Model Portfolio athompson:TPSNX

AMCON Distributing Company (AMEX: DIT) is a wholesale distributor of consumer products, serving primarily convenience stores in the Great Plains and Rocky Mountain areas. AMCON also operates thirteen retail health food stores in Florida and the Midwest. This micro-cap stock currently has a price/earnings ratio of 4.6 and a dividend yield of 1.1% (as of June 16, 2008).

AMCON's earnings per share (from continuing operations) have grown dramatically over the last several years, from a loss of $1.11 in 2005 to a gain of $1.82 in 2006, to $4.89 in 2007. Earnings per share are up by 147% for the first two quarters of 2008. How has the company been able to increase earnings so fast? Will it be able to continue to grow?

When we think of growth stocks, we generally think of companies that are expandingby opening new stores or developing new products, for example. Certainly we think of increasing sales. AMCON is not doing any of this. In fact, the company's revenue fell by 5% in the most recent quarter. AMCON is instead growing its earnings simply by reducing its debt.

AMCON had acquired a large amount of debt in the course of moving into the bottled water business and making a related misguided acquisition. These money-losing divisions have now been sold or discontinued. As a result, the company currently has considerable cash flow (in the most recent quarter, $5.38 million before debt service) and is using it to pay down debt. AMCON reduced its debt by $5.59 million in the most recent quarter, thereby reducing its interest expense by $220,000. I anticipate that AMCON will be able to pay back $4 to $5 million of debt for each of the next 5 to 6 quarters. This will enable the company to increase earnings about 30% through 2010, with growth leveling off after that. To summarize, I think that AMCON can continue to increase its earnings, at least for the next several years, although not at quite the breakneck pace of the last three years. Given the stock's extremely low P/E, I consider it a strong buy.

Of course, distribution of consumer products is not the best business to be in during these times of near-recession and faltering consumer demand under pressure of high fuel and food costs. Health food retailing might be even worse. Organic groceries and other health food items are a luxury that consumers can cut back on during tough times. Also, the health food business has become increasingly competitive, as Whole Foods Market is expanding and regular grocery stores are increasingly stocking health food items. However, I am somewhat reassured by AMCON's geographical focus. The states served by AMCON's distribution business are relatively strong economically, at least as I read the Fed's Beige Book. The retail health food division serves Florida, which is weak, but also Oklahoma, Missouri, Nebraska, and Kansas, which are relatively strong. Moreover, the earnings that I estimate do not depend at all on any assumption of increased sales.

Disclosure: I hold this stock in my own accounts.

Posted by Adam Thompson at 06:09 PM | Permalink

Drilling for Dollars

by Adam Thompson, m10 member and mFOLIO Master

You can see from Adam Thompson's Performance Zones (click here), that 41% of his gains have come from the Energy Sector. So when he writes about a stock in this sector we listen.

I believe that global demand for oil will continue to increase over the next several years although there might be a lot of volatility along the way. That’s why I have 34% of my portfolio in energy stocks. But drillers have been hit hard over the last year from the oil and gas price volatility and right now, I believe there are better buying opportunities with drillers than with exploration and production stocks. As long as the price of oil doesn’t drop back to the $40s, we’re still opening up new wells and re-opening old exhausted wells and drillers will be in demand. So even if oil prices don't increase and remain relatively high we can benefit and we should have some downside protection as long as oil doesn't drop fast, far, and fairly permanently.

Patterson-UTI Energy (nasdaq: PTEN) provides oil drilling services to oil and natural gas producers. It operates 403 rigs, giving it the second largest land-based drilling fleet after Nabors Industries. Oil and gas drilling stocks in general have fallen considerably over the last year. Patterson-UTI is down to $22.04 (3/12/07) from its high of over $35. I believe this is a considerable overreaction. Petroleum prices have declined, but it's still very profitable to drill for oil and gas at the current prices of almost $60 per barrel for oil and over $7 per thousand cubic feet for gas. These prices, and Patterson-UTI's profits, will undoubtedly fluctuate, but I believe the current trend is up. I think the world economy will continue to grow, especially in China and India, and these countries will use more and more oil as they become more industrialized and more of their residents buy cars. It's also likely that U.S. consumption of natural gas will continue to increase. For one thing, the population is shifting to the South, with its high air conditioning use. More energy will be needed for all those air conditioners, and at least some of it will come from natural gas. How much comes from natural gas will depend on political factors and public attitudes toward pollution (natural gas is much cleaner than energy sources like coal) and nuclear power.

Patterson-UTI earned $4.02 per share in 2006, giving it a P/E of less than 6. That's the P/E of a stock that the market has very low expectations for. But I think Patterson-UTI has good long-term prospects, even if 2007 is somewhat uncertain. These good long-term prospects also make Paterson-UTI an attractive takeover target, I believe.

Disclosure: I hold this stock in my own accounts and in most of my clients' accounts.

Posted by Adam Thompson at 06:41 AM | Permalink

Moving Coal for Less

by Adam Thompson, m10 member and mFOLIO Master

I originally recommended FreightCar America, Inc. (nasdaq: RAIL) at $55.45 (12/29/06). FreightCar America makes railroad cars, primarily coal-carrying railcars. Over the last two months, the prospects for this stock have dimmed considerably, and the stock has fallen to $48.63. It is now pretty clear that the company will exhaust its current backlog by the end of this year. Once they do that, their revenue will fall considerably, and they may even lose money, at least for a few quarters. However, they are diversifying into other types of railcars, and there is a decent chance that demand for coal cars will pick up by the end of the year, around the time their backlog is exhausted. Unfortunately for FreightCar America, TXU Generation has greatly reduced the number of new coal-fired power plants it plans to build (this was part of the terms of the recent buyout of TXU). Since FreightCar America had a large order from TXU, this is a big negative for the stock.

However, FreightCar America's 2006 earnings per share were an incredible $10.07, giving the stock a P/E of less than 5. At that price, I think the stock is still worth buying, even with all the negatives and uncertainties. I believe the price of oil and natural gas will remain high and that coal will therefore continue to be an attractive fuel. At some point, coal cars will need to be replaced, and FreightCar America's earnings will increase. Of course, this depends to a large extent on how willing people are to tolerate the pollution that coal usually produces.

FreightCar America's current assets exceed its current liabilities, even when inventories are excluded from current assets. Its long-term debt, including pension costs, is about $59 million, compared to $204 million in equity, so it is not very heavily leveraged.

Disclosure: I hold this stock in my own accounts and in most of my clients' accounts.

Posted by Adam Thompson at 11:00 AM | Permalink