Two Overlooked Stocks in Big Data and Security

Nice Systems $NICE and its competitor, Verint Systems $VRNT are stocks that benefit from increasing security and regulatory compliance within financial services. They make the kind of surveillance and monitoring systems that banks like UBS would have needed to make sure that rogue trader Kewku Adoboli might have been picked up early on in his activities. As such, their primary profit drivers are increasing regulation and, the growth of ever more complex needs to gather information from multiple sources, both internally and externally.


Nice and Verint set for Growth

With the implementation of Dodd-Frank and the increasing needs for firms to manage security and work flow optimization, these firms look set to grow strongly. They help companies to extract insight from interactions, transactions, and surveillance. The information is gathered from a wide range of different sources, from emails and phone calls to video surveillance.
Nice and Verint should see good growth as financial firms start to spend again in order to support expansion and deal with mounting compliance and regulatory issues. Furthermore, financial firms and Governments are under increasing pressure to protect themselves and the company from internal and external security threats as well as ensure that work flow is being properly managed. These words sound abstract, but consider criminals like Nick Leeson and Jerome Kerviel, both of whom benefitted from lax monitoring and compliance controls.


Nice Systems and Verint Systems Recession Proof?

The odd thing about these two stocks is that they both increased net income and cash flow through the recession. This is to be understood, as their revenue drivers are relatively secular. However, with Nice Systems, there was a drop in revenues of 6.5% from 08-09 and gross profit fell by 10%. However, Nice managed to only lose 7% in EBIT due to reduced SG&A  expenses.
This suggests that they are relatively recession proof but the problem is that a large amount of the company’s revenue comes from the financial services vertical. Unfortunately, if there is a Sovereign Debt Crisis induced slowdown then it is this sector and its suppliers, that will get hit the hardest. Nice Systems will not be immune from any negative sentiment.


Focussing on Nice Systems

I want to focus on Nice as I view it as the stronger of the two.
Essentially, Nice Systems is positioned at the high end of the Work Flow Optimization (WFO) market. As such, Nice tends to offer relatively expensive large scale solutions to the enterprise market. This leaves them exposed to cheaper competitors chasing Nice's installed base when they come to upgrade or renew. However, it also ensures that Nice offers a comprehensive best in class solution.

One area of possible concern is public sector end demand, but it is probable that this is an area of spending that Governments will be highly reticent to cut. Security is not the sort of area they should be cutting back on. Work Flow Optimization gives a tangible return on investment and much of Nice's end demand is regulatory and compliance led. Another cause of worry could be an increase in the demand from organizations for their WFO solutions to be sold by their contact center infrastructure provider. Although, Nice is focused on the high end so this trend is unlikely to have a great affect.


Nice Systems Q4 Results

In the previous quarter a number of questions were raised by analysts regarding current growth prospects. I’ve summarized them here.

• Slower customer bookings in the third quarter, some of which were closed in the ongoing fourth quarter
• Book to bill forecast to be much higher in the fourth quarter
• Weakness in Q3 not seen in any product line or geography
• Management explained that the book to bill also had a pattern of being weaker in the third quarter in previous years, and that this was partly due to the increase in maintenance revenues and the way that business was conducted

Fortunately, when Nice gave its Q4 numbers, all of these issues were resolved in the manner that the company suggested. The book to bill went over one, Nice reported record revenues and the pipeline was strong. There is nothing to suggest that current orders for Nice (and Verint) are not in good shape. The market reacted by marking the stock up. Verint reported later and confirmed that the industry is in good shape.


Should you buy Nice and Verint?

I prefer Nice because it generates more free cash flow and has better growth prospects than Verint. In fact Nice has generated over $380m in free cash flow over the last three years. That is not bad for a company with an Enterprise Value (EV) of $2.21bn. Furthermore, earnings estimates are for mid teens growth in earnings and revenues, for the next two years.
In summary, Nice Systems is currently generating over 6% of its EV in free cash, has strong growth prospects, and is in a favorable long term industry with plenty of upside given increasing corporate awareness of security issues and workflow optimization.

Acuity Brands Stock Research

Acuity Brands $AYI is a manufacturer of indoor and outdoor lighting and as such, is the sort of stock that has been bid up as the market prices in a recovery in the North American real estate market. Alongside its rival Cooper Industries $CBE and other real estate darlings such as Masco $MAS these stocks have been surging this year.

A quick look at a recent price chart, reveals that Acuity has been up as high as 80% above the October lows. When Warren Buffet is talking about a recovery in his annual letter, than investors can feel heartened, even after this strong rise. Longer term, the trends do look good, and Acuity has growth prospects via the increasing use of energy efficient LED lighting.

Acuity is geared to the commercial real estate market and is the market leader in commercial indoor and outdoor lighting. It is also the leader in industrial lighting as well as a major player in the residential market too.

So what happened after the Q2 results? Why the big sell off?


Acuity Q2 Results

Firstly, Acuity managed to beat revenue guidance but they missed on adjusted diluted EPS estimates.

• Revenues at $457.7m vs. $455.4m estimates
• Adjusted diluted EPS at 57c vs. 62c estimates

The market loves to punish companies for an earnings miss and with the recent market weakness, it is not surprising to see Acuity sold off after a very strong run. There are, however, a few extenuating factors here.

Firstly, the tax rate in the quarter was a 35.4% which is higher than last year’s rate of 31.4% thanks to the non-extension of a research and development tax credit. This cost Acuity 3 cents of EPS in the quarter, although management stated that the full year tax rate was likely to be 34%.

Secondly, Acuity reported a loss of $1.3m in Spain in the quarter. This is equivalent to 3 cents of diluted EPS and frankly, I’m not surprised. Spain’s commercial real estate market is in a consolidated decline and there are few signs of a quick turn around. However, the company is taking the right steps and downsizing operations in Spain. Moreover, Spain now represents less than one per cent of sales.

Thirdly, the company took a special charge of 11c relating to a reduction in the sales force in Spain and the closure of a plant in Cochran, Georgia. These streamlining efforts will allow Acuity to benefit from cost savings which should improve margins in the future.

In conclusion, the earnings miss is not really of sign of any underlying problems that Acuity can’t address, if the company is not doing so already.


A Commercial Property Recovery in Site?

As ever, an investment decision will have to be based on a sense of recovery for the US commercial property market. Whilst, Acuity described the five per cent increase in unit volumes as being ‘broad-based’ across products and sales channels, the market will want to see more evidence before taking Acuity higher. On the conference call, management referred to low to mid single digit growth for the North American lighting market for the remainder of 2012. This figure tallies with Acuity’s reported volume growth in the quarter, so it is reasonable to expect that Acuity can achieve single digit growth rates throughout 2012.

Analysts have 7.8% revenue growth pencilled in for 2012, and Acuity is likely to achieve this, provided the trend towards a more favorable pricing mix continues. Management acted quickly in 2011 and increased prices in selected lines, in order to counteract a less favorable sales mix. So, we know they are on the ball.

Moreover, the streamlining efforts will aid margin growth in time and the current glut of LEDs (thanks to over capacity in China) could result in some abating of pricing pressures. Companies, like Cree $CREE and SemiLEDS $LEDS have had pricing problems due to industry overcapacity over the last year. Similarly, if there is going to be a sharp slowdown in China’s real estate market then this too, will alleviate input pricing pressure.


Time to Buy Acuity?

I rather like the trends being discussed and, believe that with the positive trends in US employment, the outlook for property in the US is better than it has been for years. The banks are starting to loosen up on Commercial and Industrial lending, and the US banks bad debt ratios are still falling. Its time for them to start lending.

The signs do look positive and Acuity will possibly be a winner if there is a sharp slowdown in Chinese fixed asset investment. This is definitely a stock worth monitoring and I think it might be worth picking some up around if the sell off continues to the $55 mark. Sometimes the market over reacts.

A Recession Proof Small Cap

Church & Dwight $CHD  a great stock for a balanced portfolio because it is recession resistant. It trades on a good evaluation and offers the prospect of some upside from a fall in commodity input costs.

Furthermore, the company is a small player in a market dominated by large acquisitive companies like Colgate  $CL Procter & Gamble $PG and, London listed Reckitt Benckiser. In fact, Reckitt took over another British company SSL whose Durex condom brand competes with Church and Dwight’s Trojan.

Church and Dwight competes successfully with the likes of Procter & Gamble because it aggressively defends its niche markets from competition. As such, it is able to defend its positions and generate growth in a way that Procter & Gamble's management has failed to do. Furthermore, Church & Dwight offers value brands which already compete on price. A company like Procter & Gamble tends to be reticent to cut prices because consumers tends to want them to stick.

A classic example of this, would be with  the company's Arm & Hammer toothpaste with Colgate's. Arm & Hammer is the value brand and moreover, Church & Dwight's management are nimble enough to leverage the brand by releasing products such as electrical toothbrushes.

The company is little discussed but has an excellent track record of generating earnings through the cycle. I think they can generate at least double digit returns for a stock investor from here and, are a genuine takeover target.


 Church & Dwight Brands

The company’s brands can be categorized as a diversified collection of personal and homecare goods. Much of it’s brands are value propositions which offer upside in a stagnant economy, as consumers trade down to cheaper options. In terms of profits and sales, 80% of them come from the eight leading ‘power’ brands…

• Arm & Hammer (toothpaste, baking soda, detergent, cat litter)
• Trojan Condoms and Vibrators
• OxiClean Laundry Additive
• Spinbrush Battery Powered Toothbrush
• First Response Pregnancy Kit
• Nair Hair Removal
• Orajel Pain Relief
• Xtra Extreme Value Laundry Detergent

The list reads like a roll call of US value brands commonly found in the home. However, Church & Dwight is far smaller than its major competitors and, its business model is tailored towards grabbing leadership in niche markets.  This means that it can protect its market share without resorting to margin erosion via price cuts.

What makes this company really special is the quality of its execution.


Church & Dwight Earnings

The management has demonstrated a tremendous ability to grow earnings and revenues over the years, even in the face of rising commodity costs and, the great recession.  This can easily be summarized below

($m)	2006	2007	2008	2009	2010	2011
Revenue	1,955	2,221	2,422	2,520	2,589	2,749
Gross Profit	761	877	972	1,101	1,157	1,215
Adjusted EPS ($)	1.04	1.23	1.43	1.74	1.98	2.21
EPS Growth (%)		18.3	16.3	21.6	13.8	12

At the final results in February, management guided towards 3-4% revenue growth in 2012 with EPS growth of 14-15% .

All of which paints a picture of a recession proof company. However, 2011 has proved challenging. End demand was lower than initially expected and, rising commodity costs put pressure on margin expansion. No matter, the outlook for 2012 presents upside potential as the US economy generates employment gains and, commodity costs may abate with slowing emerging market growth.

It is also worth noting that gross margins jumped in 2009 with the fall in commodity prices and, Church & Dwight has managed to hold onto them despite rising costs. Similarly, with such a well run business, working capital management is excellent and, the company always generates large amounts of free cash flow.


Church & Dwight Target Price

The stock currently trades at a price of $49.59 with a market cap of $7.09bn. There is $251m in cash on the balance sheet with $249m in outstanding debt. Free cash flow has grown from $200m to $365m from 2007-2011 with a compound annual growth rate of 16%.

Obviously, on a current PE ratio of 22.4, it looks expensive but investors should focus on free cash flow. Church and Dwight trades on a current free cash flow yield of 5.1% and, that is attractive for a recession resistant company which is growing earnings in the teens. In addition, management states that they expect to generate $1.1bn in free cash flow over the next three years. This represents over 15% of the current market cap. Having increased the dividend by 41% at the last earnings, I think we should take them seriously!

 For a relatively secure double digit growth over the next couple of years, this stock could trade on an evaluation closer to $55. There is upside potential from reducing commodity costs and, a potential value outer from an acquisition bid for the company.  A $55 target represents 11% upside with plenty of room to grow, should a slowing Chinese economy reduce commodity input costs. Similarly, a strong return to US consumer spending will see upside to revenue growth at all the leading consumer goods companies.

Church & Dwight is a nice recession resistant stock which is good for balancing any portfolio.  

Sirona Dental Systems Research

Sirona Dental Systems (NASDAQ: SIRO) is a dental healthcare stock which is exposed to favorable demographic tailwinds and the expansion of the rollout of its global leading technology.  The evaluation and prospects look compelling and, there is upside potential to the stock price.

Sirona's Profit Drivers

Sirona has two key earnings drivers.

First, consider the ageing demographic. As people get older they require more teeth maintenance. Furthermore, as people tend to have more teeth decay as they are older, dentists can expect more restoration work. Ultimately, Sirona should see more demand for its products. 
Secondly, its proprietary technology currently has low market share and, provides dentists with many cost and quality advantages.

Whilst the demographic argument is well worn in healthcare plays, it should carry more weight with Sirona because of a relative lack of insurance reimbursement issues with dentistry products and solutions. Indeed, the industry is shifting towards private from public pay and, much of what Sirona does is aimed at the high end market.

The company is very well run and a global technology leader. Sirona spends around six to seven percent on research and development every year and is investing $15m in setting up a major new innovation centre in Bensheim, Germany. The balance sheet is solid, having seen the company engage in deleveraging the business over the last few years. Sirona is now in a position to make some acquisitions and, I would expect some activity on this front. Sirona has its origins as a spin off from German industrial giant Siemens (NYSE: SI)

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