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Companies trading at below net cash on hand are favorite investigative targets of value investors. Back in the Depression era, and during the brief market bottom in 2009, such stocks were plentiful. These days, however, such net cash companies are typically trading below cash for very good reasons, most commonly, because they are losing money and the cash pile is expected to shrink. Nevertheless, once in a blue moon, one comes across a net cash company with actual hidden earnings and growth prospects. ASCMA is one such company.

Ascent Media was spun off in May 2008 from Discovery Holdings (now Discovery Communications DISCA), the largest provider of non-fiction media and entertainment, and the owner of Discovery Channel and Animal Planet. Ascent Media provides support and post-production services to content producers, including digital conversion and enhancement, formatting, and distribution via satellite and the internet to worldwide movie theaters and TV stations. The company has no long-term debt, and total liabilities of $96M is offset by $97M in receivables. This leaves the company with $383M in cash and tradeable securities (consisting of diversified corporate bond funds), plus another $190M in long term assets. All this is currently trading at a market capitalization of about $370M, or below net cash. This means that we essentially get the $190M of long-term assets for free!

Why is ASCMA so undervalued? Firstly, it was spun off in 2008 through distribution of ASCMA shares to shareholders of Discover Holdings. Many of those shareholders found themselves holding shares of a business they did not fully understand nor want to understand, and proceeded to sell the shares indiscriminately. The resulting rapid decline in the stock price has baked in low expectations for this company. Also, as a newly spun-off company, there is no analyst coverage. Secondly, there are no comparable publicly traded companies on which one can benchmark. Most post-production houses are in-house divisions of large motion picture companies such as Walt Disney and Paramount Pictures, which typically do not break out their financial performance. The closest publicly traded companies are specialized outfits such as Technicolor (TCH) and Dolby Laboratories (DLB), which are not really comparable since ASCMA owns a much broader set of post-production companies and is more diversified. Lastly, the turmoil brought about by the 2008-2009 financial crisis has also taken a toll on its business. Advertising rates have plummeted, and processing of commercials have historically contributed as much as half of ASCMA’s revenue. (However, anecdoctal reports suggest that TV advertising rates will recover this year.) Mergers of cable companies have also weakened ASCMA’s negotiating position for its services. Certainly, the fact that ASCMA had an net loss of $50M in 2009 has scared away all weak hands.

What is the value of ASCMA’s $190M worth of long-term assets? ASCMA’s assets are mainly property and equipment at approximately 56 sites worldwide, including a satellite earth station in Minnesota, and leased satellite facilities in Singapore. With these facilities, ASCMA provides a variety of post-production services, including converting film into digital masters, digital enhancement and special effects, formatting content and commercials into a continuous feed for TV and cable, and distribution of commercials and shows worldwide through satellite and Internet. It also occasionally provides engineering consulting to companies who are trying to design multimedia delivery networks, such as Motorola. The profitability of this business is hard to estimate. Certainly, recent performance has been dismal, given that in 2009, ASCMA had a net loss of $50M. There appears to be 2 main reasons for this lack of profitability. Firstly, in 2009, there was a dramatic drop-off in the engineering consulting business, and more modest declines in other lines of business, which is understandable given the 2009 economic climate. Secondly, Discovery seems to have acquired its ASCMA assets in a piecemeal fashion with no real attempt to streamline costs, and as a result, there may be duplicative assets and inefficient cost structures.

However, I am optimistic about the value of the $190M of long-term assets. Management has stated that it is streamlining operations, and indeed has been selling off assets. Due to these asset sales, despite losses in operations, the cash pile has actually grown from $200M in 2007 to over $300M in 2010, which is definitely atypical of companies trading at net cash. Notably, all recent asset sales have resulted in ASCMA booking gains, an amazing feat considering that these sales took place in a weak economic environment, suggesting that the $190M is an underestimate of the true value. Also of note is that goodwill has been impaired to zero, and the $190M of assets is a fully depreciated estimate of the value of property and equipment, with no accounting for any possible intangible value. However, there is still the matter of whether the asset sales will be sufficient to offset losses at the operating level. Management has articulated a strategy of asset sales to streamline operations, retaining enough assets to provide an end-to-end service to content providers, from post-production processing to distribution, which seems to be a rational strategy. There will always be a demand for post-production services from advertisers and small production houses. Production houses will be leery of contracting these essential processes out to the post-production outfits of major motion picture companies, who are direct competitors. ASCMA is the only major independent post-production company that can provide a full suite of services. It processes about 70% of all TV commercials in the UK and 35% of TV commercials in the US, and also processes major motion pictures such as “The Hurt Locker” and TV productions like “House”. Furthermore, industries relying on creativity, such as the fashion industry and the movie and advertising businesses, tend to be fragmented and stay fragmented, because small outfits with good ideas continually enter the industry. There is no apparent reason why post-production services cannot be run on a profitable basis. There may be a temporary over-capacity due to decline in advertising and content volumes, but as in most cyclical industries, what eventually happens is that marginal and poorly-capitalized providers are shaken out of the system, and the supply-demand equilibrium is restored. Based on ASCMA’s first quarter 2010 results, it appears that operating performance is near break-even, and cash flow is actually positive again (even after excluding asset sales). While the value of ASCMA is hard to estimate, I think that asset sales of duplicative assets will more than make up for operational losses while the company and the industry as a whole streamlines into a more sustainable cost structure, and therefore I estimate that ASCMA should be worth its book value of around $570M ($380M cash plus $190M assets), or about $40 per share, a gain of 50% from its current price. This is obviously just a stab at valuation. The key point is that the cash pile is growing and not shrinking even in a weak economic environment, although the cash levels may be very volatile based on the timing of asset sales and business recovery.

Is the current management capable of carrying out its strategy? The major shareholder is John Malone, who owns 80% of the Class B supervoting stock in addition to Class A ordinary stock, and has 30% of the voting power. Malone is a veteran businessman in the media business, having been CEO and Chairman of Liberty Media and DirectTV. Malone is known to be an aggressive businessman with a keen eye for value. Interestingly, Malone has recently spent $1M of his own money to purchase even more shares of ASCMA. Another interesting name that caught my eye in the shareholder list is Mario Gabelli, a notable value investor who owns 8.8% of ASCMA. With these two veteran value-oriented investors guiding capital allocation decisions, I am confident that ASCMA will emerge as a streamlined, cost-efficient, and cash-rich post-production services company.

What are the risks associated with this investment? As with investments in any cash-rich company, there is always a cash-conversion risk, where management can squander cash on a bad investment. However, given the business reputation of Malone as the controlling shareholder, I think that this is a remote possibility. Secondly, the economy can always tank again, taking advertising rates down with it. But even in this scenario, I think that the cash pile will act as a cushion to further stock declines.

Disclosure : I have a long position in ASCMA.

John Paulson’s recent investment in casino stocks piqued my own interest in this sector, and I started looking for value in some of the smaller cap casino stocks. I believe that with the massive consumer retrenchment last year, 2009 should represent the generational low in casino earnings. Any casino companies that emerge from last year with a clean balance sheet and still making some profits should be well-poised to gain from an economic recovery, and should be able to withstand even a double dip recession. I found one casino company that met these criteria, the small-cap stock FLL.

Full House Resorts owns one casino, Stockman’s Casino in Fallon, Nevada. It also manages two other casinos, Harrington Raceway and Casino, in Harrington, Delaware, and FireKeeper’s Casino, in Battle Creek, Michigan. As of Mar 2010, the company has $12M in cash, and no long term debt. Stockman’s Casino is FLL’s smallest casino at 8400 sq ft. It has 280 slot machines and 4 table games, a keno table, and a fine dining restaurant. Stockman’s is the largest of several casinos in the city, commanding approximately 36% of slot revenues in the city. Stockman’s was acquired by FLL in 2007 for $28M, when it had a net operating profit of $2.5M. In 2009, Stockman’s net profit has declined to $2M annually, although it is gaining market share in the city of Fallon and profits are expected to stabilize. FLL also has a management contract with Harrington Raceway Inc., the owner of Harrington Raceway and Casino. Harrington’s Raceway and Casino occupies 35K sq ft, with some 2100 slot machines, an entertainment lounge, a 350 seat buffett, and a 50 seat diner. The management contract has been in place since 1996 (and will expire in Aug 2011), and pursuant to the contract, FLL receives a management fee based on Harrington Casino’s annual revenues and operating profit, and the fee is contractually guaranteed to increase at least 5% per year. The management fee from Harrington was 4.9M in 2009. Harrington faces strong competition from nearby casinos in Delaware, and probable new casinos in Maryland, and revenues are expected to hold steady or decline. Lastly, FLL also has a seven year contract to manage the FireKeeper’s Casino in Michigan, which is owned by the Michigan Tribe. FireKeeper’s Casino is the largest casino that FLL runs. At 230K sq ft, it has 2680 slot machines, 78 table games, 12 poker tables, 5 restaurants, and is expected to attract 2.9M visitors annually. It is the only casino within 100 miles (although there is a new Indian casino under construction some 70 miles to the north), and has just opened in Aug 2009. The management contract expires in Aug 2016, and FLL gets a 26% cut of net operating profits after all expenses and interest costs have been paid, with the Tribe getting the remaining 74% of profits. The fee must split 50% with RAM, a partner which contributed initial capital to the FireKeeper’s Casino, although the split will be adjusted to 70-30 in favor of FLL once RAM has fully recouped its initial investment. In the months since the opening of FireKeeper’s Casino, management fees to FLL have been running at 1M per month. However, RAM is expected to recoup its investment inside of 1 year, and FLL will then be receiving 1.4M monthly, for an annual fee of approximately 17M. FLL has 12 employees, 6 senior management, and 6 support personnel, operating out of a small leased office in Las Vegas, Nevada. Corporate expenses run at about 4 to 4.5M annually. Thus, the net income from FLL is about $19.5M, minus 35% for taxes, or about $12.5M in owner’s cash flow.

FLL’s current market cap is about $57.5M. If you subtract $12M in cash, this means that the market is valuing FLL’s cash flow at only $45.5M, or about 3.6 times earnings, an earnings yield of some 27%. How can such a bargain exist? I believe that several factors have led to this mis-valuation. Firstly, FLL is a micro-cap company in an unpopular sector, with zero analyst coverage. Secondly, the completion of FireKeeper’s Casino, the major cash flow contributor to FLL, has been delayed repeatedly, and has finally started operations less than 1 year ago. Therefore investors may not have had time to re-calibrate their expectations. Thirdly, the casino management business model, while less capital-hungry than outright purchase of casinos, may produce a less consistent cash flow, as management contracts have to be re-negotiated when they expire. We can however, make some conservative projections. Lets say that 2009 is the lowest point in casino earnings, and earnings are expected to remain at 2009 levels even in a double dip recession. Lets also assume that when Harrington’s contract expires in 2011, due to a combination of stronger competition and contract renegotiation, earnings from Harrington’s drop from $5M to $3M. Assume further that in 2016, when the FireKeeper’s contract expires, it is also renegotiated downwards. The management cut in Indian casinos tend to range from 20-30%. However, in 2016, FLL will no longer need RAM as a capital-contributing partner, and will be able to capture the full management fee instead of just 70%. Furthermore, any new management company will have to rebuild a certain amount of infrastructure, and therefore is expected to compete at a disadvantage to FLL for a renewal. If the cut decreases to 20%, but FLL now captures 100% of the management fee, the cash flow to FLL will actually go dramatically up, rather than down. Even under reasonably pessimistic assumptions, beyond 2011, corporate expenses will be covered by the cash flow from the Stockman’s and Harrington casinos, leaving fees from FireKeeper’s as pure profit, which is likely to run at $15-25M, minus 35% for taxes, for a free cash flow or $10-16M. I believe that the cash flow will bottom out at $10M, and is likely to rise substantially above that in an economic recovery scenario, possibly as much as $20M. If we apply a PE of 10 to a lowball cash flow of $10M, we arrive at a target capitalization of $100M, plus $12M in cash, for a total of $112M, or a $6.22 share price, about double current price.

What are the potential catalysts for re-valuation of this stock down the road? Firstly, the CEO has been purchasing stock for his personal account, and the company has been repurchasing stock in the recent past (the company repurchased 1.2M of shares at $1.21 in 2008, shrinking the share base to 18M), and stock repurchases are ongoing. All this stock repurchases will further increase the EPS. Secondly, 2011 is expected to be a bumper year for FLL even in a recession. Earnings from Harrington’s is going to increase to its peak just before contract expiration due to the 5% mandatory minimum increase, and there will be a reset of the FireKeeper’s split from 50-50 to 70-30. Therefore, some eye-popping EPS numbers are likely to be recorded in 2011, which will likely finally register with some investors.

In summary, I believe FLL to be conservatively worth at least $6.22 per share. FLL has a completely clean balance sheet and strong cash flows, and will have positive cash flow even in a double dip recession. In the event of an economic recovery, just a modest increase in casino revenues over 2009 is likely to propel FLL substantially above $6, perhaps even to $10-12.

Disclosure : I have a long position in FLL.

An enduring principle in value investing is to buy at the point of maximum fear. When a company becomes embroiled in complicated and uncertain legal troubles, it becomes shunned by Wall Street, and its stock can often be bought at unbelievable bargains. Such stocks often rapidly regain their true value as soon as the legal troubles are cleared up. A discerning investor who is able to correctly analyze all the legal issues involved and predict a probable outcome may be able net a spectacular return in a relatively short time. Cardiac Science (CSCX) is a company in such a situation.

Cardiac Science is a company that primarily makes automatic external defibrillators (AEDs). AEDs are required to treat people suffering from sudden cardiac arrest (SCA), which is a sudden electrical malfunction of the heart that causes cardiac arrest. A cardiac arrest is different from a heart attack, where blood flow to the heart is impaired. A cardiac arrest may be caused by a heart attack, or a heart may simply spontaneously develop an abnormal electrical rhythm and stop beating normally. If heart contraction does not resume within 4 minutes of arrest, the patient suffers irreversible brain damage, and death occurs rapidly thereafter. Due to the extremely short window during which medical treatment must be administered, the mortality rate for SCA is 95% for an out-of-hospital attack, whereas immediate treatment with an AED brings mortality rate down to 50%. An AED is able to automatically detect whether abnormal heart rhythm is present, and will give an escalating series of shocks to restart the heart, and will not shock the heart if abnormal rhythm is not present. Modern AEDs are safe enough to be used by even untrained personnel, and AED use is covered by Good Samaritan laws, which prevent liability for AED users if the device is used by volunteers in good faith. All emergency response personnel are equipped with AEDs, and laws mandate that AEDs be available at schools, cruise ships, airports and bus terminals.

CSCX sells the well-regarded PowerHeart AEDs, and holds a wide range of patents relating to AED technology, including patents on software that allows AEDs to self-test frequently, and patents on AED mounts that sound an alarm and automatically alert emergency services when opened. CSCX was experiencing rapid growth in sales as a result of laws mandating AEDs in various buildings. However, in 2009, it was revealed of its entire installed base of 300,000 AEDs manufactured before August 2009, approximately 1 in 75,000 contained 2 components that could fail, and this has resulted in a failure to deliver therapy in 2 cases over the past 6 years. The company suspended production for 5 weeks as it sourced alternative components, and resumed production in September 2009. Still, there remains the important problem of 300,000 potentially faulty AEDs in the field.

Under advice from outside experts and lawyers, the company decided that it was irresponsible to recall all 300,000 AEDs when it did not have the inventory to replace the AEDs, and given the low frequency of the failure, it was safer to leave the AEDs in the field than to recall the AED and have the AED unavailable for weeks. A main reason that the faulty components took so long to come to light was that the self-test software had been unable to detect the failure, and the company decided to work on a software update that would detect the failed components, and then specifically replace those AEDs. The software update was completed ahead of schedule in February 2010, just in time for CSCX to be hit with an FDA warning letter, which stated that FDA views the software update to be an unsatisfactory response to the problem, as it only detects the problem and does not fix it, and that leaving faulty AEDs in the field constitutes disregard of public safety on the part of CSCX. The letter threatens possible fines, seizures and injunction for CSCX if the matter is not resolved promptly. The gradually recovering stock promptly took another swoon.

Before the disclosure of the faulty AEDs, CSCX had free cash flow of approximately $12 million in 2008, up from $7 million in 2007. In 2009, CSCX set aside $18 million as liability for the recall, and posted an earnings loss. The company has $30 million in cash, $60 million in book value, and no debt. Currently, CSCX has a market capitalization of almost $50 million. A number of future scenarios are possible

Worst case scenario: FDA gets a court injunction forcing the company into an immediate recall of all 300,000 AEDs, and the company is barred from selling AEDs until the recall is complete. This leads to the collapse of the company, as the company is unable to replace all AEDs, and all $30 million of cash is expended in recalling whatever AEDs it can, leaving no value for shareholders. This scenario is unlikely to happen, as FDA will realize that it essentially means the death penalty for a company with a relatively minor infraction, and is an anti-consumer move since it leaves a huge installed base of AEDs without future service and support.

Medium case scenario: FDA fines the company $10 million for the delay in recall. The company spends $50 per AED to roll out its software update and replaces faulty AEDs, at a total cost of $20 million. This consumes all of its cash. Reputational damage results in severe decrease in sales, resulting in a 60% drop of free cash flow to $5 million annually. Applying a PE of 10 to that cash flow brings us to the current $50 million market capitalization.

Best case scenario: The company rolls out its software update to all AEDs, and expends $20 million in so doing. All faulty AEDs are replaced. The FDA is satisfied that this is a reasonable and responsible course of action, and fines the company a relatively modest $5 million. Reputational damage is minor, leading to a free cash flow of $10 million. Applying a PE of 10 to that cash flow brings us to $100 million market capitalization, a double from current levels.

Given that there has been multiple recalls of other brands of AEDs recently, and that Cardiac Science has a longstanding reputation as a purveyor of quality products, I believe that CSCX will survive this crisis in good shape.

Risks : CSCX is at risk of monetary fines and injunctions from the FDA.

Disclosure : I have a long position in CSCX.

Over the weekend, I was inspired by several blogs (The bull case for Conn’s; How to Analyze Receivables & Inventory; Conn’s Inc.) to dig further into the annual reports of the company CONN. What I found was very interesting, and highlights the dangers of investing blindly solely on the basis of financial numbers, without peering deeper into what those numbers mean.

Conns is a retailer of electronics and electrical appliances, with 75 stores in Texas. On casual inspection, the company appears to be moderately undervalued. On an asset basis, Conns has a book value of $337 million, compared to a current market cap of $102 million. On a cash flow basis, Conns has had declining earnings for years, earned $25 million in 2008, and will probably earn $2-12 million in 2009 (depending on whether one calculates on an earnings or cash flow basis). The problem, as has been pointed out before, is that Conns relies heavily on extending credit to its customers to buy its products in its business. Therefore, Conns is a combination of a retailer and a bank, and both parts of its businesses should be examined.

The electronics retail industry is a cut-throat one, as seen by the bankruptcy of Circuit City. While some have argued that Conns should gain additional market share with the demise of Circuit City, revenue has been declining in 2009 versus 2008, suggesting that Conns is losing market share instead. I detect no obvious reason why one would want to shop at Conns versus, say, at Best Buy or Walmart, except perhaps for its more generous credit policies. In the most optimistic scenario, disregarding finance charges, free cash flow is about $12 million. However, current trends of declining revenue suggest that this will further decline in 2010. The upshot is that the retail business is poised to generate rapidly declining cash flows, and the bulk of the intrinsic value of Conns is in its assets.

More than 50% of sales at Conns is financed by Conns itself. In the past, Conns has offloaded credit risk to other investors by securitizing the loans and selling them in the secondary market. Typically, such securitization deals are structured as a trust with various tranches, and the most toxic tranche which bears the risk of first loss is usually retained by the originator, as a guard against reckless underwriting. Conns has almost $150 million of these toxic securitized interests on its books. Since the collapse of the securitization markets, Conns has been unable to offload loans off its books, and hence customer receivables have been building up at a startling rate of more than 100% in a year, reaching $136 million in 2009. To finance these receivables, Conns has been drawing down its line of credit.

Clearly, Conns entire business model was based on easy credit and is now unsustainable. At some point, banks will stop extending credit to Conns, and Conns will no longer be able to extend credit to customers. The ensuing loss of 50% of revenue will be a great challenge to most businesses, and will be fatal in an industry with razor thin margins like retail. Banks and creditors will demand an immediate liquidation to protect their assets. The $150 million of securitized on its books are likely to be worth zero, given that even modest 5-10% losses in the underlying loans will likely wipe out the entire toxic tranche. The other $136 million of customer receivables will likely be sold under duress, generating an additional haircut on top of credit losses on the receivables, so I estimate a value of 50% recoverable ($70 million). I estimate that the value of inventory and cash will cover current liabilities, while the long term liabilities of $120 million will be partially covered by the sale of $60 million of hard physical assets (stores, equipment and land), held on the books at cost. In the best case scenario, the physical assets are sold at prices way above their book value (likely but not completely certain), meaning that after liquidation, the company has residual value of about $70 million derived from its customer’s receivables. This exact scenario, while speculative, is not particularly far-fetched, and is the primary reason why the company is now trading at a value of $100 million market cap, and has an incredible 44% short interest despite this. In summary, stay away from this company.

Stock Investment Risks: This is a retailer with a broken business model in its terminal spiral of death. Enormous uncertainties surround the recoverable value from the enterprise.

Stock Investment Disclosure: I have no position in CONN.

Share prices of companies that make industrial equipment tend to be very volatile. These companies are especially dependent on a healthy economy, and every time a new batch of economic statistics is released, the share prices of these companies gyrate wildly depending on the prevailing mood. However, to investors willing to take a longer-term perspective, the wild price swings in conservatively managed equipment manufacturers can be a source of great opportunities. One such company is Chart Industries (GTLS).

GTLS Stock Analysis:

Chart Industries is a company that makes equipment for the production, transport and storage of industrial gases. Its products include equipment such as cold boxes for liquefaction of gases and pressurized cryogenic cylinders for gas transport, and Chart Industries is the leading supplier in several of these product segments. The largest portion of their sales come from natural gas related businesses (62%), with the second largest segment being businesses that produce cryogenic gases (25%, mainly liquid nitrogen), and the smallest segment being businesses that produce medical respiratory gases (13%). About 65% of sales come from outside the US, but it is the US market that has the largest potential for growth, with the discovery of large natural gas deposits in the US and the tantalizing possibility of US energy independence.

Recently, enormous deposits of natural gas have been discovered in shale rock in Pennsylvania (the Report in New York Times). The natural gas deposits are large enough to theoretically power all cars in the US if the entire fleet is converted to use electrical power, thus ending US dependence on foreign oil. In addition, natural gas is a greener fuel than oil or coal, producing less carbon dioxide per unit energy released. The major obstacle to widespread use of natural gas is that utilization of natural gas requires expensive investment in equipment to liquefy, store and transport the gas. However, given that the alternative is funding expensive wars in foreign countries, there has been increasing talk of embarking on a large scale natural gas initiative in the US (a related report in New York Times), which, while expensive, would provide employment and energy security for the US.

Chart Industries has been consistently profitable through the financial crisis. Analysts predict that revenues will continue their decline in 2010 and 2011, though the company is still expected to be profitable. The company currently trades for $470 million, about 1x book value. I am predicting a free cash flow of $50-70 million conservatively, meaning that the company is now trading at below 10x earnings. The company has $190 million in cash, and $240 million in long term debt ($160 million due in 2015, $80 million due in 2012). I believe that the company has tangible assets (factories) and intangible reputation that is difficult to replicate, and that it will easily survive the downturn to capitalize on the growth industries of the future.

Stock Investment Risks : The company is in a cyclical industry, and is tied to commodity price swings. Share price also tends to be highly volatile due to low float.

Stock Investment Disclosure : I have a long position in GTLS.

Harvest Natural Resources (HNR) is an oil producer whose major oil producing assets are located in Venezuela, where it is subject to confiscatory taxes or outright nationalization by Hugo Chavez. Its major attraction is it cash-rich and debt-free status. HNR has approximately $2.85 per share in cash free and clear. The rest of HNR’s value derives from possible cash flow from its Venezuelian assets, as well as oil exploration projects now ongoing in other parts of the world.

HNR has been extensively written up previously (see this excellent article at Seeking Alpha, as well as writeups at Value Investing Club), and I agree with the central theses of these articles. In a nutshell, although contract law does not exist in Venezuela and cash flow is likely to fluctuate according to the whims of Chavez, it is unlikely to drop to zero. In other nationalizations that Chavez has ordered, the companies have been reasonably (but not lavishly) compensated for their losses, and have generally found it desirable to continue operations at low to moderate levels of profitability, if only to extract residual value from their now annexed assets. Chavez is a power-hungry thug, but he also understands that he needs foreign expertise to continue to extract money from Venezuela’s natural resources, and he is intelligent enough to realize that if he wants somebody to work for him, he has to pay them at some level.

My main purpose for investing in HNR is that it is a low-risk high reward way to hedge inflation risks and ride any upside in oil price. HNR should not fall past $3 due to its cash, but can possibly ride up to $10 or more depending on prevailing oil price and Chavez’s whims. I believe China will now vigorously diversify away from its huge US dollar exposure by aggressively bidding for commodities as well as commodity-producing assets. Rather than buying gold (a non-productive asset, and one in which China found impossible to accumulate holdings of any size without moving the gold price), China could stockpile crude oil (a productive asset, and one with a much deeper and broader market) and build a Strategic Petroleum Reserve much like the US has done. Stockpiling an essential input to its economy at historically cheap prices makes a lot of economic and military sense. Along the same lines, I also have positions in ZINC and MEOH, both of which are premier companies in their industries and should serve as excellent inflation hedges.

I now hold HNR at an average buy-in price of $5, and am unlikely to liquidate this position without hitting at least $8-10.

Biogen Idec (BIIB) is a biotechnology company with two major products, Avonex (an interferon), which treats multiple sclerosis, and Rituxan (a monoclonal antibody), which treats non-Hodgkin’s lymphoma. Near-term growth is likely to come from the drug Tysabri, another monoclonal antibody meant for treatment of multiple sclerosis. Tysabri was withdrawn from the market after several clinical trial patients developed progressive multifocal leukoencephalopathy (PML), but was later reintroduced into the market when FDA determined that the benefits outweighed the risks. Despite a few additional reports of PML, sales of Tysabri have grown rapidly, and the company has a robust pipeline of potential drugs. During the wave of pharmaceutical-biotech mergers that took place in 2008, BIIB’s stock was driven into the $80s as its acquisition by a major pharmaceutical company was widely anticipated. BIIB plummeted when it’s CEO revealed that there were no buyers willing to bid for Biogen. A major factor for the lack of bids is believed to be the complicated contracts covering its two main products. Both products were co-owned or co-marketed with other major pharmaceutical companies, which means that much of the value will be derived from the pipeline of drugs, which is highly uncertain. However, I believe that the decline has overshot, and based on the cash flow potential of Biogen’s 3 major drugs, even assuming a zero value for the pipeline, the stock is siginificantly underpriced. With analysts estimating an EPS of $3.70-$4.30 for the current year, and minimal 10% growth in profits year over year, BIIB is trading at a conservative PE of 11-12 at a share price $45-46. Furthermore, BIIB is in the drug industry, which tends to perform adequately even in recession. The biotechnology industry in particular is a coveted segment of the drug industry, as FDA has not provided a process for the testing and manufacture of biotechnology drugs, which are significantly more complicated to manufacture than simple chemical drugs. This makes it very likely that even off-patent biotechnology drugs will remain very lucrative, which is a major reason for the recent acquisition of biotech companies by traditional pharmaceuticals.

Fresh Del Monte Produce Inc (FDP) is a vertically integrated producer of fresh and canned fruits and vegetables. While most fruits and vegetables require minimal processing and are typically shipped directly from local farmers to supermarkets over several hundred miles, some produce (notably bananas) are shipped over thousands of miles and/or require canning and extensive processing, and therefore require an intermediary which can handle these diverse operations. FDP owns and operates ocean freighters, land trucks, distribution depots, canning/juicing factories, and of course, farms. The chief attraction of FDP is that it is in the recession-proof food business. Analysts are predicing EPS of $2.00 to $2.40 for 2009. I estimate that FDP will sustain a free cash flow of at least $1.50 per share in 2009. With a modest $150 million in LTD (1.5x annual free cash flow), FDP is trading $15-16, which is around PE 10 off my conservative estimate of FCF, and has insider trading at the $14.50 level. I have a largish position in FDP at a small loss, and intend to add more if the price drops further.

Regal Entertainment group owns the largest theatre network in USA, mainly under the Regal Cinemas and United Artists brand. I initiated this position due to the reputation of movies being a robust industry in a depression, and also because I had a price target of $15, which is a PE of 20 over its previous year’s EPS of $0.73. During the two months when I held it, the stock has underperformed the general stock market, and does not appear to be moving towards the price target. I liquidated my position for a small profit of 6% over 2 months. Perhaps the threat of Internet distribution of movies is threatening the core business of RGC, or perhaps a PE of 20 is simply too rich in this climate. I chalk this one up as a miss.

Ball Corporation is a major manufacturer of metal and plastic packaging for food manufacturers, with a minor business in aerospace and defense. Almost 80% of revenues are derived from making aluminum cans for beverages, with the remaining 20% from plastic packaging and the aerospace business. A significant amount of revenue is derived from sale of beer cans, with Ball having 30% of the US market. This is largely a mature industry, although there are small pockets of innovation and higher-than-normal profit niches, such as the introduction of vented wide-mouth cans for pouring, and cold-activated cans. Profitability is dependent on the price of aluminum and demand from major customers such as Coors and Miller.

Free cash flow in 2008 came in at around $300 million, or $3.20 per share. Analyst estimates for 2009 range from $3.70 to $4.00. Assuming an EPS of $3.50, BLL should trade at $35 at a PE of 10, $44 at a PE of 12.5, and $53 at a PE of 15. There appears to be major support at $37.50, and some resistance at $44. Given the recent improvement in economic conditions, it is likely that demand for its product will show a slight improvement. For an established company in a defensive industry, despite a moderate exposure to commodity price swings, I feel that a PE of 12.5-15 is reasonable. I have initiated a position at a price of $41.50.