L&L Energy ( Nasdaq - LLEN ) -- Picks Up the Pace

L&L Energy (LLEN $1.90) reported excellent on target Q2 (October) results.  The company also completed an effective asset swap, acquiring two high potential coal mines that are in an early stage of development in exchange for a coking plant and a more mature mining operation.  That transaction also included a common stock component, which was valued at a premium because it enabled the other party to move money out of China by trading the shares in America.  L&L Energy is based in China but is managed by an American team.  Earnings from the previous asset mix nearly doubled to $.21 a share on a 9% increase in sales ($45.5 million).  A higher proportion of coal sales accounted for the rise in profit margins.  The coking facility (preparing coal for steel making) suffered a decline in the period due to weaker economic growth in China.  Washing and distribution services (provided to small third party coal producers in the region) additionally marked time. 

The new mines promise to boost overall results immediately.  Both have been developed on a limited basis to date, but the infrastructure has been created to facilitate mechanized operations.  L&L Energy hopes to lift output substantially over the coming year.  Our fiscal 2013 (April) estimates could be understated.  Sequential gains are likely even if the mines are not expanded.  Incremental improvement has the potential to be meaningful since margins on coal sales are relatively high.

The Chinese coal market is heating up again.  Overcapacity plagued the industry earlier in the year as the economy stalled.  New political leadership has assumed the helm in China.  Stimulative measures are being introduced to enhance economic growth in upcoming periods.  Coal prices have firmed in recent months.  Inventories are being worked off as the winter heating season kicks in.  If prices advance further L&L Energy's margins could widen.

Earnings are poised to accelerate even if coal prices don't improve.  Higher coal production from L&L Energy's new and existing mines are likely to deliver substantial bottom line improvement.  More wholesale deals, which yield low margins but help the company market its own output by raising overall volume, could support rapid top line gains, as well.  In the absence of additional property acquisitions we estimate fiscal 2014 (April) income will climb 50%-75% to $1.25-$1.50 a share.  Revenues have the potential to jump 35%-50% to $275-$300 million.  A higher stock price could lead to even faster growth by facilitating the acquisition of larger properties.  Sellers are attracted to the company's U.S. based stock, which provides a mechanism for escaping China's rigid currency controls.  Government regulations are forcing the industry to consolidate, moreover, creating an additional tailwind.

Currency controls do limit L&L Energy's ability to repatriate cash to U.S. stockholders.  The stock itself can be sold without consequences.  But dividend payments and other cash transfers likely would be taxed at a 35% exit rate.  Those payments might not be deductible for U.S. income tax purposes.  In 2-3 years a more realistic system could be implemented as part of an overall treaty between America and China.  Failing that, L&L Energy has plenty of opportunity to reinvest earnings at a high rate of return in China, improving the company's overall value.

( Click on Table to Enlarge )

 

Foraco International ( Toronto - FAR ) -- Burns the Midnight Oil

Foraco International appears on track to produce good on target Q4 results.  The company is a leading provider of drilling services used by mining companies to identify new deposits.  More than 75% of its business is derived from major mining companies.  Those companies are better capitalized than so-called junior operators, and while they have scaled back in the face of declining economic activity their exploration efforts tend to remain consistent over time.  Even the majors deferred projects and cut back spending in other ways during the September period.  That caused Foraco to operate at 65% of capacity, instead of a predicted 75% rate.  Foraco works in both the northern and southern hemispheres, so some of its rigs always are idle due to weather conditions. 

Fourth quarter performance probably will dip sequentially due to the holidays, as well.  A 55% utilization rate seems realistic, in light of the fact overall industry conditions remain sluggish.  Budgeting plans now are being set for 2013, though, and Foraco's customers have begun to move forward now that conditions have stabilized, albeit at a reduced level.  Pricing is apt to be lower than in the past.  But Foraco focuses on the high performance end of the market where competition is less intense.  So decent margins are likely to be sustained.  Last year the company purchased 51% of a Brazilian driller.  The final 49% is expected to be bought out at the end of 2012.  Those revenues already were reflected in the company's accounts.  But the incremental earnings will be included now, too, bolstering bottom line results in the year ahead.

We estimate that income will rise modestly in 2013 to $.40 a share.  A year of consolidation could improve Foraco's competitive position, laying the groundwork for a stronger advance if the mining industry returns to normal in 2014.  Demand for metals is virtually certain to rise over the next decade as emerging economies mature.  At the stock's current price substantial appreciation potential could be realized.

 

( Click on Table to Enlarge )

 

Sevcon ( Nasdaq - SEV ) -- Customers Retrench

Sevcon (SEV $3.75) reported lower than expected Q4 (Sept.) results.  Earnings were bolstered by a non-recurring gain caused by the company's decision to close its pension plan.  Required contributions were skyrocketing due to plunging long term interest rates.  That saved Sevcon $.15 a share.  Non-recurring inventory adjustments clipped income by $.06 a share.  Reported earnings were $.08 a share.  Adding everything together, the company essentially broke even during the period.  Lead times dwindled to 4-5 weeks from a more typical 6-8 weeks.  Sevcon did generate good results in the forklift and motorcycle markets.  But the larger off road (construction and mining) and automotive segments posted large declines.  The off road business suffered from poor macro economic conditions.  The city car operation experienced a setback due to re-engineering issues by Renault.  Demand in that line appears likely to recover in upcoming periods.

Sevcon is continuing to expand its engineering force.  The company historically has focused on control systems for electric vehicles.  That emphasis will be continued.  Electric off road machines already have demonstrated superior price performance characteristics.  And automotive demand is poised to increase in response to rising (fleet) fuel efficiency standards.  Sevcon's expansion is aimed at the high potential hybrid sector.  That technology delivers good performance and attractive pricing while being compatible with the existing re-fueling infrastructure.
 
We have reduced our fiscal 2013 (Sept.) estimates.  Sevcon has several high potential projects in the pipeline.  But poor macro economic conditions could cause those programs to be delayed or scaled down.  Existing business is difficult to predict, as well, for the same reason.  The long term outlook remains bright.  Ineffective government involvement presents a risk, however.  And with the re-election of Barack Obama it's hard to see reason why that participation will yield better results in the future.  Despite the government's negative showing the industry remains likely to make progress over the next several years.  Sevcon has a very small share base, so it won't take much to get the stock moving.

( Click on Table to Enlarge )

 

3-S Bio ( Nasdaq SSRX ) -- Acquisition of the Company Remains Likely

3-S Bio (SSRX $13.25) reported excellent on target Q3 results.  The company accelerated research and marketing in the period.  That caused income to finish relatively flat with the prior year at $.22 a share.  Revenues improved 22% to $28.7 million.  Further margin compression is anticipated in upcoming quarters.  The Chinese government implemented a national health insurance program in 2010.  That legislation expanded the potential market.  But also gave the central authorities greater control over pricing.  One round of price reductions was implemented last year.  Another is slated for the first half of 2013.  Those will vary by product and they might be phased in.  The ultimate impact is expected to be in the 10% range.

Unit volume continues to expand.  3-S Bio expanded its marketing organization in 2012 to penetrate smaller cities and rural markets.  The company already had a leading market share for its principal products in the major population centers.  Those efforts promise to keep volume rising at above average rates well into the decade.  3-S Bio also tripled its production capacity in 2010.  The company still has ample room to expand within its current facilities.  That should reduce unit costs, helping offset the coming price reductions.

3-S Bio's CEO is leading an investor group to take the company private at $15.00 a share.  An committee comprised of outside directors is evaluating the proposal.  3-S Bio still holds approximately $6.00 a share in cash, following the write-down of an R&D investment.  Other bids are possible.  But the current deal appears likely to proceed in light of the CEO's involvement.

( Click on Table to Enlarge )

 

L&L Energy ( Nasdaq - LLEN ) -- Sequential Gains Likely

L&L Energy ($1.60) appears on track to report solid on target Q2 (October) results.  The company is a Chinese coal producer run by Americans.  Thermal coal (electricity) prices fell during the summer due to a variety of factors.  They've bounced back in recent months.  Metallurgical coal (steel) prices remain depressed.  L&L Energy unloaded part of its metallurgical operation earlier in the year, minimizing the damage from that segment.  A series of acquisitions and divestitures are being made to position the company to take advantage of new government regulations that are slated to take effect in China.  Larger mines are being pursued.  And higher quality coal is being added.  Political (environmental) factors are forcing the industry to discontinue the use of dirty coal. 

Sequential earnings improvement is anticipated.  Our full year (April) earnings estimate is unchanged at $.85 a share.  Faster improvement is possible in subsequent years as the industry consolidates and the Chinese economy keeps growing at a fast pace.  The stock has been under pressure following President Obama's re-election.  U.S. coal producers are likely to feel the heat from tighter federal regulation.  But alternative fuels aren't generally available in China.  Equity values in China have declined across the board following the revent change in government.  The new group is considered to be far less progressive than what many in the country had hoped for.  That may slow the pace of reform.  Economic growth is likely to remain a top priority, though.  And coal is sure to remain a key source of energyin China for decades to come.

( Click on Table to Enlarge )

 

L&L Energy ( Nasdaq - LLEN )

L&L Energy (LLEN $2.00) is a small but ambitious Chinese coal producer.  The company is managed by American nationals who live in China.  L&L has five coal mines with about 75 million tons of reserves.  Coal production represents approximately 30% of sales (60% of earnings).  It also runs two coal washing plants, three wholesale distribution networks, and a coking facility.  Washing eliminates impurities.  Coking produces higher quality coal used in steel making.  Operations are located in the central part of the country, in Guizhou and Yunnan provinces.  That's a relatively new coal producing region.  L&L Energy invests heavily in capital equipment to boost safety and productivity, similar to the more mature mining regions in China.  A lot of the neighboring mines are owned by small under-capitalized operators.  Many of those mine just a sliver of the reserves they control.  They also tend to rely on manual labor and skimp on safety measures.

The central Chinese government established a new road map for the industry in 2009.  It set a goal of consolidating the coal industry into 300 large scale producers with the capital and expertise to industrialize operations, mine more of the nation's untapped reserves, reduce costs, and improve safety.  That program hit a speed bump in 2010 when a series of deadly accidents occurred.  The government shut down large sections of the industry right away, and proceeded to inspect each mine individually before allowing them to start operating again.  In many cases production limits were implemented after the inspections were finished.  Those delays caused a sharp decline in L&L Energy's results in fiscal 2011 (April).  L&L Energy wasn't hit with any sanctions.  But coal output suffered.  The services it provides to other coal producers experienced substantial blows, as well.

Political uncertainty has created regulatory inertia.  The central Chinese government is establishing a new leadership group.  That transition occurs every ten years.  The final roster will become official next month (November 2012).  A high level murder trial delayed the process.  Bureaucrats in charge of the coal industry have tread lightly during the changeover.  That's put a damper on L&L Energy's expansion efforts.  There still exists some risk that the original road map will be changed.  But the underlying fundamentals indicate the industry should resume its march towards becoming more modernized.  Coal accounts for 80% of the country's electricity.  Reserves are high.  Alternatives like oil and natural gas are in short supply.  Economic growth in China has moderated over the past year to a 4%-5% rate (7%-8% officially).  Coal production has trailed development for the past decade, though, so a substantial opportunity exists to displace imports from Vietnam, Australia, and North America.  If costs can be reduced and output raised GDP and employment could benefit.

Acquisitions promise to leverage results.  If the Chinese government continues its existing plan for the coal industry thousands of small producers will be forced to sell out to larger companies.  The consolidation currently is slated to wind up in 2015.  L&L Energy already has made several deals that were simple business combinations, that weren't related to the government's consolidation rules.  Currency controls in China tend to make L&L Energy's U.S. traded stock attractive to prospective sellers.  It's a convenient and legal tool for getting money out of the country.  Future deals are likely to involve stock, cash, and earnouts in combinations that yield immediate bottom line benefits.

Coal prices have begun to strengthen.  L&L Energy is less vulnerable to import competition than much of the Chinese industry because of its location in the interior of the country.  Still, the surge in imports had exerted indirect pressure on prices earlier in the year.  Industrywide inventories have reverted to normal levels, helping profitability improve in recent months.  Costs remain under control.  And more outside producers have been signed up to use L&L Energy's washing and distribution services. 

The long term outlook is bright.  Organic growth is likely to accelerate once the new government takes over and the regulatory cloud lifts.  Further acquisitions already are being pursued.  And overall energy demand continues to rise.  China is aggressively developing its natural gas fracking industry.  That still accounts for a minor part of the total energy mix but it is likely to expand materially over the coming decade.  Serious thought is being given to using that resource for transportation, though, rather than electricity production.  Hydro-electric output already is at full capacity.  And while some solar installations are being built most of the panels made in China still are exported.

We estimate sales will rise 39% in fiscal 2103 (April) to $200 million.  Income could advance 70% to $.85 a share.  Our 2-3 year projection assumes 15 million more shares outstanding than at present, to finance the company's acquisition program.  Sales could reach $500 million to provide earnings of $1.65 a share.  Our baseline case, excluding acquisitions, puts revenue at $350 million and earnings at $1.50 a share (modest share count increase).  Applying a P/E multiple of 7x to the lower figure suggests a target price of $10 a share, potential appreciation of 400% from the current quote.

( Click on Table to Enlarge )

Computer Modelling Group ( Toronto CMG ) -- Market Share Expands

Computer Modelling Group (CMG.to $20.00) appears on track to report excellent on target Q2 (September) results.  Energy prices remain at elevated levels, providing the cash flow to support new development.  And most of the reserves that are being identified these days are difficult to extract.  Computer Modelling is the leading provider of simulation software used by energy companies to maximize production of tar sands, heavy oil, shale, and other challenging targets.Competition is provided by Schlumberger and Halliburton.  Those companies have a large installed base of customers who use their software for so-called "black oil" deposits, which are relatively straightforward to extract.  Both also offer high end solutions.  Those products are less powerful and comprehensive than Computer Modelling's.  As a result, users often spend enormous sums on consultants to muscle the work through.  A growing number of oil and gas developers are switching to Computer Modelling while maintaining their other business relationships with Schlumberger and Halliburton.

At a recent trade show Schlumberger and Halliburton didn't advertise their high end simulators.  Both products remain on the market.  The two giants are becoming resigned to working with Computer Modelling in high end applications, though.  That trend promises to boost financial performance in upcoming periods, particularly in international markets where large national oil companies typically have relied on the majors for one stop shopping.

Our estimates are unchanged.  Future growth could be amplified by a next generation system that is slated for commercial release in late 2013.  Shell and Petrobas are sharing the development cost.  Those companies will obtain first crack at the technology.  But Computer Modelling will retain 100% of the marketing rights with no obligation to pay royalties or any other reimbursement.

( Click on Table to Enlarge )

Points International ( Nasdaq - PCOM ) -- Slower Deal Flow

Points International (PCOM $10.00) appears on track to report somewhat reduced growth in upcoming periods.  We have reduced our financial estimates, accordingly.  The company is the leading provider of loyalty programs for airlines, retailers, banks, and other consumer oriented companies.  Growth has been explosive over the past several years.  Further gains are likely as more companies implement the technology and additional features are introduced. 

Competition is becoming more intense.  Points has several potential deals in the pipeline.  Most of the prospects are large corporations that run their own loyalty programs.  In many cases they employ large consulting companies to help out.  Points's technology is superior.  But it's getting more difficult to dislodge the entrenched consulting companies.  Those firms provide a wide range of services beyond loyalty programs and are using discounts and bundled pricing to retain the business.

Organic growth is being sustained at a 15%-20% pace.  Existing customers are broadening their programs.  And smaller accounts continue to be added.  Growth is poised to moderate somewhat, though, due to the slowdown in landing larger accounts.  The long term outlook remains positive.  Gains are likely to be maintained in the near term but at a reduced rate.

( Click on Table to Enlarge )

3-S Bio ( Nasdaq - SSRX ) -- Receives Buy-Out Offer

3-S Bio (SSRX $13.50) appears on track to produce excellent Q3 results.  The long term outlook remains favorable, as well.  Finances are robust, moreover.  The company holds approximately $7.00 a share in cash.  3-S Bio's chief executive in combination with a local private equity firm recently submitted an offer to purchase the entire company for $15.00 a share in cash.  Several other U.S. listed Chinese companies recently have made plans to go private, as well.  Numerous China based companies have blown up during the past three years due to accounting fraud and other irregularities.  That's caused the value of Chinese shares in general to trade at reduced valuations. 

The American short selling community has investigated 3-S Bio on several occasions.  Nothing out of the ordinary has ever been discovered.  The company is run by U.S. trained scientists.  It's products compete on the world stage.  A major American dialysis company, Davita, recently formed a joint venture with 3-S Bio to take advantage of the high potential Chinese health care market. 

The price being offered appears low.  After the company's cash is backed out the deal values the ongoing business at 8x earnings.  In light of 3-S Bio's growth potential and high likelihood of success a significantly higher multiple appears justified.  Since the company's CEO is part of the buy-out group it's unlikely competing offers will emerge.  Existing shareholders might insist on a higher price.  It's uncertain if the buyers will agree to that, however. 

Financing appears to be in place.  The transaction looks like it has a high probably of going through.  Current holders might want to wait and see if a better price emerges.  The stock still has 10% to go to reach the stated buy-out price.  Investors realistically can hold off to earn that arbitrage income, as well.  More aggressive investors can sell the shares now and reinvest in another Special Situation.

( Click on Table to Enlarge )

Computer Modelling Group ( Toronto - CMG ) -- Energy Prices Reinforce Demand

Computer Modelling Group (CMG.to $18.00) appears on track to produce excellent on target Q2 (September) results.  The year ago period was affected by a temporary decline in perpetual software license sales.  Those generate higher immediate revenue than year to year licenses.  The latter often are more profitable over time, though.  A strong comparison is likely this year.  Demand remains robust because energy prices are high enough to justify new development projects, most of which are complicated and are candidates for the company's technology.  Shale oil, tar sands, heavy oil, and deep offshore programs have begun to dominate the industry's exploration agenda.  It's unknown what the split between annual and perpetual licenses will look like in the current period.  Even if perpetuals fall off again, a solid showing is expected. 

The long term outlook is positive.  Competition remains far to the rear from a technology standpoint.  Shlumberger and Halliburton are resorting to bundling other products with their offerings.  Many customers rebuff the offers because Computer Modelling's technology provides unique capabilities which generate paybacks far beyond any discounts the majors might offer.  Marketing is being beefed up in the Middle East to unlock that geographic market.  Halliburton and Schlumberger have controlled that segment due to longstanding relationships, but new reserves are becoming more difficult to develop even in the Middle East.  A sales breakthrough could emerge over the next 1-2 years.  Venezuela will have national elections later this year.  The incumbent party has boosted spending to help win reelection.  Much of those funds have been sourced from the energy industry.  So Computer Modelling may experience some slow payments as a result.  Venezuela always has paid up in the past, however.  So the potential for write-offs appears slim.

Our full year estimates are unchanged.

( Click on Table to Enlarge )



3-S Bio ( Nasdaq - SSRX ) -- Sales Force Drives Growth

3-S Bio (SSRX $11.25) reported excellent better than expected Q2 results.  Product prices were similar to the year ago period.  Unit growth propelled sales higher by 31% to $28.1 million.  Earnings advanced 38% to $.29 a share.  3-S Bio's leading product maintained its market share at 40%-43%, suggesting robust expansion by the industry overall.  A new product was purchased in the quarter, which will head into general distribution in the September period.  Another product entered Phase 3 clinical trials.  Exports rose 85% and represented 5% of sales.  Volume gains are likely to continue in upcoming quarters as the big increase in sales reps added in 2010 and 2011 continue to improve performance.  More hiring is underway.  The sales force probably will keep growing at least at a 5%-10% pace.  We have raised our 2012 earnings estimate by a nickel to $.95 a share to reflect the sturdy Q2 showing.

Government mandated reimbursement cuts are likely in the September quarter.  China implemented a wide ranging health plan in 2010.  A key trade off for industry participants has been a big increase in the number of people covered in exchange for lower prices.  Another round of price reductions is expected.  The specifics will vary depending on a variety of factors.  But 3-S Bio anticipates an average hit of 10%-20%. 

Manufacturing margins currently are nearly 90%.  That's typical of drug companies around the world.  3-S Bio expanded capacity threefold in 2010 to meet the expected rise in demand the new health care envisioned.  The company still is operating at 50%-60% of capacity.  While margins will be impacted by the upcoming price reductions, rising volume promises to offset the full effect.  More efficient sales operations could alleviate the pressure on margins, as well.  And 3-S Bio is actively seeking additional products to feed through its distribution network.  Meantime, exports to emerging markets like Turkey and Egypt are growing quickly due to the products' efficacy and relatively low price points compared to American and European offerings.

We have reduced our 2013 earnings estimate by a dime to $1.05 a share.  That figure assumes the upcoming reimbursement changes will approach the high end of the range.  A somewhat stronger performance is possible if the cuts prove less severe than expected.  Downside risk remains modest.  The stock trades close to book value ($9.45 a share).  Cash and equivalents total $124 million ($5.62 a share).  The Chinese population is aging quickly, suggesting above average industry growth for an extended time.  A joint venture with U.S. based Davita to run a network of kidney dialysis centers promises further leverage.  That project is slated to start rolling out next year. 

( Click on Table to Enlarge )

Sevcon ( Nasdaq - SEV ) -- Legacy Business Slows

Sevcon (SEV $5.00) reported lower than expected Q3 (June) results.  The company is the leading independent provider of computerized controls for electric vehicle engines.  Revenues increased 8% to $8.88 million.  Earnings fell 75% to $.01 a share (fully taxed).  Engineering talent was added in the period to support anticipated growth.  Margins were crimped when revenues grew less rapidly than predicted.  Rising expenses were offset to a degree by better manufacturing margins.  Sevcon outsources most production work.  The entire supply chain demonstrated improving productivity. 

Industrial vehicle demand slowed due to economic considerations.  Sevcon provides the brains for a wide range of electric powered work machines.  Those include fork lifts, aerial lifts, mining vehicles, airport trucks, floor polishers, turf equipment, and a variety of other units.  The company's technology maximizes battery efficiency so the engines can hit higher speeds and last longer before recharging.  Before the recession began sales in that segment were pushing $40 million a year.  Rising energy prices and tighter environmental rules promised to support further gains.  Demand collapsed when the worldwide economy slowed.  A rebound appeared to be underway.  But the latest woes in China, Europe, and elsewhere put the brakes on that during the June quarter.

The on-road market continued to advance.  Sevcon entered the electric car segment a few years ago, building on technology it already was delivering for motorcycles and all terrain vehicles.  Bolstered by government regulations, but primarily economics, the electric car market has been expanding rapidly and is continuing to go.  Rising fleet fuel efficiency standards are accelerating demand among auto makers.  But consumers are clamoring for the product, too.  Based on the size of the worldwide car market, which is mammoth, and the regulatory path that's in place, and growing consumer support, there's a strong consensus among industry observers that unit volume could expand 25%-35% annually over the next ten years.  A recent deal to supply controls for Renault's new "city car" is generating near term momentum.

Sevcon is well positioned to grow even faster in the on-road segment.  Even if it doesn't, though, overall performance should be reinforced by a return to normal by the industrial segment.  That would entail a 100% jump just to get back to to 2007 levels (an extra $20 million a year in sales). 

These shares require a long term orientation.  The share count is so low, however, and the potential market is so big, a patient investor could enjoy enormous appreciation.  A rebound by the economy likely will drive conventional energy prices higher, making electric cars increasingly attractive.  In 2-3 years income could attain $.75 a share.  Applying a P/E multiple of 20x suggests a target price of $15 a share, potential appreciation of 200% from the current quote.  Beyond that, it might be a long runway.

( Click on Table to Enlarge )



Points International ( Nasdaq - PCOM ) -- Gears Up

Points International (PCOM $13.00) reported excellent on target Q2 results.  Earnings advanced 233% to $.10 a share (fully taxed).  Revenues improved 11% to $36.4 million.  All of the revenue increase was provided by existing customers.  Points is the leading independent provider of loyalty program services used by airlines, hotels, car rental companies, banks, and retailers.  The company's software enables customers to manage their loyalty accounts with a variety of features, like purchasing or exchanging miles and points.  Several large new deals are in the pipeline.  Implementation work is underway.  Formal roll outs are slated for the December quarter. 

Our estimates assume only a $5 million revenue contribution from those contracts in 2012.  If they all come to fruition next year the incremental revenue boost could be in the $50 million range.  The company is actively pursuing additional partners, moreover.  It thinks about 25%-30% of the potential market has been penetrated to date.  And direct competition is incidental.  Most alternatives entail in-house computer systems.  Product enhancements are being developed to lift revenues at existing accounts.  Points International revamped its technology platform in 2011 to facilitate the creation of new features.  It also makes it easy to take ideas that are working with some customers and roll them out to the rest of the base.  A move into mobile applications promises further leverage over the long haul.  Our estimates are unchanged.

( Click on Table to Enlarge )

Computer Modelling ( Toronto - CMG ) -- Positive Outlook

Computer Modelling (CMG.to $18.00) reported excellent on target Q1 (June) results.  The company is the leading provider of reservoir simulation software used by energy producers to retrieve heavy oil and other difficult deposits.  Licenses are sold on an annual and perpetual basis.  The latter are more unpredictable.  Most customers renew the annual licenses at a high rate.  In the June period perpetual sales dipped compared to the year ago, holding the overall year to year revenue gain to 3% ($16.5 million).  Annual revenues ($13.2 million) climbed 46%, however.  Non-GAAP income slid 6% to $.17 a share.  A large perpetual contract was finalized in early July.  Additional large contracts are in the pipeline.  Perpetual business is likely to rebound to normal levels, leveraging the sustained growth in annual licenses.  We are maintaining our full year earnings estimate at $.80 a share. 

The next generation DMRS software program appears to be back on track.  Computer Modelling is developing that technology in conjunction with Shell and Petrobas.  The giant companies' engineers steered the effort in a highly technical direction that made it hard for end users to operate.  Computer Modelling stepped in during the June period to shift gears towards a more user friendly format.  The streamlined software is functioning better.  And a less complicated user interface is being implemented.  Field testing is likely to start before long.  Commercial sales are expected by the end of next year.

Competition continues to fall behind.  Schlumberger has begun giving away its software, to little avail.  Halliburton recently licensed Computer Modelling's offering for shale gas applications.  There are a handful of small niche software providers but nobody measures up to the company's expertise and customer support.  Margins are likely to remain elevated.  Growth is poised to be sustained at above average rates.

( Click on Table to Enlarge )

Foraco ( Toronto - FAR ) -- Order Rate Moderates

Foraco (FAR.to $4.00) reported excellent on target Q2 results.  Bolstered by an acquisition (51% of Brazil based Servitec) revenues improved 36% to $106.6 million.  Organic growth was 19%.  Non-GAAP income widened 33% to $.12 a share.  That improvement was impacted a higher tax rate, which is likely to persist in upcoming periods.  More work is being performed in higher tax countries.  Foraco maintained its operating rate at 76% in the quarter.  The rig count increased by six to 290 altogether.  Pricing was little affected because most work was performed under long term contracts.  Some activity was delayed, however, due to weak economic conditions.  The next round of bidding is slated for the fall.  Preliminary indications suggest order rates will moderate, although growth is likely to be sustained in most key mining regions.  Price hikes probably are a lost cause but significant discounting isn't anticipated.  Foraco remains the industry's high end leader. 

We are lowering our 2012 earnings estimate by a nickel to $.50 a share.  Higher taxes and slightly reduced margins likely will prevent income from accelerating sequentially over the rest of the year.  The new unit in Brazil could deliver some countervailing impetus, though.  We've reduced our 2013 estimate by the same amount to $.60 a share, reflecting the muted outlook.  Foraco is poised to benefit no matter which way the industry turns.  If China and other emerging nations lift commodity demand, earnings should improve directly.  And if conditions stay depressed, attractive acquisition opportunities could emerge. 

In 2-3 years income could reach $.75-$.95 a share.  Applying a P/E multiple of 12x to the midpoint of the range suggests a target price of $10 a share, potential appreciation of 150% from the current quote.

( Click on Table to Enlarge )



3-S Bio ( Nasdaq - SSRX ) -- No Government Reimbursement Ruling Yet

3-S Bio (SSRX $12.00) appears on track to report excellent on target Q2 results.  The Chinese drug provider still is operating on the government's old price list, so margins probably widened in the period.  Volume has been expanding, producing economies of scale at 3-S Bio's manufacturing facility.  That plant still is operating at approximately 50% of capacity, so further leverage is likely.  The central government is expected to slash reimbursement by 10% or so when new regulations are implemented.  Adoption of national health insurance expanded the market dramatically in 2010.  Reduced prices are on way the government hopes to make the program affordable.  Meantime, export sales continue to rise quickly.  A joint venture with U.S. based Davita is on schedule.  That deal promises to leverage 2013 performance.  Our estimates already reflect a price cut for the current year.  So a somewhat stronger showing is possible if the new scheme isn't adopted soon.

( Click on Table to Enlarge )



Computer Modelling Group ( Toronto - CMG ) -- Momentum Continues

Computer Modelling Group (CMG.to $17.75) reported excellent on target Q4 (March) results.  Non-GAAP earnings advanced 36% to $.19 a share.  Revenues improved 20% to $17.2 million.  All figures are in Canadian dollars.  Perpetual software license revenue declined 13% to $3.4 million.  That segment tends to bounce around from period to period.  Annual subscriptions generally are more consistent.  That segment was responsible for the quarter's growth.  The next generation DRMS software project experienced technical problems and probably won't be launched for another two years.  Computer Modelling is working with Shell and Petrobas on that effort.  Meantime, though, the company's core reservoir simulation line is continuing to build momentum.  Computer Modelling is the leader in the hard to recover end of the market, which is the industry's fastest growing area.  Fiscal 2012 (March) earnings rose 30% to $.65 a share.  Revenues improved 18% to $61.0 million.  Our fiscal 2013 estimates are unchanged at $.80 a share and $70 million, respectively.  The quarterly cash dividend was increased to $.16 a share.  An extra $.10 a share will be paid in June.

( Click on Table to Enlarge )



3-S Bio ( Nasdaq - SSRX ) -- Unit Volume Rises, Costs Decline

3-S Bio (SSRX $13.25) reported excellent on target Q1 results.  Sales climbed 24% to $23.4 million.  Earnings surged 53% to $.23 a share.  Selling prices were generally unchanged compared to the December period, although they did decline 3%-5% from the year ago quarter.  Volume remained robust despite the fact prices probably will be forced lower by new Government regulations.  Those have not be formalized yet but are expected to go into effect in Q2.  In theory, customers could have waited for the prices to fall before purchasing in Q1.  China established its own health reform law in 2010, expanding coverage to most of the country.  The quid pro quo with the health care community has been one of greater volume in exchange for lower prices.  The upcoming round could see 3-S Bio impacted by 5%-10%.

Margins held up well after prices were reduced last year.  3-S Bio built a series of new manufacturing facilities which came on stream in 2011.  Modernized equipment and procedures enabled the company to cut production costs directly.  Depreciation expense jumped in the short run, though, since the new facilities were 4x larger than the former site.  The company now has ramped up volume sufficiently to achieve 50% capacity utilization rates.  Further cost reductions are possible, suggesting overall margins will remain attractive despite the Government's upcoming price cuts.

Marketing efforts are accelerating.  3-S Bio plans to boost its distribution channel by 20%-25% this year, with an emphasis on penetrating second tier hospitals.  Those customers are exhibiting the fastest growth as the health law kicks in.  The company also recently formed a joint venture with U.S. based Davita to set up a chain of dialysis centers in two Chinese provinces.  That deal is likely to begin contributing early next year.  New products are in the pipeline, moreover.  And export operations are picking up momentum.  A new version of the company's top selling drug will enter clinical trials this year.  Other trials are approaching the finish line.  Those include products licensed from international companies for sale in China.  3-S Bio's new facilities also are being fine tuned to make generic biological drugs.  Those are off patent biotech products that offer huge potential but even western companies find challenging to make.  Exports remain focused at high population mid range countries like Egypt and Turkey which need high quality products at affordable prices. 

Our estimates are unchanged.  A stronger performance is possible if the next round of Government price reductions come in at the low end of the anticipated range.  The long term outlook remains bright.  3-S Bio is well positioned to expand in China without government help.  Its world class scientific talent promises to attract additional foreign partnerships.  Finances are solid.  And for a bunch of scientists, the management has a proven track record when it comes to marketing pharmaceuticals.

( Click on Table to Enlarge )



Sevcon ( Nasdaq - SEV ) -- Scaling Up

Sevcon (SEV $7.25) reported excellent on target Q2 (March) results.  Earnings improved 8% to $.14 a share.  Sales expanded 30% to $10.1 million.  The company is a leading provider of drive train controls for electric vehicles.  In the past Sevcon emphasized the off road market.  That segment was hit hard by the recession and remains far below historical levels.  The company has been picking up the slack with on road programs including scooters, bikes, and small city cars.  Those are niche markets as far as the automobile industry is concerned.  So the big drive train producers haven't participated in those markets in a meaningful way to date.  Sevcon is taking advantage of its opportunity to cultivate a number of relationships that could become substantial contributors over the coming decade.  It also recently formed a manufacturing relationship with outsource giant Flextronics to ensure it can meet higher levels of production if demand suddenly arises.  Sevcon is establishing an arsenal of engineering know how that promises to yield additional contracts in the future.  Profits are rising in the meantime as the off road business recovers and the new programs kick in.  The electric vehicle market holds ample potential even if it remains a niche business.  If new battery technologies are developed the industry could expand dramatically in the future, propelling Sevcon to substantially higher levels of business activity.

( Click on Table to Enlarge )

Foraco ( Toronto - FAR ) -- Growth Intact

Foraco (FAR.to $4.85) reported excellent on target Q1 results.  Earnings climbed 50% to $.12 a share.  Sales improved 35% to $88.2 million.  Utilization rates improved by one percent to 71%.  Pricing improved, as well.  Backlog expanded in the quarter, setting the stage for additional gains in future periods.  Foraco purchased 51% of Brazil-based Servitec at the end of April.  That operation will be consolidated for two months in Q2.  A modest financial lift is expected right away, with bigger contributions possible down the road.  Incoming orders remain robust despite the recent drop in commodity prices.  Foraco drills exploratory wells for mining companies to delineate prospective deposits.  That work tends to be less volatile than actual production.  Further gains appear likely in 2013 as Foraco capitalizes on its expanding backlog and the Servitec business builds momentum.  Longer term, the company's niche water drilling business could become a more significant contributor.

( Click on Table to Enlarge )



Points International ( Nasdaq - PCOM ) -- Improving Pipeline

Points International (PCOM $12.50) reported good Q1 results.  The company is the leading provider of loyalty and rewards programs for the travel and hotel industries.  That segment generates 70% of revenues.  New markets like retailing, financial services, and gambling provide 25%.  Points also operates its own on-line exchange where consumers can swap points from different programs, i.e., Lufthansa miles for American Air miles.  That business delivers the remaining 5% of sales.  Promotional activity by airlines and hotels tends to increase in Q2 and Q4, which in turn drives additional volume the company's way.  The period just ended was typically slow due to that seasonal influence.  Points didn't start any major new programs in the quarter, either.  So comparisons were relatively muted.  Sales actually declined 2% to $28.0 million.  Non-GAAP earnings doubled to $.06 a share.

Points has more than $50 million of new annualized business in its sales pipeline.  The company has a high degree of confidence the contracts will be signed this year.  But if most are implemented late in 2012 the revenue contribution probably won't become meaningful until the year following.  We have reduced our full year sales estimate by $10 million to $150 million, which reflects the amount of volume Points expects to generate with its existing book of contracts.  We also have lowered our earnings estimate by a nickel to $.45 a share.  Sales could accelerate in 2013 as the new contracts come on line and existing accounts keep expanding.  New Internet products launched in mid 2011 could yield further leverage.  We estimate sales will hit $200 million to provide income of $.75 a share. 

( Click on Table to Enlarge )



Foraco ( Toronto - FAR ) -- Scouting for Mineral Deposits

Foraco ( FAR $4.75) is a leading provider of exploratory drilling services for mining companies.  The company is hired by resource producers to delineate potential targets, estimate the degree of difficulty involved, and resolve any water issues.  Foraco operates about 200 rigs around the world.  It trains and provides its own crews, which generally are in short supply due to surging exploration activity.  Industry spending has expanded more than 200% over the past decade, fueled by booming demand for metals in Third World markets.  Foraco added nearly another 100 rigs in March when it purchased 51% of a major drilling services provider in Brazil.  Approximately 85% of revenue is generated by contracts with major mining companies.  The balance is derived from smaller operators that typically sign short term deals, enabling Foraco to keep its crews busy between major engagements.  More long term contracts are being signed, which is bolstering revenues and margins by reducing downtime.  Demand for exploratory drilling is continuing to grow despite the threats posed by economic uncertainty and volatile commodity prices.  That trend is apt to continue as consumption of metals outstrips production over the next several years.

Foraco specializes on the most technically challenging targets.  That's enabled the company to earn above average margins throughout its history.  It now is helping to expand market share, as well.  Like in the energy business, new discoveries increasingly are being found in remote locations that involve specialized talent.  In 2011 South America accounted for 42% of revenues; Africa, 28%.  Russia and Canada represent most of the balance.  Foraco has established a presence in those geographies through a combination of internal growth and effective acquisitions.  Most of those transactions, similar to latest deal in Brazil, involved purchasing a partial controlling stake to begin with.  A few years later, an option to buy the rest was exercised. 

Growth has been explosive.  Sales and earnings were unchanged in 2009 following the worldwide banking crisis.  Sales climbed 37% in 2010 as the industry regained its footing.  Another 84% gain was registered last year.  Earnings recovered from a temporary dip in 2010, jumping 162% to $.34 a share last year.  Backlog expanded 44% to $418 million, laying the groundwork for another strong performance in 2012.  Bolstered by the recent acquisition in Brazil, we estimate sales will improve 38% to $415 million to provide earnings of $.55 a share (+62%).

In 2-3 years income could attain $1.00 a share on sales of $600 million.  Applying a P/E multiple of 15x to those earnings suggests a target price of $15 a share, potential appreciation of 215% from the current quote.  A higher valuation is possible if environmental stress creates water shortages in Africa or elsewhere.  Foraco currently generates 5%-10% of sales by drilling wells for drinking water.  That business has the potential to exceed mining over the long haul if global warming creates substantial droughts.  Management owns 42% of the stock.  Foraco is based in Marseilles, France.

( Click on Table to Enlarge )



Sevcon ( Nasdaq - SEV ) -- Boosts Battery Performance

Sevcon (SEV $6.50) is a leading provider of microprocessor based controls that maximize engine output in electric and hybrid vehicles.  The alternative vehicle market has bogged down in recent years due to economic reasons.  But a bigger factor has been the lack of progress in battery technology.  Incremental improvement is likely over the next several years.  But major breakthroughs are not in the pipeline and are unlikely to enter large scale production through the end of the decade.  Despite that, the electric vehicle market is poised to deliver substantial growth.  And those gains are likely to be amplified by hybrid vehicles, a market the company also serves.  Electric vehicle manufacturers are improving their products's price performance by introducing a higher concentration of computer controls.  Those microprocessor based units regulate temperature and other variables to minimize wasted power.  They also regulate the environment so batteries retain their ability to charge up at full capacity.  With the addition of more software electric vehicles promise to become increasingly powerful and long lasting.  Gasoline powered cars and natural gas fueled trucks and buses are likely to dominate the high volume transportation market for the foreseeable future.  But plenty of niche markets remain to be exploited. 

Most of Sevcon's business historically focused on off-road and industrial vehicles.  Sales reached $39.2 million in 2008, most of which was generated by work machines.  The subsequent recession collapsed demand, forcing Sevcon to develop new markets.  The company landed a large number of small deals with on-road electric vehicle makers, aided by its track record in the industrial area.  Most of the rebound witnessed over the past three years was produced by those relationships.  Last month Sevcon landed its largest partner to date (Renault).  The contract calls for the company to supply controls for two new lines of city-cars the auto giant plans to manufacture.  Sevcon also recently signed a manufacturing subcontracting arrangement with Flextronics.  That relationship will cover new business signed either by Flextronics or the company.

Growth is threatened by near term economic and political factors.  Sevcon's traditional off-road and industrial markets have gained momentum in recent quarters.  The company didn't lose any customers during the downturn -- just order volume.  That business now is coming back, albeit gradually due to the weakness in Europe and around the world generally.  The on-road market still is advancing.  But government subsidies are still required to underpin that segment.  And those are being threatened by deficits and other fiscal problems.

Sales advanced 24% in Q1 (December) to $8.52 million.  Earnings improved to $.08 a share from a break even showing the year before.  The near term outlook is difficult to predict due to the political and economic headwinds.  Despite those obstacles we estimate fiscal 2012 (September) sales will climb 24% to $40 million to provide earnings of $.40 a share (+90%).  Longer term margins promise to expand on rising sales.  Assuming no real change in character in the electric vehicle industry we estimate sales will attain $75 million in 2-3 years to produce earnings of $1.20 a share.  We use GAAP figures because stock option expense is minimal and there aren't any other material adjustments that need to be made.  Applying a P/E multiple of 16x to those earnings suggests a target price of $20 a share, potential appreciation of 200% from the current quote.

Sevcon is based in the United Kingdom.  It's official corporate headquarters are in Southborough, Massachusetts.

( Click on Table to Enlarge )

3-S Bio ( Nasdaq - SSRX ) -- Shrugs Off Regulatory Threat

3-S Bio (SSRX $14.00) reported excellent on target Q4 results.  The company is a leading provider of nephrology and oncology drugs in China.  Management consists of American trained scientists.  Products are developed internally and in collaboration with international pharmaceutical companies.  3-S Bio has plenty of industry knowledge and marketing talent.  The company doesn't rely on the Central Government.  Above average growth has been sustained with merit.  Earnings doubled in the December quarter to $.16 a share.  Last year's figure was reduced by a one time licensing fee.  Excluding that, income improved 23%.  Sales advanced faster than we predicted, at a 45% rate, to $22.2 million.  The Chinese health care reform law expanded the potential market, bolstering unit volume.  Performance was enhanced by aggressive marketing efforts.  Margins were reduced by lower reimbursement rates that were part of the new law.  3-S Bio also suffered from over capacity.  The company tripled its manufacturing potential in 2010.  Utilization rates were in the 30%-40% range in 2011, allowing depreciation and other fixed costs to depress margins.

Another round of Government mandated price reductions is likely.  Our estimates reflect an across the board cut of 8%-10%.  That's probably a worst case scenario.  3-S Bio will offset some of that with lower unit costs.  Volume is poised to expand, as well.  Reliable numbers are hard to come by but the company estimates only 10%-20% of the Chinese population receives the kind of drugs the company makes.  As the society modernizes and more citizens take advantage of the national health care law the penetration rate could rise materially.

A recent deal with U.S. based Davita validates the company's legitimate status.  Davita is the largest provider of independent kidney dialysis centers with more than 1,800 locations in the United States.  It established a joint venture with 3-S Bio in March to create a similar operation in China.  The initial investment is $20 million, 70% supplied by Davita, 30% by 3-S Bio.  Profits will be shared using those percentages, as well.  3-S Bio will earn extra income by supplying the essential drugs to the venture.  The initial foray will encompass two provinces comprising 5% of the country's total population.  Even that probably will take 2-3 years to really get rolling.  But the long term potential is enormous.  The deal also should make it easier for 3-S Bio to establish partnerships with other American companies that want to break into the Chinese health care market.

We estimate 2012 sales will advance 16% to $100 million.  A stronger performance is possible if the Government slashes prices less than we predict, or unit volume accelerates.  Exports totalled 4% of 2011 sales.  They could jump, as well.  Earnings appear headed to $.90 a share (+17%).  At year end cash and equivalents stood at $5.53 a share ($122 million).  So 3-S Bio has plenty of flexibility to make investments if the opportunity arises.

( Click on Table to Enlarge )



Points International ( Nasdaq - PCOM ) -- Loyalty Program Leader Expands its Pipeline

Points International (PCOM $9.25) reported excellent on target Q4 results.  Sales were at the low end of the range at $32.9 million (+22%).  Earnings were a little above our target at $.10 a share (+100%).  The company added six new partners during the year, bringing the total to 25.  Existing partners added more loyalty programs, as well.  Margins improved in Q4 because several programs achieved key thresholds, triggering bonus payments.  Points International's new Internet offering elicited growing interest but didn't generate material sales.  That effort holds substantial potential but probably will take a few years to produce big numbers.  A large number of prospective customers are in the pipeline.  Results in 2012 will depend on when those deals take effect.  For now we are maintaining our estimates at sales of $160 million (+30%) and earnings of $.50 a share (+85%).  Growth could sustained at above average rates well into the decade.

( Click on Table to Enlarge )