Thursday, September 17, 2009

Alloy Steel, Altman Z-Scores, China, and Vertical Branding


Connecting the dots between some recent topics:

- Alloy Steel International (Nasdaq: AYSI.OB) is the sort of company that is benefiting from China's New, Self-Propelled Economy.

- The Altman Z-Score model can be used by equity investors to evaluate current long holdings for signs of financial distress, as we did with Alloy Steel most recently back in May. When the model predicted that the company was not at risk of bankruptcy at that point, we added more to our position (at about 23 cents per share), despite the weak quarter the company had just announced.

- The Altman Z-Score model can also be used to look for potential short ideas, as in the previous post re BAGL. We'll see how that one works out.

- Vertical Branding (Pink Sheets: VBDG.PK), retailer of such fine, made-in-China products such as this,



is an example of the sort of company associated with China's pre-self-propelled, more export-dependent economy. When China's exports of these sorts of products started to drop precipitously as the global economy sunk into recession, one of the concerns pundits raised was the plight of the migrant workers from China's rural West who were getting laid off. China decided to address this via its stimulus package by increasing investments in Western China, including job-creating infrastructure projects there. Infrastructure requires steel, and to make steel you need iron ore. Companies that mine for iron ore need wear plates to protect and increase the efficiency of their mining equipment. Alloy Steel International makes best-of-breed wear plates.

22 comments:

DaveinHackensack said...

Related to this post: FT: BHP sees global steel demand doubling in next 15 years.

Albert said...

Dave, do you use any particular site to calculate the Z-scores of companies, or do you just do it yourself? Your original post on the subject included a link that's now non-functional.

Just curious.

DaveinHackensack said...

Try the calculator on Ironwood Advisory's site. My company is launching a site soon which will have better tools than this, but Ironwood's calculator should suffice for now.

Nice price action with AYSI and USEG today, btw.

Albert said...

Thanks Dave. I appreciate the link. You're supposed to use MRQ EBIT right, not trailing twelve month?

DaveinHackensack said...

No problem, Albert. Both income statement inputs (EBIT and Sales) should be TTM; the balance sheet items should be MRQ.

Albert said...

Thanks. I became more interested after reading a recent article in Barron's (I know, insert criticism of Barron's here). Anyway, one of the column writers wrote an article about Winnebago (WGO) and how it is burning through cash, has been losing money for the last year, and is probably going to disappoint investors when it announces its year results 10/15. The stock (of course) dropped like 15% on the Monday after the article came out, but bounced all the way back within a day, due in no small part I bet to the fact that a Citi analyst had upgraded the whole sector a week earlier. Still, the article made a pretty compelling case about why WGO was in troubled waters. I wondered what its Z-score would be, and calculated it to be 2.2 so not clearly in trouble.

We will have to see...

DaveinHackensack said...

Yeah, that would be in the gray zone.

Albert said...

Dave, I went back and re-read all your AYSI posts. Congratulations again on sticking with the thesis. I know that your original investment wasn't at prices all that much lower (if at all) than the current stock price, but to continue investing in the company as it dropped into the twenty cent range took some courage. Anyway, it's good to see that it worked out for you.

DaveinHackensack said...

Thanks, Albert. My original investment in AYSI was at $2.28, but my average cost on it is under a dollar per share, after averaging down between $2.28 and 23 cents. It closed today at $2.49.

JK said...

I locked in my AYSI profits here.

Might buy back with an increased position by reinvesting the funds if we correct to the (approx) 1.75 and/or 1.45 support. If it just shoots to the moon from here, then oh well. I don't think it will, however. Solid company...just rose too much too fast for there not to be a significant correction, IMO. Look at the 5 yr chart.

DaveinHackensack said...

No one ever lost money by taking a profit, but I'll tell you why I'm holding here. In its biggest quarter so far, the company earned 6.8 cents per share. That was with one mill. Now it has two mills operating at capacity, and the second mill is making the new product (super arcoplate), which is presumably higher margin. In addition, the company is planning to build two additional mills due to demand. But set that aside for a moment, and just consider the current two mills.

If one mill operating at full tilt earned ~7 cents per share, what will two operating at full tilt earn over a full quarter (they didn't start operating at full capacity until part way through the current quarter)? Annualize that, give it a modest 10x multiple, and compare it to the current share price.

JK said...

I agree with your positive assessment, that's why I'm looking forward to take advantage of a dip to re-establish a larger position. I just happen to strongly think we will get one, and soon.

But if I miss a further run-up, I do happen have other opps in mind, otherwise I would have let it stay there. AYSI might go higher because there just aren't a lot of shareholders to dump and depress the price in the first place. And I also do definitely understand why you are holding. It's a great little microcap. Plus getting rid of your winners is not usually a good strategy. For me, since I have not been funding my account with new moolah recently, I need to attempt other ways to increase positions.

JK said...

Also, I remember when you first brought the company to my attention, I waited to buy until it cooled off some based on the chart, which turned out to be prudent (of course it did end up declining further than I anticipated after I bought in). I could be wrong this time but I'm not going to second guess my instincts just yet. I don't like stocks that get too hot, too fast, no matter what the story is.

DaveinHackensack said...

Yes, you did get a better initial entry point in the stock by waiting, but the stock didn't drop because of the chart, it dropped because it posted sequentially lower earnings, after a blockbuster quarter. I've been trying to get a sense of how low a number the company would need to report next Q to disappoint current shareholders, given the revenue visibility of the 5-year, $50 million BHP deal. Rawnoc got that the thread where I asked this question deleted, but, if memory serves, the consensus seemed to be that folks would be cool with a mid-to-high single digit number for this quarter. I'd be surprised if AYSI missed that relatively low hurdle, but we'll see.

I'm not adding more here, and if it dips to $1.50-$2 I may consider adding more, but I'm not as confident as you that it's going to drop that far, absent some materially negative news specifically relevant to the company. So that's why I continue to hold. I think this company may have more potential upside than any other stock I own, and I'd hate to sell it here and have it run away from me.

JK said...

Stocks have risen on bad news and fallen on good news frequently. The chart can help you gauge market sentiment to determine what is priced in and what is not.

The stock dropped past through its support around 1.50 - 1.75 because of the lower earnings, but just based on the chart I estimated that it would hit the 1.50s range, which is where I entered. I believe it would have hit this level no matter what the earnings were. My hope was that improving fundamentals would cause support to hold firm and the stock to increase from there, but the fundamentals did not improve and the bounce we got from the support instead turned into the right shoulder of a head and shoulders top formation when the PPS plummeted further.

I've found when looking at a chart, it tells what will happen in two near-term scenarios, a bullish scenario and a bearish one. The key is to decide which one is more likely. But even if you are wrong about the near term scenario, having both potential future patterns in mind allows you to optimize your entry point in a way you couldn't if you did not take the chart into consideration, because there are some entry points you just do not want to take, no matter what the fundamentals say. For example, I would not reccomend anyone buy now, because for the stock to move much higher from here, it would have to form a very unusual chart. If I would definitely not enter here, that is a good signal to me that I should take my profits if I'm already invested. Even non-chartists know that you need to let hot stocks cool down. We just came off an exponential increase in stock price that exceeded the highs we got in the commodity bubble. Color me skeptical we will have another breakout just yet. (Yet I will glady congratulate you if it happens.) The best thing that can happen to this stock -short of another blockbuster contract- is if it forms new support in the 2's for a few months. Then I will be able to get back in. Other than that, I'll be waiting for 1.75 and 1.45. Charting stocks helps even a fundamentals investor because it is the recognition that there are some patterns that stock charts just do not make, for whatever reason (mass psychology), and other patterns that are very common. The markets fit a fractal model, as Mandelbrot found when he studied cotton prices in the 60s. Being as though the markerts are basically a biological organism (humans making decisions) it makes sense that they would follow the same rules of fractal geometry that all other aspects of nature follow. There is not as much direct cause and effect in price fluctuations as people think, otherwise the market would be much more efficient as it calibrates itself to whatever makes the most logical sense.

If I had a very large position here, I would not have sold everything, but still have taken some profits. The company is still a baby and there will be plenty of entry points going forward. It won't be mentioned on Jim Cramer or anything for some time yet.

DaveinHackensack said...

Just to clarify: I don't see the stock going higher from here without additional positive news. But I also don't see it going significantly lower without bad news specific to the company or its industry. I could be wrong, but my gut says that absent news we'll stay above $2 until earnings. If earnings are inline with expectations or better, I see it going higher; same if it announces another big supply deal with another major client or if it announces that the Mongolian JV is back in play.

Also, the high last year was $2.95, if memory serves.

I get your point about the use of technical analysis as a complement to fundamental analysis, and I have nothing against it in principal. I just think certain peculiarities here need to be taken into account. E.g., that the float is so tiny, with 70% of the stock held by insiders. That's made the stock much more volatile on the way down and the way up.

Also, re the behavior of crowds, with this stock we've got a pretty small crowd right now -- ~100 shareholders. My guess is that the company's recent run has been driving almost entirely buy buyers who owned the company before the news -- either investors who held and added more, or investors who owned it before and raced to get back in. With the numbers the company generated over the last few quarters, I doubt anyone has picked this company up from screening. If the next earnings release broadens the shareholder base by attracting some new investors, that may smooth out the charts a little going forward.

In any case, the last time I tried to time this company I failed miserably. I will remain guided by fundamentals here and we'll see how that works.

JK said...

Those pecularities are significant. It is doubtful the company has been picked up by stocks screens also. However I would add that while there were not many shareholders on record, AYSI is widely followed by swing traders on IHUB and other places, even if they didn't own the stock after it crashed. They could have jumped in right after the big announcement. Rawnoc, for example, followed it for a reason, he knows it is a quality microcap whether or not he will admit it. The Rawnocs of the world probably bought when they saw the news, and the low float magnified this development. When the swing traders sense the rally is out of gas they will sell and we will get a significant correction, unless there is big money to support the price.

That's my theory, anyway.

DaveinHackensack said...

If Rawnoc jumped back in, he hasn't admitted it. You make a good point about the effect of swing traders, but the five year deal I think puts a floor under this, because if it goes low enough folks like me will consider getting more because of that. Who knows. We'll see in any case.

OT: I hope you can watch video at work, because I think you'll enjoy this one I'm about to post by one of the partners at 37 Signals. It's relevant to our previous discussions about entrepreneurship.

JK said...

Yep, we will see.

Ack.. no, youtube is blocked here. I'll check it out tonight at home.

DaveinHackensack said...

Let me know what your technical spidey sense says about USEG. I'd like to add to that on a dip, ideally before well results come in. But I think what would drive big upward movement from here would be the company posting positive earnings based on production from the new deal. I may have to circle back with management and see if I can get a feel for when that might kick in.

JK said...

LOL. There are two strong levels of support I can identify with USEG: about 3.00 and about 2.50 (I could be more exact with a large candlestick chart with M/A's and such, but don't have time for that now). I don't follow this company closely so I don't know what fundamental developments to expect soon, but if I was looking to buy for my own account, I would have buy orders in mostly at 3.00 and some at 2.50; assuming it is consolidating for a new "up" trend based on the fundamentals. If you think it might really take off in a major way there is weak support at 3.75 it could touch before squirting to new high of approx 5.00-5.50, but personally I would try for the other two because I'm a bottom feeder.

The chart is technically in break-out mode when you take into consideration the previous highs and their shape, and the volume associated with this rally, so in theory it should be a fairly safe buy now. But like I said I'm a bottom feeder not a momo guy, so I can only rec what I'd do personally, which is orders at 3.00 and 2.50. The chart looks really nice whichever way you cut it. It's less likely you'll have a large correction here than with AYSI. So my spidey sense tells me, anyway.

DaveinHackensack said...

OK, thanks. I think I'll be patient with USEG and aim to add below $3, partly based on your technical analysis, and partly based on my reluctance to add at a higher price than I first bought it.