Breakdown

The correction is here. Just about every single chart I look at is flashing a sell signal.

Fear!

There were lots of stories today about the subprime mortgage sector blowing up, so of course CCRT falls another $2 to $33 even though they don't have any subprime mortgage debt. You should now be completely convinced that markets are not efficient or rational in the short-term. The stock is being treated like a piece of trash and is now trading under 7 times conservative forward estimates. What's that saying, "Be greedy when others are fearful." Yeah, I like that.

First Marblehead (FMD)

I purchased some shares of FMD this morning for my Roth IRA. The stock has overreacted on the downside to worries about new legislation impacting their business. Tom Brown discusses the stock here:

http://www.bankstocks.com/article.asp?type=1&id=9881302

Stock Based Acquisition Strategy

Alcoa (AA)

Alcoa looks very interesting to me with improving fundamentals (rising aluminum prices + lower costs) and a cheap valuation of ~11 times earnings and 1 times sales. I could also see them getting bought out for $45-$50 from the current $34.80 price.

Motley Fool, Tom Brown and CompuCredit (CCRT)

This is an interview with Motley Fool's Emil Lee and Tom Brown of Bankstocks.com about CCRT. I got to it from this link:

http://www.fool.com/investing/value/2006/12/27/rounding-the-second-curve-part-2.aspx

Emil Lee: Can you tell us about the bull case for CompuCredit?

Tom Brown: CompuCredit's primary business is the issuance of subprime borrowings. [It has] two main products. One is a fee-based card with a $300 line of credit, where it makes more money off fees than the net interest income. The other is at the upper end of the subprime market, where CompuCredit makes more money off the balance with a $1,000 to $1,500 line of credit. That business has grown nicely as a result of portfolio acquisitions, and primarily on the basis of organic growth.

CompuCredit has emerging businesses -- such as payday lending, subprime auto financing, and debt collection. Those businesses are growing wildly, and they're turning profitable. The real wild card is the $700 million of liquidity -- $100 million of cash and $600 million they could draw down. What are they going to do with that liquidity? If, in the next six months, they don't find anything, my prediction is they'll buy back more stock. Management and the board own 60% [of the company].

Emil Lee: It seems CompuCredit might be underleveraged.

Tom Brown: Tangible equity to assets is at about 33%; 20% is where they feel comfortable.

You can buy this company at eight times 2008 [Second Curve's estimated] earnings -- plus the excess liquidity. CompuCredit has managed earnings and GAAP earnings. This year, the consensus earnings estimate is around 4 bucks; that's the GAAP estimate. The managed [earnings] estimate, which is what Bloomberg uses, is $3.63 per share. My feeling is next year it'll do $4.50 to $5.00 per share. In general, the difference between GAAP and managed earnings is that the managed earnings acts as if securitizations stay on a company's books. This gives a more holistic view of the company.

Emil Lee: It seems as though CompuCredit has a built-in hedge -- when credit is tight, and advance rates on securitization and warehouse facilities dry up, that means favorable pricing for the debt-collection segment. What are your thoughts on this?

Tom Brown: I must be careful what I wish for! [In those circumstances], it'll be the best time for CompuCredit to be making acquisitions, and for the debt-collection segment to be making credit card receivable acquisitions [in other words, buying up bad debt] -- but it'll be the worst time for CompuCredit's stock price.

Emil Lee: Why don't other credit card lenders do this?

Tom Brown: There's reputational risk. With two-year delinquent borrowers, you have to get aggressive. That person may never pay you. Lousy collection practices affect the performing business because of word of mouth and media headlines. Another issue is that large card issuers can book gains [from selling charged-off debt] right up front. It's a way of shoring up weak earnings.

Emil Lee: Why is CompuCredit able to exploit the subprime segment better than its competition? It seems that CompuCredit's 22% net interest margin would attract competition, so is there a long-term competitive advantage?

Tom Brown: Right now, that's one of the thing I like about CompuCredit. To issue Visa and MasterCard cards, you have to be a member of the network. CompuCredit works with three different banks that house new credit card receivables. The banks that are issuers of the cards, such as JPMorgan and Bank of America, are heavily regulated, and the regulators don't like the subprime business -- that walls off competition. It's very difficult [for competitors] to serve CompuCredit's customers.

Emil Lee: CompuCredit says its loans must make sense for the borrower. Is this warranted, given the seemingly heavy fee structure and 22% net interest margins? Do you see CompuCredit's customers climbing the FICO ladder -- and does CompuCredit retain the customers that are able to improve their credit scores?

Tom Brown: CompuCredit is expending an increasing amount of its effort to retain those "moving up" customers. [CompuCredit] would really like to migrate customers from fee-based cards to balance-driven cards. It has specific rewards programs. For example, if a borrower makes timely payments, [CompuCredit] will increase the line of credit. The program works to increase timely payments.

Emil Lee: CompuCredit has only a 10-year operating history. Is that enough credit cycles to judge the company?

Tom Brown: Senior management came from the collections business, so management has a longer history of dealing with collections. When you're lending money to subprime borrowers, underwriting is more important than the economy.

Emil Lee: How do you judge whether a merger will create real synergies or not?

Tom Brown: First, we have to understand the buyer. Does [the merger] make sense? What [is the buyer] trying to do, and does what the seller wants to do make sense? I go in knowing historically that two-thirds to three-fourths [of acquisitions], from the acquirer's standpoint in banking in corporate America, destroy value. The burden of proof is on the acquirer. We know most [acquisitions] fail, so let's figure out why this is going to fail.

Emil Lee: How do you value the residual value a company retains in securitizations?

Tom Brown: We go through the assumptions -- there's enough information in the trust, such as prepayment [assumptions]. Sometimes, we need to know from management what their models are, the lumpiness with prepays -- [such as] right after graduation -- but there is data to track the actual performance of trusts versus the gain on sale calculation.

Emil Lee: CompuCredit is expanding into other subprime segments, such as auto financing and payday lending. How does this build the company's moat?

Tom Brown: Well, that's what we'll see in 2007 -- which could cause CompuCredit to be a home run. It's testing in a Texas storefront location whether it can cross-sell these services.

Emil Lee: It seems CompuCredit has recently had an uptick in charge-offs and delinquency. Is this a cause for concern? Do you think defaults will stay reasonable?

Tom Brown: I think defaults will go up. The fastest-growing part of its portfolio is the fee-based card, which has higher delinquencies but significantly higher revenue. The fee-based card is more profitable. Overall, it's a positive for profitability.

Emil Lee: In the end, it comes down to this: The stock market thinks CompuCredit is vulnerable to a credit crunch when an increasingly debt-laden borrower starts to default, spurred by things such as a possible housing downturn or a weakening economy. What would your rebuttal be?

Tom Brown: I would respond that underwriting is more important than the economy. CompuCredit is going to a higher level of earnings growth and profitability throughout the economic cycle.

Bubbling Crude Oil Update

It simply amazes me that hoards of people think the futures market reflects some sort of commodity pricing equilibrium. Sure, it's the best system that we have, but it's far from perfect. A flood of hot, speculative money chasing a "story" or returns can easily generate a bubble. This isn't rocket science, it's simply greed. Here's what has happened in the oil market over the past few years.

Strong demand from India and China combined with declining OPEC spare capacity and geopolitical tensions led to higher crude prices (and justifiably so). Stories started to emerge that demand from China would continue at a torrid pace forever and that the world was running out of oil (i.e. peak oil theory). This caused a mania in the energy markets and oil prices soared from $40 to $78. The high prices generated massive investment in non-OPEC oil rigs and related equipment causing supply production to increase contrary to the kooky peak oil theorists. Now, demand is running well below expectations but the oil bugs are either blind or think/hope it's a temporary phenomenon. As a result, the futures price curve is still upward sloping from $58 to about $64 while the traditional inventory/price model says prices should be around $40.

Look at what ISI's Mike Rothman had to say today:

"* Our estimate for end-January oil storage in the OECD countries shows a month-to-month draw of 5 million barrels, which is much smaller than expected given oil supply figures.

*Using our storage estimate, world oil demand for January may have been a million barrels per day BELOW our forecast - put another way, the year-over-year growth rate looks about 70% lower than we expected.

*While we already get a lot of push back on our non-OPEC supply forecast (largest annual gain in 30 years) we think the market is also not focused on prospects for a weak oil demand environment.

*In a related sense to the last point, with crude prices still in a steep contango the data for NYMEX open interest in crude suggests we have yet to see the "capitulation sell-off" in the oil market.

*Energy equities are still trading as if the drop in crude prices is a temporary phenomenon. A look at the XLE shows stocks trading above current oil prices levels on both an absolute and relative basis.

*Weather guidance for the US sees temperatures moderating significantly to a warmer than normal levels. Essentially, a return to unseasonable readings highlights prospects for natural gas storage to end the winter at high levels."

Fundamentals are poor yet prices are still massively inflated. If that's not a bubble I don't know what is.

iShares MSCI Taiwan ETF (EWT)

The intrinsic value and dividend yields are high and potential political changes and lower commodity prices are positive catalysts. Price momentum is positive too.

ComputCredit (CCRT) 4Q06 Earnings

CompuCredit (CCRT) reported managed EPS of $0.40, in line with management’s preannouncement. The biggest issues during the quarter were the changes in billing practices which lowered earnings (but makes them higher quality), a focus on lower FICO customers and the $2.3 million pre-tax loss in the auto segment reflecting difficulties with a systems conversion. The conversion took up a lot of management’s time and resources and hurt sales/credit quality. The good news is that the systems issues have been addressed and the new platform is fully functional allowing for greater scale which is important given the recent acquisition of ACC.

Marketing spend is increasing significantly but that’s because management is seeing good returns on their online marketing dollar. They are also more confident in deal making right now than they were 6-12 months ago as prices have come down. I got the sense that management is very disciplined in their deals and use of capital. They are also not opposed to share buy-backs if the stock continues to trade at a low multiple and looks more attractive than acquisitions.

For FY07, management guided to EPS of $4.00 (without acquisitions) which is a bit lower than consensus and reflects the billings issues, higher chargeoffs from lower FICO customers and increased marketing spending. I think the company is well positioned to exceed $4.00 in FY07 and at least $5.00 in FY08 as investments pay off. At $35 per share, the stock trades at a compelling 8.75 and 7.0 times estimates.

The regulatory and subprime mortgage fears appear to be substantially overblown as they relate to CCRT. Management stated that about 30% of their customers have subprime mortgages but they are not seeing any adverse affects from that fallout on credit quality. Furthermore, the weakness in the subprime mortgage space may give the company an opportunity to pick up some distressed assets very, very cheaply.

Subprime Lending

I noticed that many of the subprime mortgage lending stocks got whacked last week, and I can't help but think CCRT may have gotten lumped in with that mess of stocks even though the company has no mortgage exposure. The stock is discounting a lot of problems while there don't appear to be any.

Earnings will be out after the close with a conference call at 7:00 am CST.

Payday Lending

It appears that Tom Brown received my email as he put out a nice report today about the economics of payday lending and how it's getting a bad rap by lawmakers. You can read the report here:

http://www.bankstocks.com/article.asp?type=1&id=9881282

In summary, it's better for consumers with a short-term liquidity problem to do a payday loan than get charged late or overdraft fees.

Payday loans are only about 9% of CCRT's revenues but they are hoping to grow this business.

CompuCredit (CCRT) Update

Last Friday, CCRT announced the acquisition of ACC Consumer Finance along with $275 million of subprime auto finance receivables and a $195 million auto loan portfolio. Not many details were available, but CS raised EPS estimates by 10 cents to $4.35 and $4.95 for 2007 and 2008 respectively. CS also estimates that this acquisition represents about 10-15% of CCRT’s excess liquidity, so similar deals could be significantly accretive to earnings and yet the stock is still selling at about $36 or just 8.2 times 07 estimates.

One reason the stock has a depressed multiple is because 8.72m of the 20.77m floating shares (42%) have been shorted. This is an extremely high short interest to float ratio. If the company comes through with their projected earnings and provides reasonable guidance after the close of market on Feb 13th, I suspect the stock will have a nice rally, maybe even a huge rally in the event of a short squeeze. I can only speculate as to why the shorts are attacking this company, but my guess is that they see a lot of risk in the regulatory environment. Payday lenders in particular are receiving a lot of scrutiny by lawmakers. Hopefully the politicians will not destroy industry profitability.

Energy Markets Still Frothy

More good stuff from ISI:

"* Unknown to most all market watchers, Angola's entry into OPEC last month came with a proviso that the African producer's supply projects will be "grandfathered" and not subject to quota restrictions.

*We continue to view Angola's supply as being effectively part of non-OPEC. The country's production growth this year will take output from a wee under 1.5 mm b/d in December to just over 1.9 mm b/d by the end of '07.

*The total non-OPEC growth we see for 2007 should ease market concerns about spare production capacity. A dissipation of these fears is expected by us to eventually help lever down crude prices.

*Even with arctic air, distillate stocks are expected to draw by a smaller than normal volume. We continue to focus on total US demand numbers which turned decidedly weak in December."

So, in other words, fundamentals stink!

Some Attractive International ETF's

The iShares Taiwan (EWT) and Malaysia (EWM) funds still look very attractive with excellent value and momentum characteristics. It's not too late to buy them IMO.

Japan is looking overvalued and is draining liquidity, so EPP (Pacific ex-Japan) is probably my favorite for broader international exposure. EEM still looks pretty good too but the rally is getting a little long in the tooth.

Natural Gas Prices Too High

From the good guys at ISI:

"* Our updated analysis of the "carry out" - where natural gas storage will sit come April - suggests inventories will be about 1.73 trillion cubic feet or almost 50% above normal.

* That figure assumes normal withdrawals during February and March. If we look at a scenario where draws are much larger than normal, stocks would still be 25% above normal.

* With inventories high, come spring, storage gas effectively has to compete with wellhead supply - a phenomenon called gas-to-gas competition.

* For prices, we see the storage situation essentially manifesting in a 12 month natural gas strip price of $6.75-$7/MM BTUs as opposed to the current figure of $8/MM BTUs.

* For equities, this means we still favor the idea of being short (or underweight) stocks leveraged to natural gas prices with one vehicle being the American Stock Exchange Natural Gas Index (the XNG).

* The XNG shows a very strong positive correlation to the one year-strip price. As of last night's close, the XNG is trading off a $10 strip price, suggesting there is about 30% downside potential."

The cold weather has caused a short-term rally in energy stocks but they look bad across the board. Oil stocks are trading like crude is at $70 and gas stocks are trading off a $10 price.

FundAlarm.com

A friend recently turned me on to FundAlarm.com, an excellent site that ranks mutual funds and uncovers/reports the slimy industry's secrects along with various corporate governance issues that invetors need to know about. The commentary is updated on the first day of each month and is worth a read.