Personal income in September 2008 rose 0.2% from August.  Real personal consumption expenditures (PCE) fell 0.4% and nominal PCE fell 0.3%.  Real disposable personal income (DPI) rose 0.1% and nominal DPI increased 0.2%. The personal savings rate as a percentage of DPI was 1.3% in September.

According to the latest data from the Federal Reserve, Baa corporate bonds are yielding 4.56% more than 10-year Treasuries. The chart below shows this relationship over the last 40+ years.

Source: Bureau of Labor Statistics

The American Trucking Associations’ advanced seasonally adjusted For-Hire Truck Tonnage Index decreased 0.3 percent in July, marking the first month-to-month drop since April. The seasonally adjusted tonnage index equaled 116.2 (2000 = 100) in July, while the not seasonally adjusted index fell 0.1 percent to 119.7.

A major risk for the outlook is that aerospace backlogs are making up an unusually high proportion of total backlogs, now at 43 percent vs. 35 percent only four years ago before recovery in the airline sector began to feed a rush of Boeing and Airbus orders. But the airline sector is, as are many other sectors, now slowing, putting pressure on the finances of airlines and raising questions over their commitment to prior orders. To close, the graph below tracks year-on-year percentage changes between unfilled orders for aircraft (black) and total unfilled orders (red). –Mark Pender, Econoday senior financial writer

Owens & Minor (OMI) is the nation’s leading distributor of medical and surgical supplies to the acute-care market. It’s also a health care supply-chain management company and a national direct-to-consumer supplier of testing and monitoring supplies for diabetics.

Most of its revenue is derived from fees based on a percentage of the value of products distributed, but 32% of its revenue is contracted on the basis of the company’s costs. Its primary competitor in medical/surgical distribution is Cardinal Health (CAH) . In the direct-to-consumer diabetes supply business, its largest competitor is Liberty Medical, a subsidiary of MedcoHealth Solutions (MHS) .

Owens & Minor has been establishing a track record of earnings surprises, beating analysts’ estimates in each of the last three quarters. Analysts are beginning to reward the company with higher full-year 2008 and 2009 estimates, which now stand at $2.36 and $2.64, respectively. By contrast, estimates for MedcoHealth have been steady, and those for Cardinal are falling. Owens is expected to post higher revenue growth than its peers, and that may account for the differential in earnings trends.

Over the next three to five years, the consensus among analysts is that OMI earnings per share can grow 18% annually. Much of this growth is likely to come from acquisitions, such as its recent agreement to purchase privately held Burrows. Given the uncertainties surrounding the timing of acquisitions and the fact that they will likely require additional investor financing, my valuations are based on a more conservative 10% growth rate, in line with the company’s sustainable growth rate. Combined with a 1.7% dividend yield, the double-digit total return potential isn’t too shabby — and the acquisitions could provide a boost to that, if and when they materialize.

Better still, the growth has a backstop in the form of strong cash-flow generation. Over the last 12 months, Owens & Minor generated free cash flow (cash flow from operations less expenditures on capital assets and software) of $190 million — a whopping 10.5% of the company’s market capitalization. Over the last year, most of the free cash flow has been used to pay down debt. Long-term debt was $369 million in June 2007, but it declined to $221 million by June 2008. The debt reductions free borrowing capacity for larger acquisitions, or alternatively the company could turn to share repurchases as debt levels decline further.

For a company growing 10% annually, I believe the 10.5% free cash flow yield represents a huge risk premium. By contrast, the free cash flow yields at Medco and Cardinal are less than 5%. I don’t see why a company with this growth profile should yield more than 6%, which would still be twice the current yield on five-year Treasuries and a premium to the cash flow yields of its peers. Were it to trade at a 6% free cash flow yield, the shares would be at $75, which is 65% above the current level.

That’s not the kind of valuation change I’d expect to see overnight. Over the next few years, however, I believe it is likely. Even if it took five years for the valuation to converge with that of its peers, the total return would exceed 20% per year.

Overnight or over time, those kinds of returns look good to me.

Disclosure: At the time of publication, William Trent has no financial position in the companies mentioned in this article.

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Since 2001, hospital stocks have been looking green around the gills. Shares of LifePoint (LPNT) , Universal Health Services (UHS) and Community Health (CYH) have pretty much gone nowhere. Tenet Healthcare (THC) and Health Management Associates (HMA) look even worse, having lost more than 50% of their value.

That may be about to change. As I have noted before, employment statistics show hospitals as being one of the few industries reporting significant hiring. Unfortunately, I believe the lean years have left analysts who are covering the stocks too shell-shocked to notice improving fundamentals.

Evidence of the high degree of skepticism can be found in a Forbes article published on Aug. 8, when LifePoint issued a positive earnings report and raised guidance. The article focused on declining admissions and fears that a sinking economy could increase bad-debt expense. JPMorgan analyst Dawn Brock was quoted as saying, “We are concerned about the sustainability of margins given the weak admissions growth, especially as we do not believe the company can continue to see bad debt improvement given the overall macro environment.” Stifel Nicolaus analyst Robert Hawkins said the company had done a poor job of managing its expenses.

Investors weren’t listening to the analysts. LifePoint shares soared 10% on the increased guidance and have held steady since. I believe the company’s strategy may finally get the shares out of their multiyear rut. If I’m right, the analysts covering the name will probably be the last to hear about it.

Better Than Its Price

LifePoint operates hospitals in non-urban communities in 17 states. Of the company’s 48 hospitals, 44 are in communities where LifePoint is the sole community hospital provider. Its strategy is to increase the services available at such hospitals to capture more of the revenue opportunity in these communities. On the recent conference call, LifePoint CEO Bill Carpenter said that “early deep dive hospitals have already through the first six months of the year met or exceeded their full year 2008 targets.”

Even after the 10%, rally the shares certainly don’t seem excessively priced. At less than 13 times the 2009 consensus earnings estimates, many would likely consider them cheap. Given that the company has exceeded earnings estimates in three of the last four quarters, the current consensus estimates could be too low. That would make the shares cheaper still.

The earnings also translate into strong free cash flow, measured as cash from operations less capital expenditures. Over the last 12 months, LifePoint’s free cash flow totaled $127 million, or 6.9% of the company’s market capitalization. With five-year Treasuries yielding barely more than 3%, that represents a pretty healthy risk premium, even before considering growth opportunities due to the company’s strategy.

Analysts expect LifePoint to increase earnings by 10% annually over the next three to five years, a rate that is in line with the company’s sustainable growth rate on the basis of fundamentals. Meanwhile, at 1.2 times book value, it is trading well below the industry average of 2.1 times.

If earnings grow as expected and the price/book multiple expands to the industry average multiple over the next five years, total returns could approach 25% per year.

Maybe by then the analysts will have caught up to the story.

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Source: U.S. Census Bureau, Durable Goods Report

Source: U.S. Census Bureau, Durable Goods Report

Can a market leader in clothespins hang short-sellers out to dry? Investors in Jarden (JAH) may soon find out. The company has acquired a portfolio of leading brands in outdoor and consumer products that includes Sunbeam, Oster, Coleman, Rawlings and Mr. Coffee. I think these market leaders, sold in a wide range of stores, are generating more than enough cash flow to service debt and fuel additional growth, making life uncomfortable for their considerable short float.

According to its latest 10K, Jarden is now a leader in a variety of categories, including (deep breath) alpine skis and bindings, snowboarding and snowshoeing, baseballs, bats, softballs and gloves, camping gear, cordage, firelogs and firestarters, soft baits, rods, reels and combos, home canning, home vacuum packaging, matches and toothpicks, personal flotation devices, playing cards, boxed plastic cutlery, selected small kitchen appliances, warming blankets and a number of other branded consumer products. (Does that give you an idea of the breadth of their product lines?)

The 2007 acquisitions of K2 and Pure Fishing helped make outdoor solutions the company’s largest business segment. Unfortunately, they also helped saddle the company with $2.8 billion in total debt just as the consumer slowdown began in earnest. Investors headed for the exits, sending the shares down by nearly half since last summer’s peak. Short-interest stands at nearly 23% of the floating shares.

I think the shorts may now be pressing their luck. For example, some investors consider Jarden’s high exposure to Wal-Mart (WMT - Annual Report) a cause for concern. However, judging from last week’s earnings report, Wal-Mart looks like exactly the place to be supplying these days.

Meanwhile, I think the same credit crunch that is giving investors such concern is likely to prove the remedy for their concerns. If Jarden does not have additional access to debt, obviously the debt load won’t get any bigger — and they can use their cash flow to reduce the current debt load while waiting for the market to improve.

And quite a flow of cash it is. Over the last 12 months, the company’s operations generated $402 million in cash flow and required just $89 million to build and maintain productive capacity. The remaining $313 million can be used for anything the company wants. Historically, it has been acquisitions, but in the current environment, I’m betting they will clean up the balance sheet.

Finance theory says there shouldn’t be a difference in the value of a firm based on whether it is financed by debt or by equity. But we all know that theory and reality don’t always mesh. Last year when debt was cheap, the sensible thing to do was to grow by borrowing money to acquire other companies, and that’s what the company did. This year, with the debt load higher by $1 billion, and the market capitalization $1.5 billion lower, the debt/equity ratio is all out of whack. I think nervous investors have taken the market cap lower than is justified by the cash flow, and that each dollar used to repay debt will increase the value of the company by more than one dollar as investor concerns subside.

Without any further growth in cash flow, I think a strong debt reduction effort could increase the market capitalization from $1.9 billion today to at least $2.2 billion next year and $2.5 billion the following. While that would not be sufficient to restore the stock to its previous highs, the 15% annual returns and $33 potential value after two years are well worth the effort. Jarden management did the right thing in last year’s credit environment, which leads me to believe they will do the same in this one.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this column.

Related Stocks:  WMT

Since 2001, hospital stocks have been looking green around the gills. Shares of LifePoint (LPNT) , Universal Health Services (UHS) and Community Health (CYH) have pretty much gone nowhere. Tenet Healthcare (THC) and Health Management Associates (HMA) look even worse, having lost more than 50% of their value.

That may be about to change. As I have noted before, employment statistics show hospitals as being one of the few industries reporting significant hiring. Unfortunately, I believe the lean years have left analysts who are covering the stocks too shell-shocked to notice improving fundamentals.

Evidence of the high degree of skepticism can be found in a Forbes article published on Aug. 8, when LifePoint issued a positive earnings report and raised guidance. The article focused on declining admissions and fears that a sinking economy could increase bad-debt expense. JPMorgan analyst Dawn Brock was quoted as saying, “We are concerned about the sustainability of margins given the weak admissions growth, especially as we do not believe the company can continue to see bad debt improvement given the overall macro environment.” Stifel Nicolaus analyst Robert Hawkins said the company had done a poor job of managing its expenses.

Investors weren’t listening to the analysts. LifePoint shares soared 10% on the increased guidance and have held steady since. I believe the company’s strategy may finally get the shares out of their multiyear rut. If I’m right, the analysts covering the name will probably be the last to hear about it.

Better Than Its Price

LifePoint operates hospitals in non-urban communities in 17 states. Of the company’s 48 hospitals, 44 are in communities where LifePoint is the sole community hospital provider. Its strategy is to increase the services available at such hospitals to capture more of the revenue opportunity in these communities. On the recent conference call, LifePoint CEO Bill Carpenter said that “early deep dive hospitals have already through the first six months of the year met or exceeded their full year 2008 targets.”

Even after the 10%, rally the shares certainly don’t seem excessively priced. At less than 13 times the 2009 consensus earnings estimates, many would likely consider them cheap. Given that the company has exceeded earnings estimates in three of the last four quarters, the current consensus estimates could be too low. That would make the shares cheaper still.

The earnings also translate into strong free cash flow, measured as cash from operations less capital expenditures. Over the last 12 months, LifePoint’s free cash flow totaled $127 million, or 6.9% of the company’s market capitalization. With five-year Treasuries yielding barely more than 3%, that represents a pretty healthy risk premium, even before considering growth opportunities due to the company’s strategy.

Analysts expect LifePoint to increase earnings by 10% annually over the next three to five years, a rate that is in line with the company’s sustainable growth rate on the basis of fundamentals. Meanwhile, at 1.2 times book value, it is trading well below the industry average of 2.1 times.

If earnings grow as expected and the price/book multiple expands to the industry average multiple over the next five years, total returns could approach 25% per year.

Maybe by then the analysts will have caught up to the story.

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I know, I know … the construction industry should not be touched with a 10-foot pole right now. But the depth of conviction investors have in that belief sends my contrarian side looking for names that might buck conventional wisdom. I didn’t have to look far to find one.

Despite a market capitalization under $800 million, NCI Building Systems (NCS) is one of North America’s largest integrated manufacturers and marketers of metal products for the nonresidential construction industry. With 44 manufacturing facilities located in 18 states and Mexico it sells metal coil coating services, metal components and engineered building systems, offering one of the most extensive metal product lines in the building industry.

The metal-coil-coating segment cleans, treats, paints and slits continuous steel coils before the steel is fabricated for end use. The metal-components segment sells metal roof and wall systems, metal partitions, metal trim, doors and other related accessories. The engineered building systems segment manufactures mainframes and Long Bay Systems, and includes value-added engineering and drafting. This last segment is both the largest and the highest-margin business for NCI.

NCI management pursues a four-pronged strategy of (1) developing new markets and products; (2) successfully identifying strategic growth opportunities; (3) controlling operating and administrative costs; and (4) managing working capital and fixed assets. The limited focus seems to be working.

New market opportunities include the shift toward metal roofing systems from conventional tar and gravel systems. Though more expensive to install, metal roofing systems are more durable and require less maintenance. As a result, they are gaining share in commercial-building applications.

For NCI, “strategic opportunities” means just that. The 1998 acquisition of Metal Building Components Inc. doubled its revenue base, making the company the largest domestic manufacturer of nonresidential metal components. The 2006 acquisition of Robertson-Ceco II Corporation resulted in product and geographic diversification, a stronger customer base and a more extensive distribution network.

Control over operating and administrative costs is exemplified by the fact that SG&A expense declined from 18.1% of revenue in the first half of 2007 to 17.7% in the same period this year. Meanwhile, working capital has been reduced, as have expenditures on fixed capital.

The operational discipline is translating into financial success. Sales in the second quarter grew 13.1% from the year-ago period. The $0.76 in earnings per share reported far exceeded the consensus analyst expectation. The company also narrowed its guidance for full-year 2008 earnings per diluted share to $3.19 to $3.44, compared to the prior consensus estimate of $2.90 per share. Estimates for 2009 were subsequently boosted from $2.88 to $3.39.

Over the last 12 months, NCI has generated $114 million in free cash flow (measured as cash from operations less capital expenditures). At 14.6% of market capitalization, the free-cash-flow yield is enticing enough that I don’t really require any growth to justify an investment. I could even tolerate some declines in cash flow, particularly if they were of a temporary nature related to the economic cycle.

Analysts, however, expect the company to grow 13% annually over the next three to five years. I think that estimate is probably too high — at least without tapping external financing. The sustainable earnings growth rate based on ROE is closer to 11%. With a 1.3 price/book multiple (in line with the industry average) and a P/E of just 11.5, I think the valuation is more than reasonable.

I think the shares could trade to a free-cash-flow yield of 10%, which would ultimately justify a $58 share price (45% above the current level), based on the most recent year’s free cash flow. While this may take some time to play out, I think double-digit returns over the next three to five years are quite possible.

Disclosure: At the time of publication, William Trent has no financial position in the companies mentioned in this article. 

Sometimes you have to wait for a bit of bad news to get a stock at the price you want. I think that is the case with Chattem (CHTT) , a leading niche provider of over-the-counter health care products, toiletries and dietary supplements.

Chattem’s brands include Pamprin, Gold Bond, Selsun Blue, Dexatrim and Bullfrog. About one-third of its sales are to Wal-Mart (WMT - Annual Report) stores. Chattem’s share price has fallen more than 10% since the company was forced to recall several Icy-Hot Heat Therapy products that were providing too much heat and causing burns. With that episode resolved, I think the lower price represents a buying opportunity.

By focusing on niche market segments outside the core product areas of larger consumer product companies, Chattem has built brand equity and leveraged its distribution capabilities, which has resulted in increased profit margins. The strong brands also allow for multiple brand extensions, such as Gold Bond Restoring, Cortizone Intensive Healing, Icy Hot PM and Aspercreme Heat.

When Johnson & Johnson (JNJ) bought Pfizer’s (PFE - Annual Report) consumer products division in 2007, regulators required it to divest certain brands. Chattem swooped in. For $410 million, the company added ACT, an anti-cavity mouthwash/mouth rinse; Unisom, an OTC sleep aid; Cortizone-10, a hydrocortisone anti-itch product; Kaopectate, an anti-diarrhea product; and Balmex, a diaper-rash product. The new products increased Chattem’s revenue base by more than a third.

While such acquisition opportunities arise only occasionally, Chattem’s focus strategy and brand extensions should allow for strong organic growth as well. For 2009, the company expects organic sales to grow at a high-single-digit rate or higher. As the acquired JNJ products reached their anniversary this year, Chattem has continued to exceed earnings expectations.

For the full-year 2008, analysts have ticked their estimates up slightly, and the consensus for 2009 per-share estimates has risen from $4.47 to $4.54 over the last month. Chattem management expects the firm to generate $90 million to $95 million in free cash flow this year, which amounts to a 7.25% free cash flow yield based on the current market capitalization.

At more than twice the yield on five-year Treasuries, the cash flow offers investors both a risk premium and a margin of safety. The cash is also being put to good use. So far this year, the company has repurchased 418,000 shares at an average price of about $63 a share. The company also reduced its total debt load by $50 million over the last year. The risk premium is further enhanced by the 15% earnings growth expected over the next three to five years. That growth rate is below the sustainable rate based on ROE, and given the company’s history of share repurchases, I think there could be room for upside EPS surprises.

I don’t see the need for such a high free cash flow yield when the cash flow is growing so quickly. When you combine 15% annual growth with a 6.3% terminal free cash flow yield (100% of the current Treasury yield), you get the equivalent of 18.5% annual returns over the next five years.

Investors have awarded Chattem an average P/E ratio of 20.7 over the last five years. If shares trade back up to that historical multiple, then you are looking at 30% to 34% share price appreciation, based on 2009 estimates. That multiple of the $4.54 consensus 2009 estimate suggests the shares could increase 34% to $94 a share over the next year or so.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article. 

Related Stocks:  JNJ, PFE, PM, WMT

Crown Holdings CCK - Annual Report) looks to me like the type of boring stock Peter Lynch would love. The company’s primary products include steel and aluminum cans for food, beverage, household and other consumer products and metal caps and closures.

Cans and bottle caps certainly don’t sound particularly glamorous. A glance at the recent producer price index report, however, shows that this industry has been steadily gaining pricing power over the last several years.

Year/Year Change in PPI Index for Fruit and Vegetable Canning Industry

Click here for larger image.

Source: Bureau of Labor Statistics

You may be surprised by how much innovation actually occurs in the business. The company highlights its research and development activities, including the SuperEnd beverage can end, which requires less metal than existing ends without any reduction in strength, and value-added shaped beverage, food and aerosol cans, such as Heineken’s keg can. Innovative products and strong industry pricing showed through when the company reported second-quarter earnings on July 17. Analysts were expecting the company to earn 55 cents per share. The actual earnings came in at 61 cents because of both higher volumes and stronger pricing. A particular strong area was the company’s European operations.

Growth in a Plain Metal Can

Wachovia Capital Markets analyst Ghansham Panjabi said second-quarter results reflect “torrid growth” in Crown’s European beverage can business. I suspect that if you asked 100 investors at random to describe Crown’s business, “torrid” would not be a common response. Of course, that is the point. Everyone knows that Apple (AAPL) , for example, is experiencing torrid growth. And they are paying up for it. With Crown, you find strong momentum while the stock is still flying under the radar of most investors.

The company is expecting more of the same. As recently as April, the company expected segment income of $750 million to $780 million. It now expects $800 million to $820 million for the full year. Analysts raised their earnings per share estimates to $1.68 this year and $1.98 next year, up from the prior levels of $1.61 and 1.93, respectively.

A Further Indicator

Better still, this year’s earnings-per-share growth is hampered by a higher tax rate stemming from the reversal of a deferred tax valuation allowance late last year. Companies must take such an allowance when it is “more likely than not” that future net income will be insufficient to use deferred tax credits before they expire. Reversing such an allowance is a signal that management expects future profits to be better than previously thought. Further, until the tax rate is normalized the underlying earnings growth is understated. On an apples-to-apples tax basis, earnings per share would have grown 36% in the first six months of 2008 — twice the reported growth rate. The company also increased its free cash flow guidance, even after boosting planned capital expenditures. It now expects free cash flow to be in the range of $350 million to $390 million after capital expenditure of $185 million.

At the midpoint of its free cash flow guidance, Crown is yielding 8.3% of its market capitalization — a solid premium over the yield on five-year Treasuries. At 14 times the 2009 consensus estimate (at the very low end of the company’s five-year P/E range), it is hard to argue that investors have priced in significant growth.

Disclosure: At time of publication William Trent has no financial position in the companies mentioned.

Related Stocks:  AAPL

With consumers under duress, it is likely wise to avoid consumer-discretionary stocks, especially those in companies that sell goods that cost thousands of dollars. But few fortunes are made by following conventional logic, and often investors must look for unconventional opportunities that may be unfairly priced. I think Polaris Industries (PII) may be one such opportunity.

Polaris make all-terrain vehicles (ATVs), snowmobiles and motorcycles and markets them — together with related replacement parts, garments and accessories — through dealers and distributors principally located in the United States, Canada and Europe. Its primary competitors include Arctic Cat (ACAT) , Bombardier and Honda Motors (HMC - Annual Report) .

Polaris shares are down 20% over the last year, as investors appear to expect a slowdown in sales and profits. Yet those metrics are rising. Second-quarter sales were up 21%, and earnings were up 16% compared to last year. The earnings beat the consensus estimate by 4 cents, and the company raised its full-year guidance by a similar amount.

Polaris’ strength is being driven by sales of ATVs, which account for two-thirds of total revenue. In particular, the company’s popular Ranger and RZR brands of multi-passenger “side-by-side” ATVs have given the company the top market share in that category. Polaris grew sales of its side-by-sides by more than 50% in the latest quarter, even as the overall ATV industry has been essentially flat. On the recent conference call, investors heard that channel checks indicate continued supply shortages. With the hot side-by-side ATVs in short supply, moderating sales would simply bring supply and demand into balance.

Over the last 12 months, Polaris generated $140 million in free cash flow, measured as cash flow from operating activity less capital expenditures. At 9.8% of the company’s market capitalization, the cash-flow yield represents a healthy premium to the yield on five-year Treasuries. The company has been using its free cash flow to pay out a healthy dividend (the yield is now 3.5%, itself comparable to the Treasury yield) and to buy back shares. From nearly 44 million diluted shares in 2005, the share count has been reduced by nearly a quarter, to less than 34 million today.

Analysts expect the company to grow earnings by 12% per year over the next three to five years, a rate that is well below the rate that can be sustained given the company’s high returns on equity. I think the estimate is a reasonable one. If growth remains in double-digits, as I suspect, then investors won’t continue to require such a high free-cash-flow yield from the stock. Even at a 7% yield, the risk premium over Treasuries would be 100%, a level often cited by value investors as a target premium.

If free cash flow per share rose by 12% next year, and the shares were priced for a 7% free-cash-flow yield, the resulting $65 share price would represent nearly a 48% premium from the current level. Even if it took five years for the valuation to adjust to a 7% yield, total returns would be 15%-20% annually. With that kind of return, I’d be willing to wait for the valuation to correct.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this column.

Related Stocks:  CAT

On July 23, J.D. Power & Associates cut its 2008 forecast for new light-vehicle sales and said it now expects U.S. sales to hit a 15-year low this year. The new estimate calls for 750,000 fewer cars to be sold than had been estimated as recently as March.

I’m sure that high gas prices are encouraging marginally more use of alternatives such as car-pooling or public transportation, but I also know from experience that those options are not always viable even if desired. Commuting and work schedules vary widely, so finding someone going your way at the time you need is often all but impossible. So I read the decline in new vehicle sales as a different kind of cost-cutting — namely, keeping a perfectly good older vehicle for a little longer. In other words, the average age of a U.S. vehicle is likely to increase somewhat from the current 9.2 years. And, of course, an aging vehicle requires more repairs. Even cost-conscious consumers may decide it is worthwhile to get the car tuned up and eke out an extra mile per gallon. That, in turn, should benefit companies such as Advance Auto Parts (AAP) , Autozone (AZO) and Genuine Parts (CPC) . Of the three, I believe Advance Auto Parts is best positioned for gains.

Advance Notice

Advance is the second-largest specialty retailer of automotive parts, accessories and maintenance items to “do-it-yourself,” or DIY, and “do-it-for-me,” or DIFM, customers in the U.S. Its stores carry a standard 16,000 stock-keeping units, or SKUs, on hand and can access another 80,000 for overnight delivery. In other words, if you need a part, Advance can get it for you. The company reports earnings on Aug. 7 and is expected to earn 72 cents a share for the quarter, though that really seems to be just a guess. Advance seems to alternate between missing estimates in one quarter and beating the next.

The full-year numbers should be more reliable, however, and on that basis Advance Auto is expected to earn $2.66 in 2008 and $2.92 in 2009. Both of those estimates have been revised higher over the last 90 days. The revisions, which are in the 3% range, compare favorably with a 1% increase in estimates for Autozone over the same time period and shrinking estimates at General Parts.

At 15.6 times the current-year earnings estimate, Advance Auto Parts is trading at the low end of its five-year valuation range (its average P/E has been 18.4 times). If the company earns $2.92 per share next year, as expected, and trades at that average P/E, the shares could appreciate by 30%, to $54.

Click here for larger image.

Source: Zacks Research Wizard, compiled by William A. Trent

Given that Advance has been improving its returns on capital, I believe that, if anything, it now merits an above-average earnings multiple. For one thing, the rising returns on investment lead me to believe that the 13.7% consensus three-to-five-year earnings growth forecast is, if anything, conservative. If the growth forecasts are realized, however, and the company returns to its average P/E after five years, the shares could reach $93, for total annual returns of 17.5%.

At the time of publication, Trent had no positions in stocks mentioned, although positions may change at any time.

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These are tough times for office furniture makers, which have seen their shares fall 20% to 50% over the last year. A difficult economic environment and poor showings from office retailers such as Office Depot (ODP) have investors worried.

Customers, on the other hand, appear relatively unfazed. Last month, Herman Miller (MLHR) kicked off earnings season with a positive surprise. Last week, HNI (HNI) and Knoll (KNL) followed suit. Only Steelcase (SCS) posted disappointing numbers.

The one that looks most attractive to me is Knoll. The company managed to grow sales by 7.5% compared with last year, and its backlog grew at an even faster 9.7% rate. The growth is significantly higher than that of the industry, which is basically flat. Andrew Cogan, Knoll’s CEO, said, “The strategy we embarked on earlier in the decade to diversify our sources of revenue and profits away from a dependence on North American systems sales and to focus on high design content businesses is paying off in a challenging macro-economic environment.”

Better still, it seems that investors haven’t fully grasped the significance of Knoll’s strategic shift. The stock, which traded at $24 little more than one year ago, rallied after the earnings report but remains well off those highs. Analysts are expecting full-year growth of just 4.1% this year and 0.8% next year, suggesting a slowdown is imminent when the backlog growth is saying exactly the opposite.

Unbought Guidance

The skepticism is so strong that while 2008 earnings estimates have gone up only 12 cents in the last 90 days, the entire increase is attributable to the positive first- and second-quarter surprises. The raised third-quarter guidance, I suppose, is free. Meanwhile, estimates for 2009 have barely moved and at $1.63 are actually lower than the 2008 estimates. So we have a stock with decent sales growth and a string of positive earnings surprises under its belt trading at a single-digit P/E. That in itself is enough to spark my interest.

That spark becomes a flame when I see that the company generated $90 million in free cash flow over the last 12 months, or 12% of the market capitalization. With Treasuries yielding just 3.4%, the 850 basis-point premium is enough to compensate me for Knoll’s risk even if the cash flow remains stagnant. The cash flow has been put to a variety of good uses, including last year’s acquisition of Teddy & Arthur Edelman Ltd. for $71 million and the return to shareholders of more than $65 million through dividends and buybacks. The share count is 2 million lower (about 4%) than it was one year ago.

As I see it, Knoll should trade at no less than 10 times free cash flow, even if the growth potential is limited. Meanwhile, I believe the cash flow can grow, possibly in line with the recent growth in backlog. Under those circumstances, I believe the market cap could be closer to $1 billion than the current $750 million. That would represent a $21 share price, or 34% appreciation from the current level.

Disclosure: At time of publication, William Trent owns shares of Office Depot (ODP)

William Trent currently has a short position in put options related to Office Depot (ODP).

Related Stocks:  ODP

Chart Industries (GTLS) is a leading independent global manufacturer of highly engineered equipment used in the production, storage and end-use of hydrocarbon and industrial gases. As an infrastructure supplier to the energy industry, Chart lies at the intersection of two major investment themes that I think will continue to work for some time.

The advertising bombardment relating to T. Boone Pickens’ “Pickens Plan” can’t hurt Chart. A central component of the plan is to increase the use of natural gas in transportation.

For the Pickens Plan to work, money will have to be spent building out an infrastructure to transport the gas from remote areas to those where it is needed. Enter Chart, which supplies engineered equipment used throughout the global liquid-gas supply chain.

While the Pickens Plan ads may increase awareness of natural gas, Chart has been doing fine without it. Sales grew 24% in 2007, but backlog grew at twice that rate. The current backlog amounts to more than 60% of projected 2008 sales, offering high visibility.

What’s more, demand continues to rise. In a recent note, Lehman Brothers estimated that the expansion plans of a single customer (Energy World Corporation) could mean more than $250 million in additional orders for Chart.

For a company that looks like it can generate 20% annual growth, I don’t really require the free-cash-flow yield to be higher than the 3.2% return on five-year Treasury bills. The growth alone is sufficient reward for the risks involved.

Seen another way, the average free-cash-flow yield in the S&P 1500 Supercomposite is about 3.1%, and the average growth forecast is 14%. With Chart, you get higher growth at a lower valuation.

If Chart can grow its cash flow 20% over the next year and increase its valuation so that the free-cash-flow yield matches the Treasury yield, the stock could more than double in that time. That would make for a (stock) chart I could appreciate.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

General Dynamics operates through four business groups: aerospace, combat systems, marine systems and information systems and technology. The way I see it, the sum of these parts is greater than the whole.

The aerospace division consists of Gulfstream business jets and accounted for 18% of the company’s sales in 2007. I believe investors have some doubts about whether the pace of private jet sales can be sustained in an economic downturn. Although the company’s backlog extends past 2010, investors are likely to react more strongly to new orders than to shipments from backlog. It’s worth noting, though, that more than half of Gulfstream sales are outside the U.S. Another 35% of revenue accrued to the information systems and technology group, which provides electronics and software primarily used for defense purposes.

Combat systems accounted for 29% of sales and produces a variety of products, most notably the Stryker armored combat vehicle that has been so necessary in Iraq and Afghanistan. Stryker shipments under the current contract wind down in 2009, so the group will likely contribute less to future sales for some time, barring an escalation in combat operations. However, the unit continues to develop new systems and is expanding sales internationally.

As combat systems slow, marine systems seem poised to pick up the slack. In particular, production of Virginia-class submarines is now expected to double to two per year by 2011, one year earlier than previously thought. The unit’s 18% share of 2007 revenue should rise in the years ahead.

Sales forecasts through 2009 are more or less in the bag. The company’s backlog at the end of March was $50 billion, and annual sales are in the $30 billion range. What’s more, both orders and prices for aerospace and defense equipment have been increasing rapidly in the last few months. The backlog looks like it could grow still further.

The company has a strong track record of exceeding earnings expectations, and analysts have been raising their 2008 and 2009 estimates over the last three months. Meanwhile, the stock has fallen more than 15% since mid-May. The current valuation could be a strong buying  opportunity.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

“It’s a sucker’s rally,” Kathy Boyle, president of Chapin Hill Advisors, says of this week’s market move.

Band-aids for cancer.

For her latest amazing feat Finerman puts her head directly into the lion’s mouth.

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Also, I’ve added a News Headline section for newly available reports.  You can see it at the top of the right nav bar on the site.  This is updated daily, as new documents, filings, and investor materials become available for all companies in the service.  Just click any headline and it will take you straight to that company’s information.

For stocks, the world is your oyster with ETFs: you can buy sectors like healthcare or energy.  You can also buy into country-specific funds like Taiwan, Singapore, or Brazil, or regional funds like Asia and Europe.

Though Asia and Europe are also mentioned, they do not qualify as “nations.”

Perp-walk is not in the post.