Saturday, December 15, 2012

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.

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Tuesday, December 11, 2012

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.

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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.

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