help the company as well. After-market groups and retailers have increasingly gravitated to supporting private labels, as opposed to national brands. Also, the company’s competitive position is enhanced by the uncertainty associated with several of the major full-line brake companies. The company reported revenues for 2001 of $71.8 million, which was slightly higher than 2000 levels. The company is likely to grow revenues from these levels, but it should be able to meet or exceed earnings targets merely from the operating improvements it initiated last year.
The company has a market valuation of just $26 million on a fully-diluted basis, which means that it is trading at approximately 1/3 of its sales. The stock has rallied 22% in the past month, as investors have begun to notice the company’s improving fundamentals. We feel that as it continues to demonstrate that its restructuring activities are generating results, that the stock could quickly return to its 52-week high of $4.10.
Pac-West Telecomm, Inc. (NASDAQ: PACW) $0.68
Although we have made no secret of our concerns about the health of the overall telecom sector, and large debt-laden companies such as Worldcom in particular, we feel that investors have indiscriminately dismissed virtually every company in the sector. This creates opportunities for those investors of the mindset to try and separate companies that are likely to prosper despite a tough environment. One company we believe that can is Pac-West Telecomm, Inc., a provider of integrated communications services to Internet service providers and business customers in the western U.S.
While other telecommunications companies have reported declining revenues, Pac-West announced first quarter revenues of $43.1 million, a 19.1 percent increase from revenues of $36.2 million in the fourth quarter of 2001. The sequential revenue growth resulted from increased lines in service and minutes of use. Unlike other companies in the sector, it has been able to successfully reduce its dependence on low margin business without destroying its revenue base. It continues to increase top-line results, despite its continuing departure from residential resale, customer owned and maintained equipment, and DSL resale businesses.
The company posted operating net income for the first quarter of 2002 of $0.2 million, compared to a net loss of $3.9 million for the fourth quarter of 2001, and a net loss of $0.5 million for the first quarter of 2001. Earnings before interest, taxes and depreciation (EBITDA), a much better measure of a company’s ability to generate cash flow, increased by 47.1% to $15.1 million.
The company has a strong cash position, with cash and short-term investments totaling $64.9 million. The company recently reduced its long-term debt by retiring $21 million in senior notes through open-market purchases. This has seldom been done lately by telecom companies, and demonstrates the confidence it has in its business. These purchases will decrease Pac-West's annual interest payments by approximately $2.8 million.
The company continues to provide superior customer service, which should enable it to capture market share from its struggling rivals. Customer service continued to improve in the first quarter, with sequential reductions in open trouble tickets of 43 percent, and a decline of 62 percent in the average age of trouble tickets. The improved customer service we believe has been one of the catalysts for the first quarter increase of over 100,000 new lines. The improving mix of revenues should further increase profitability.
Despite a strong growth in revenues, and a sequential increase in EBITDA of 94.8%, the company trades just off its 52-week low of $0.40. Clearly, it has been impacted by many of its struggling competitors. In fact, it currently trades for a record low multiple of its cash flow. Based upon its current valuation of $25 million, the company trades for less than our forecast for its current year’s cash flow. Although it has long-term debt equal to twice its current cash position, we believe that the steps it has taken to reduce debt makes it quite different than others in the sector. Despite the telecom sector being down 38% year-to-date, Pac-West is higher by 23%. We feel, however, that its fundamentals support a much higher valuation, and that investors will see significantly upside from its current price in the near-term.
Do you have a company you would like to see us cover? Please let us know at news@ceocast.com.
The CEOcast Newsletter is an electronic publication committed to providing our readers with factual information on selected publicly traded companies. All statements and expressions are the sole opinions of the editors and are subject to change without notice. A profile, description, or other mention of a company in the newsletter is neither an offer nor solicitation to buy or sell any securities mentioned. While we believe all sources of information to be factual and reliable, in no way do we represent or guarantee the accuracy thereof, nor the statements made herein. The profiles, critiques, and other editorial content of CEOcast may contain forward-looking statements relating to the expected capabilities of the companies mentioned herein. THE READERSHOULD VERIFY ALL CLAIMS AND DO ITS OWN DUE DILIGENCE BEFORE INVESTING INANY SECURITIES MENTIONED. INVESTING IN SECURITIES IS SPECULATIVE AND CARRIESA HIGH DEGREE OF RISK. THE INFORMATION FOUND IN THIS NEWSLETTER IS PROTECTEDBY THE COPYRIGHT LAWS OF THE UNITED STATES AND MAY NOT BE COPIED, OR REPRODUCEDIN ANY WAY WITHOUT THE EXPRESSED, WRITTEN CONSENT OF THE EDITORS OF CEOcast. Moreover, as detailed below, this publication accepts compensation from certain of the companies that it features. To the degrees enumerated herein, this newsletter should not be regarded as an independent publication. The profiles, critiques, and other editorial content of CEOcast may contain forward-looking statements relating to the expected capabilities of the companies mentioned herein. This information has not been independently verified by CEOcast. The reader should use caution, as a result. The following companies, featured in this newsletter, have compensated CEOcast:, Enterra Energy, sixty thousand dollars, Mooney Aerospace, one hundred thousand dollars, SurgiCare, seventy-five hundred dollars per month and thirty thousand shares of common stock, Drew Indsutries, seventy-five hundred dollars, Agnico Eagle, seventy-five hundred dollars, Essex Corporation, seventy-five hundred dollars per month and nineteen thousand shares of common stock and warrants to purchase an additional twenty-five shares at $8.50, SuperGen, seventy-five hundred dollars, Pac-West, seventy-five hundred dollars, Universal Automotive, seventy-five hundred dollars, Questcor Pharmaceuticals, twenty-five thousand, Xybernaut, five thousand dollars per month, plus thirty thousand shares of stock plus warrants to purchase thirty thousand shares of stock at $2.00 and I-trax, five thousand dollars per month plus forty-five thousand shares of stock.
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