Oscar Schafer
Barron's: Last June you told our readers to short Enron. How can you top that?
Schafer: I probably can't. I think I'll quit while I'm ahead as far as short recommendations are concerned. Clearly Enron was just the first of a series of companies with problems, including Tyco, Adelphia, Dynegy, Xerox, Arthur Andersen, Merrill Lynch and others. These revelations have eroded individual and institutional investors' confidence in the market. One thing people worried about for years was the individual investor. In May the net equity inflow into mutual funds was only $5 billion versus $11.8 billion a year ago. With the bursting of the technology bubble, an individual investor who came into the market in 1995 probably is up only 10% cumulatively. If the market continues to flounder we could see the reverse of individuals pouring money in. We could have a vicious circle, where in the past we had a virtuous circle. Stocks would go down and the cost of capital would go up. It would hurt capital spending, which already is weak, and probably reverse all of the boom of 1999 and 2000. In a long-winded way, this could be the fallout from Enron.
Q: What are the odds this happens?
A: As the market goes down, strangely enough, the more likely it is to go down. I can't put probabilities on it. At the beginning of the year I thought the market would be 5% up or down. I'm surprised the biotech index, for example, is down in the 40% range. Overall, stocks aren't cheap. The market is trading at 20 times trailing operating earnings, with all the questions about what earnings are. As the market falls it has more risk, not less. I don't think you've heard the term "momentum investing" in a long time, for good reason. There has been no momentum.
Q: Except in reverse.
A: Something else we've seen in the past year has been the reverse Robin Hood effect. The rich have robbed from the poor, and that is affecting investor confidence. A weaker dollar also has potential ramifications -- increasing inflation and long-term rates, leading to lower P/Es. I think the economy will bumble along at best, because heavy capital spending led to overcapacity in many areas of the world. The economy has done well lately due to inventory restocking, but that will end at some point. And, it's a jobless recovery.
Oscar Schafer
Company Symbol Recent Price
Aviall AVL $11.02
Osteotech OSTE 7.35
Q: How do you make money at a time like this?
A: I try to focus on companies that I've known for years, whose stocks have come down but whose fundamentals are turning around. That brings me to Aviall. This parts distributor for the aviation and defense industries is in the early stages of a dramatic turnaround. The company was spun out of Ryder System in 1993, and in the subsequent seven years suffered through a couple of CEOs, poor financial performance and a botched sales process. The stock sold as high as $19 in 1999, and is now about $11. In 2000 Paul Fulchino, a man with significant experience in the aerospace and transportation community, took the helm and has made a series of smart moves that are positioning the company for sustainable growth. The fruits of his efforts are just beginning to show up in Aviall's financial performance. Late last year Aviall signed an exclusive 10-year contract to distribute parts for the Rolls- Royce T-56 engine, which is used in, among other planes, the C130 that transports the U.S. military. There are 8,000 T-56 engines in place all over the world. This agreement will add revenues of roughly $300 million a year to Aviall's base of $500 million, and provide the company entrée into the defense business. Aviall also has sole-source distribution agreements with Honeywell, and is positioned to add customers in aviation, aerospace and defense.
Q: What does all this mean for earnings?
A: Largely as a result of the Rolls-Royce agreement, Aviall's earnings will rise from 51 cents per share last year to roughly 80-85 cents, fully taxed, in 2002. This, despite the fact that commercial aerospace distribution revenues are down dramatically year-over-year as a result of Sept. 11. Also, the company has a net operating loss carryforward with a present value of roughly a $1.25 a share. Next year Aviall could earn close to a dollar, and could sell closer to $19 again.
Q: Have you another pick?
A: Osteotech is a leading processor of allograft bone-graph products. "Allograft" comes from other people's bodies, "autograft" comes from your own. These products are used principally in the fast-growing spine market, which is growing by 15% to 20% a year. The company has sales of about $90 million, and 14 million shares outstanding, and trades for about $7-$7.50. The market value is a little over $100 million. The stock sold as high as 41 in 1999, but declined as the company suffered from increasing competition and the need to spend on developing a broader product line. In addition, a series of lawsuits diverted management's focus. Finally, the company had difficulty obtaining sufficient tissue.
Recently Osteotech settled several patent lawsuits, reaching agreement with a supplier of tissue to obtain increased supplies and a broader product line, to be fully competitive. The company will benefit from reduced legal costs, international expansion and growth in market share, as well as operating leverage, thanks to a new state-of-the-art plant. Earnings could rise from 25 cents a share this year to more than a dollar in several years, and the stock could sell for two-three times its current price.
Q: Thanks, Oscar.
SCHAFER
Price Price Percent
Company Symbol 1/7/02 6/14/02 Change
Pharma Resources PRX 28.52 29.00 1.68%
Viasys VAS 22.75 18.36 -19.30
Principal Fin'l Group PFG 23.85 30.31 27.09
Dr. Reddy's Labs (ADR) RDY 19.45 20.54 5.60 |
