Tuesday, June 11, 2013

Coastal Contacts ( Nasdaq - COA ) -- Loses Focus

Coastal Contacts (COA $4.75) reported Q2 (April) results that were significantly below our expectation.  The company is a leading provider of contact lenses and eyeglasses, sold over the Internet.  Contact lenses account for 2/3 of revenues, but the greatest growth potential lies in the virtually untapped eyeglass segment.  Contact lens sales slowed modestly from the immediately preceeding quarter.  But that was a normal fluctuation influenced by re-order timing.  The overall trend remains intact.  Eyeglass sales, on the other hand, were much slower than anticipated.  Pricing increased, an indication that promotional discounts were relied upon to a lesser extent.  Even with that adjustment volume should have been considerably higher.  Coastal Contacts raised $20 million in fresh equity earlier in the year.  About 25% of that was spent in the April quarter to accelerate growth.  It could be the extra spending will produce higher results in the current quarter.  Demand is likely to be reinforced by a wider selection of brand name frames and sunglasses, and a more streamlined website.  Coastal Contacts elected not to provide a sales forecast, though, so there remains considerable doubt about what the immediate future will bring. 

The long term outlook remains positive.  The on-line eyeglass category holds enormous potential.  Even if only 10% of the eyeglass market goes to the Internet that business will equal the on-line contact lens industry.  Coastal Contacts faces competition at the high and low ends.  But the company remains the leader in the mid-range segment.  Downside risk is limited by the company's acquisition potential.

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3-S Bio - Acquisition of the Company is Complete

Monday, June 10, 2013

Computer Modelling Group ( Toronto - CMG ) --

Computer Modelling Group (CMG.to $23.00) reported excellent on target Q4 (March) results.  The company is the leading provider of simulation software used by energy companies to maximize production of heavy oil, tar sands, and other complex reserves.  Customers purchase the technology either on a perpetual basis or year to year.  Perpetual licenses generate more immediate revenue.  Deals that renew annually tend to yield greater lifetime income.  In the latest quarter Computer Modelling booked fewer than normal perpetual deals, resulting in a muted year over year comparison.  But recurring revenue improved by 23%.  Earnings increased by a penny to $.20 a share despite the 33% decline in perpetual license sales.

Demand remains vibrant.  Computer Modelling continues to fare best in the North American market.  Activity in Calgary and North Dakota is continuing to expand at a superior pace.  The U.S. oil fracking market is thriving as costs come down, helped in growing measure by broader software use.  Tar sand costs are falling, as well.  Each of those areas is believed to possess potential reserves that are bigger than Saudi Arabia's.  A price collapse in the oil market remains a significant risk.  In theory worldwide demand for petroleum should be exploding as Third World countries modernize their transportation systems.  The ongoing recession has muted demand, though.  And most OPEC producers depend on their oil income, making it unlikely they'll cut production.  Prices have held up so far because the Obama Administration has virtually eliminated Iran from the picture.  The U.S. and Canada have picked up the mullahs' market share.  Further output increases could start putting pressure on prices, though, unless economic activity rebounds.  Fracking and tar sand costs are declining, so a bigger cushion is being created.  But a big acceleration in sales probably won't emerge until unit volume demand accelerates, forcing energy producers to develop even more challenging fields. 

Natural demand promises to advance in the Middle East.  That's been Schlumberger's province for decades.  And the French oilfield services giant probably will continue to supply a sizable share of the software market over the long haul due to its tight customer relationships.  But even in the Middle East oil has become increasingly difficult to recover.  Computer Modelling has the best technology for exploiting difficult reserves.  The company already is working with Halliburton in North America.  If worldwide demand takes off Computer Modelling could make some direct forays in the Middle East as those kingdoms try to rebuild their own reserve bases.  A collaboration with Schlumberger, while it's unlikely at this point, could develop.

The company's next generation system is slated for launch in the December quarter.  That project was funded equally by Shell and Petrobas, which also supplied part of the engineering team.  Computer Modelling retains exclusive ownership and marketing rights to the technology.  Shell and Petrobas get first shot at using the software.  It should be a pretty big deal.

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Thursday, May 23, 2013

Coastal Contacts ( Nasdaq - COA ) -- Deploys New Capital

Coastal Contacts (COA $5.75) appears on track to produce good Q2 (April) results.  Of greater importance, the company raised $18 million in fresh capital during the period.  Three million shares were sold at $6.00 apiece.  That money is being gradually deployed to support the company's penetration of the U.S. on-line eyeglass market.  The template for that business in Canada remains strong.  That operation has been in place for the past few years.  Selling eyeglasses on-line is challenge because new customers are wary of the process.  Once they do place orders, however, the far superior pricing drives repeat business and referrals.  Returning customers are accounting for an increasing share of Canadian orders, generating better margins.  At present the company is focusing on first time buyers in the United States.  As that base starts re-ordering margins promise to surge there, as well.

Large deals with health care insurance companies could amplify growth.  Coastal Contacts provides eyeglasses at approximately 50% lower cost than conventional retailers.  That's opening up opportunities among managed care providers that want to provide eye car insurance at low costs. 

The company's contact lens business continues to grow at a 5%-10% rate.  That segment had been starved for advertising funds before the recent stock offering.  Business in Northern Europe and Canada had held up well despite that lack of marketing effort.  Renewed spending promises to reinforce the company's competitive position in upcoming quarters.

In 4-5 years pretax margins could reach 20%-25%.  We project they will attain half that level by 2014-2015 as marketing costs continue to rise quickly, laying the groundwork for further sales improvements.  In 2-3 years sales could reach $325 million to provide fully taxed earnings of $.75 a share.  In 4-5 years income could hit $2.00 a share.

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Tuesday, April 23, 2013

3-S Bio ( Nasdaq - SSRX ) -- Buyout Price Increased to $16.70 a Share

3-S Bio (SSRX $16.20) said the buyout group attempting to purchase the company raised its offer from $15.40 a share to $16.70 a share.  No explanation for the 8% improvement was given.  A shareholder meeting is scheduled this month to vote on the proposal.  The price remains modest in relation to 3-S Bio's long term potential.  The company enjoys leading market shares with two fast growing drugs.  Additional products are in development.  The Chinese medical industry is poised to expand dramatically over the next decade.  And 3-S Bio has a joint venture in place with U.S. based Davita that could yield substantial benefits.  The private equity fund orchestrating the acquisition is connected with the Chinese government, though.  And the company's C.E.O. is part of the buyout group.  So alternative offers are unlikely.

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Coastal Contacts ( Toronto - COA ) -- Expands to the United States

Coastal Contacts (COA.to $5.85) is a leading Internet provider of contact lenses to consumers in Canada and Northern Europe.  Over the past few years the company has developed a second product line for eyeglasses.  That segment now accounts for approximately 25% of sales.  Eyeglasses normally are sold at extremely high prices in relation to cost at retail stores and optometrist offices.  Coastal Contacts has created its own manufacturing facilities which, combined with an online distribution network, facilitates pricing that's 40%-60% below conventional levels for identical brands and models.  Customer acquisition is more challenging than contacts because the concept is new and customers are uncertain how well the glasses will fit and look.  So Coastal Contacts has had to resort to promotional offers to get customers in the door.  In Canada and Europe, where the company has operated for the most part to date, repeat business has been excellent, though.  And most users refer additional customers, indicating high levels of satisfaction.  The core contact lens business is relatively mature and provides a positive cash flow.  Earnings have declined in recent years as that money and more has been invested in developing the eyeglass segment.  Profits in Canada and Europe are starting to emerge as repeat orders comprise a rising share of the business.  Those sales yield attractive gross margins due to Coastal Contacts' vertical integration and efficient web-based marketing platform.  During the past year efforts were stepped up to penetrate the U.S. eyeglass market.  Sales already are advancing at greater than 100% a year.  Even faster gains are possible as advertising expands, renewals kick in, and referrals contribute further -- replicating the success model in Canada and Europe.

A recent stock offering reinforced finances.  Coastal Contacts sold 3.0 million shares at $6.00 a share, raising $17 million after expenses.  Those funds will be earmarked mainly to support expansion in the U.S. eyeglass market.  Facilities were improved last year, doubling capacity.  Most Internet competitors outsource production to Asia, lengthening turnaround times.  Coast Contacts typically delivers within a few days.  Quality control is superior, as well, since any errors can be corrected immediately and at low cost.  Coastal Contacts shipped 987,452 sets of glasses in the fiscal year ended October, 2012, up 272% from two years before.  A high percentage were low margin promotional deals, designed to get new users to sign up.  Even so, overall gross margins improved to 43% from 39% due to the superior profitability the eyeglass business provides.  As normally priced glasses (still 40%-60% below regular retail) comprise a larger share of total sales both revenue and margins promise to widen materially.

We estimate financial performance will remain muted in fiscal 2013 (Oct.) due to the promotional effort to penetrate the U.S. eyeglass market.  Sales advanced 17% in the January period to $54.9 million.  But selling and marketing costs jumped 45%, leading to a loss of $.11 a share.  Eyeglass sales rose 35% to $13.9 million.  Eyeglass units increased 42% to 277,159.  Eyeglass gross margins improved to 46% despite high levels of discounted pricing.  U.S. eyeglass sales jumped 95% and now represent about 50% of the company's total eyeglass volume.

The eyeglass market is approximately 9x larger than the contact lens segment.  Only a small fraction has shifted to the Internet to date.  But the pricing advantage could precipitate a wholesale change, similar to what happened in the contact segment.  The retail sector is bound to fight back.  Unless it completely restructures, though, Coastal Contacts should remain the low cost provider by a wide margin.  The company's strongest Internet competitors provide their own proprietary designs, which generally are upscale and attract a younger hip demographic.  Coastal Contacts goes for that market, as well, with brand name designers.  But the largest portion of its business is generated by cost conscious consumers, often families buying multiple pairs for children.  Weak economic conditions promote demand from a broad range of buyers, as well.

Margins promise to widen as volume builds.  As advertising and promotion level off in absolute terms the company's high gross margins should yield substantial operating income leverage.  Over the long haul (4-5 years) pretax margins could rise into the 20% vicinity.  We estimate profitability will expand about half that far within 2-3 years.  Sales could reach $300-$325 million to provide fully taxed earnings of $.50-$.70 a share. Applying a P/E multiple of 30x to the midpoint of the range (reflecting the company's further margin potential) suggests a target price of $18 a share, potential appreciation of 200% from the current quote.  Limits are advised when placing orders.  The shares also trade on the Nasdaq exchange under the ticker symbol "COA."

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Thursday, April 18, 2013

L&L Energy ( Nasdaq - LLEN ) -- Pursues Dual Listing In Taiwan

L&L Energy (LLEN $2.25) appears on track to produce excellent on target Q4 (April) results.  Performance surged in the January period.  Further gains are likely as new mines and capacity improvements at existing locations generate larger contributions.  We estimate income for the entire fiscal year will finish in the $.90-$.95 a share range.  Excluding acquisitions, which are likely and could be substantial, income of $1.25 a share represents a realistic target for next year.

A listing on the Taiwan stock exchange is likely in the near future.  L&L Energy currently trades exclusively in the United States.  While the company is based in America all of its operations take place in China.  Most Chinese stocks trade at a discount on U.S. markets due to past irregularities at some companies.  Slower growth in China has caused investors additional concern.  Valuations tend to be significantly higher in Taiwan.  L&L Energy is hopeful that a listing there will lift its P/E multiple so it can take advantage of a government mandated consolidation in the Chinese coal industry.  The company previously made some non-accretive acquisitions which increased its size sufficiently to put it in the "safe harbor" category, meaning the government can't force it to merge at the deadline (December 31, 2013).  In fact, L&L Energy is in position to make acquisitions at attractive prices, if it can raise the capital to do so.  Stock deals at 2x-3x earnings promise to be earnings neutral.  If the company can achieve a higher valuation larger transactions might become possible.  Plus any deals will add to income right away.

Business remains strong in the meantime.  Coal prices are steady in China.  Industrial expansion has slowed in relation to historic rates but remains high compared to the U.S. and Europe.  Imports provide some competition but their impact is limited by distribution bottlenecks from the ports they unload at.  China is starting to develop a natural gas fracking industry.  That output is likely to replace petroleum more than coal, however, at least for the next 5-10 years.  Pollution from coal remains an issue.  The current focus is on reducing smog rather than co-2 emissions.

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Thursday, March 21, 2013

3-S Bio ( Nasdaq - SSRX ) -- Hikes Expenses

3-S Bio (SSRX $14.90) reported better than expected Q4 revenues.  Despite price reductions mandated by the Chinese central government volume advanced 18% to $26.3 million.  Higher sales and marketing costs enabled the company to penetrate less populated areas.  They also blunted competitive inroads.  Market share for 3-S Bio's leading drugs was preserved in the 40% range.  Product development costs accelerated, as well.  The company signed a partnership with U.S. based Davita last year to establish a chain of dialysis centers in China.  3-S Bio will supply a large component of the drugs to that venture.  Development costs jumped to get those formulations approved and into production.  Earnings declined 33% due to the elevated spending, coming in at $.12 a share.

The acquisition of the company remains on track.  An offer was announced last September.  The purchasing group included 3-S Bio's chief executive, a large bank controlled by communist party members, and a hedge fund also run by communists.  In February an agreement was reached to purchase all the outstanding stock at $15.40 a share.  3-S Bio's shareholders must approve the transaction by a 2/3 margin.  A vote is expected in the second quarter.

The uptick in spending suggests the deal is likely to go through.  The Davita venture holds good potential in its present form.  That encompasses a small part of the total Chinese market.  The addition of state controlled entities could open up additional territories, generating a bid payday for the private equity group.  3-S Bio has plenty of cash on hand to fund operations.  So any new capital won't be sidetracked from the huge opportunity the Davita partnership affords.  Investments in other initiatives could be made through the private structure, as well.

The shares are trading close to the ultimate buyout price.  An upward revision to the price appears unlikely.  Aggressive holders are advised to close out positions and put the money to work in another Special Situation.

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Tuesday, March 12, 2013

L&L Energy ( Nasdaq - LLEN ) -- Breaks Out

L&L Energy (LLEN $2.10) reported excellent better than expected Q3 (Jan.) results.  The company is an American managed coal producer that operates in China's interior.  Regulatory crackdowns on the entire industry, to promote worker safety, impacted performance in 2011 and 2012.  Output declined while the government inspected all the mines in the region.  L&L Energy received passing grades.  But the interruption caused earnings to decline.  During that stretch the company swapped a variety of properties, trading proven commodities for high potential mines that required devlopment but held substantially greater profit potential.  Those efforts started to bear fruit earlier in the fiscal year (April).  Momentum accelerated in the January quarter as volume picked up and margins expanded.

Earnings jumped 167% to $.32 a share.  Sales climbed 98% to $59.9 million.  The advance was led by a 253% increase in coal production.  Wholesale and coal washing operations also improved.  Expansion efforts promise to keep output rising in future periods.  The April quarter will be affected by the Chinese New Year celebration.  So the immediate sequential comparison might be flat.  But further gains are likely in fiscal 2014.  We estimate income will finish around $.90 a share this year and $1.25 a share in fiscal 2014.

Acquisitions are possible.  The Chinese central government has implemented a consolidation program for the coal industry.  Small operators are required to merge with larger groups by the end of calendar 2013.  The actual transactions need to be consummated by 2015.  L&L Energy has identified several candidates.  Substantial leverage could be achieved.  A successful roll-up strategy could reinforce the share price.  A higher price, in turn, could yield even more accretive acquisitions.

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Thursday, February 21, 2013

Computer Modelling Group ( Toronto - CMG ) -- Schlumberger Falls Behind

Computer Modelling Group (CMG.to $22.00) reported Q3 (Dec.) results that were somewhat below our expectation.  The company is the leading provider of simulation software used by energy companies to understand their underground reserves, and manage them for maximum profit.  Computer Modelling's specialty is heavy oil and hard to recover reservoirs.  Competition is provided by Schlumberger and Halliburton, the largest all around oilfield service providers.  Those companies dominated the software market during the "black oil" days, when new discoveries were just giant pools of petroleum that were relatively easy to exploit.  Computer Modelling started up in the 1990s and created advanced mathematics to work on more challenging fields.  Today, those are the only reserves left to find.

Earnings rose a modest 6% in the last quarter to $.17 a share.  Revenues also were up 6% to $16.8 million.  Excluding the company's deal with the Venezuelan national oil company, though, recurring revenue climbed 34%.  Computer Modelling trusts the government of Venezuela to pay its bills.  But its auditors don't.  So the official books don't recognize any accounts receivable.  Revenues equal cash collected.  The bad comparison isn't the result of delayed payments, at least in the December period.  What happened is that Venezuela fell behind last year during the run up to to the elections.  Then they made up for it in the year ago quarter.  So this year's comparison was muted.

Referrals from Halliburton continue to rise.  That company still has a terrific collection of customers with black oil reserves.  They continue to be served by Halliburton's in-house software.  When it comes to new drilling, though, Halliburton can't even give it away.  Computer Modelling's technology is superior.  The rate of return on the technology is far beyond whatever it might be worth to get Halliburton's product for free.  So Halliburton has started to license Computer Modelling's products, figuring it will keep its customers happy and make up the difference by selling all its other products and services.

Schlumberger still has not joined forces with the company.  It hasn't come out with a competitive product, either, from a technology standpoint.  And its top software engineer and product manager recently left the company, casting doubt on the likelihood a big breakthrough is coming soon. 

The offshore project could finish by the end of the year.  That effort continues to be funded 33%-33%-33% along with Shell and Petrobas.  Computer Modelling retains 100% of commercial sales potential to other companies.  The company's partners will get first use of the software.  The structure of the technology allows ample plug-in opportunities.  Shell and Petrobas are developing quite a few of those proprietary programs, which probably won't be made available to their competitors.  Over time, though, word gets around, and those competitors may write their own.

Computer Modelling remains a phenomenal company.  Gross margins are sufficient to pay for aggressive marketing, high levels of product development, and plentiful dividends.  The executives running the company are approaching retirement age.  So a buyout is possible.  But Computer Modelling has a clear cut runway to 2020, perhaps farther.  If it remains independent above average growth could persist as the new product kicks in, existing customers expand, Halliburton referrals keep rising, and Schlumberger throws in the towel and licenses the software, too. 

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Monday, January 7, 2013

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

Computer Modelling Group (CMG.to $21.50) appears on track to report excellent on target Q3 (December) results.  The company is the leading provider of simulation software used to model energy reservoirs so that production is maximized.  Demand is rising because new deposits have become increasingly difficult to exploit.  A wide range of enhanced recovery technologies have reached the market in recent years, making it more cost effective to extract those reserves.  Complexity has grown, as well, requiring more computer horsepower to analyze the best route to take.  Competition is provided by Schlumberger and Halliburton.  Those companies offer less robust products that originally were built in the "black oil" days, when drilling required simpler techniques.  Schlumberger is continuing to offer its own product line, often without charge, to try to retain marketing control of its accounts.  Many customers are gravitating to Computer Modelling's superior technology, nonetheless.  Halliburton now licenses the company's key products for its consulting group.  That provides a direct revenue contribution.  End users often buy Computer Modelling licenses once Halliburton's consulting efforts finish, giving the company access to a larger customer base.

Existing customers are purchasing additional licenses, too.  Demand is vibrant in all geographic markets.  Volume is responding to the combination of steady selling prices for oil and declining production costs.  Enhanced recovery techniques traditionally were expensive and unreliable.  Computer Modelling's software has played a role in driving costs down, and production up.  Companies that deliver those enhanced recovery and fracking methods have boosted price performance dramatically, moreover.  Difficult to recover reserves like tar sands, shale, and heavy oil are becoming increasingly economical to produce.

The renewal rate remains in the 95%-98% range.  Occasionally a license is not renewed after a project ends.  But most customers retain the technology and just move the expertise to a new target.  Computer Modelling has been transitioning its customer base from perpetual to annual licenses for several years.  Some still prefer the perpetual format, though.  Those deals cause quarterly results to fluctuate, due to the higher dollar amounts involved.  The underlying trend in annuity revenue continues to advance at a 15%-25% rate.  Profitability exceeds 50% pretax.  A large portion of income is paid out as cash dividends.  Our estimates are unchanged.

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3-S Bio ( Nasdaq - SSRX ) - Mexican Standoff

3-S Bio (SSRX $13.50) remains subject to a $15.00 per share buyout offer.  A China based private equity firm launched the all cash offer in September.  That group is believed to report to the Central Government, which provides some or all of its funding.  3-S Bio's chief executive officer is part of the buyout group, as well.  One purpose for the transaction is to leave the U.S. stock market.  Several Chinese companies have been pursued by short selling groups.  Even the Securities and Exchange Commission has given greater scrutiny to Chinese accounting practices.  Many of those challenges have proven correct.  But valuations of China based companies have declined across the board.  There's no evidence 3-S Bio is involved with any shady practices.  Yet its shares trade at an unusually low valuation due to the cloud cast over Chinese stocks in general.

A two thirds majority of shareholders is required to accept the offer.  Several funds that own the stock have been reluctant to agree to the $15.00 a share price.  The bone of contention is that 3-S Bio would be worth $25-$30 a share under normal circumstances.  The company holds $7.00 a share in cash.  It earns about $1.00 a share.  It has a leading position in a high growth industry, suggesting a P/E multiple of 18x-25x plus the cash value.

That valuation might be too high considering 3-S Bio is subject to price controls.  The Chinese government sets the price 3-S Bio can sell its products at.  Those prices have been regularly lowered in the past.  And another round of cuts is slated for 2013.  3-S Bio already prices its products well below the legal maximum.  So it won't have to go down as much percentage wise as the new rules suggest.  But there will be some pressure on margins over the next few quarters.  3-S Bio expanded capacity 200% a few years ago.  So margins are likely to rebound in the future as volume expands.  Income growth may moderate in 2013 but the long term outlook remains positive.

3-S Bio also is engaged in a joint venture with U.S. based Davita, the world's leading dialysis provider.  3-S Bio will deliver some of the drugs used by Davita in China.  The U.S. company is creating a national network of dialysis centers.  While the Central Government could harass 3-S Bio if it turns down the buyout offer, doing so might raise concerns at Davita.  That might be especially true if the government singled out 3-S Bio for special treatment.

The chief executive officer is in an awkward position.  Right now he is part of the buyout group.  But he still has a fiduciary responsibility to his existing shareholders.  How everything plays out remains to be seen.  Our guess is that the share price will hold up even if the deal falls through. 

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Foraco International ( Toronto - FAR ) -- Outlook Improves

Foraco (FAR.to $2.50) appears on track to report relatively poor Q4 results.  The company is the leading provider of high end drilling services used by mining companies to delineate potential targets.  Since the reserves haven't been exploited yet, drilling usually occurs in remote areas that require special expertise and original thinking.  Rates generally are elevated.  And demand tends to remain steady despite fluctuations in spot market commodity prices.  Mining companies normally expand their reserve base in a regular fashion.  Approximately 75% of Foraco's sales are provided by major mining companies.  So-called junior operators are more likely to cancel projects due to their reduced access to capital.  Foraco's performance nosedived during the second half of 2012 despite its relative strengths.  Worldwide demand for minerals skidded as third world economic growth stalled.  Foraco additionally suffered from management mistakes at its Chile subsidiary.  Those factors likely impacted December period results, as well.  A negative comparison is likely in the quarter.

New contracts are being signed at a solid clip.  A large portion of Foraco's contracts come up for renewal in the fourth quarter.  It appears the company has been successful in arranging work for most of its fleet of drilling rigs.  Prices probably are lower due to the industry's persistent weakness.  But a solid showing appears attainable in 2013, nonetheless.  Results will be reinforced by a series of acquisitions Forcao completed last year.  Those transactions took place after the industry declined, enabling Foraco to sign the deals at attractive prices.  Organic growth is likely to fall 10%-20% in 2013.  But overall sales are poised to increase 10% due to the acquisitions.  Income could advance 33%, bolstered by a return to profitability at the Chile subsidiary.

The long term outlook is uncertain.  If the world economy keeps struggling for several years the demand for commodities is certain to remain muted.  Even so, these shares could rise in value as Foraco's market share expands and free cash flow is invested in more accretive acquisitions.  If the "New Abnormal" winds down a more vigorous showing is possible.  Our projections assume a modest performance in 2013 as the U.S. and Europe endure an adjustment process to their government finances.  Once that foundation is established growth could re-accelerate.  In 2-3 years sales could reach $500-$600 million to support income of $.50-$.60 a share.  Applying a P/E multiple of 15x to the low end of the range suggests a target price of $7.50 a share, potential appreciation of 200% from the current quote.

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