Douglas TerresonMorgan Stanley
Valero Energy Corp. (NYSE: VLO) +128.46%
In the fall of 2002, Morgan Stanley’s Douglas Terreson looked at oil and saw gold. Based on his assessment that the global oil supply-demand equation would produce substantial improvements in refining margins, he recommended refiners, especially Valero Energy Corp.
The largest, most-liquid stock in the refiner group, San Antonio, Texas–based Valero had grown through acquisitions over the previous five years. What’s more, Terreson told investors, the company had a lot of earnings leverage. On the day he recommended the stock, September 18, 2002, Valero’s shares were trading at a split-adjusted $7.62.
What followed, of course, was a global oil boom. Refiners have been enjoying their highest margins in 20 years, and Valero has continued to make acquisitions, most notably that of fellow refiner Premcor in September 2005. The company’s refining capacity has risen from 175,000 barrels a day in 1997 to 3.3 million.
Valero’s shares closed at $51.60 on December 31, 2005, for a 128.46 percent gain last year. Investors that followed Terreson’s recommendation from the outset saw their holdings increase by 577.17 percent. In mid-March the shares were at $57.68, and Terreson is still bullish. He predicts that Valero’s free cash flow and lower capital spending could spur share repurchases. His target price for 2006: $75.
Houston-based Terreson, 44, trained as a petroleum engineer at Schlumberger and has followed the integrated oil category at Morgan Stanley since 1995. He has been a first-teamer on Institutional Investor’s All-America Research Team for the past two years. “We’ve known management a long time, and we understand the strategies of the company,” Terreson says of Valero. “If I were the chairman, I’d have done exactly the same things.”
Benjamin Reitzes
UBS
Apple Computer (Nasdaq: AAPL) +123.26%
On January 14, 2004, when Apple Computer released its earnings for its fiscal ’04 first quarter, it showed lower-than-expected PowerBook sales. Investors sold shares, causing a 7 percent drop in the stock in one day. UBS’s Benjamin Reitzes, who was more intrigued by the potential of Apple’s iPod than worried about the PowerBook, took advantage of the decline to upgrade his Apple rating from neutral to outperform, at a split-adjusted $11.35.
Other analysts focused on the iPod’s halo effect on other Apple products, but Reitzes posited a “multiplier effect": The Cupertino, California–based company’s sales would be boosted not only by traffic brought into Apple stores by iPod users, the analyst asserted in a February 2004 report, but also by iPod users’ purchases of music from iTunes and other products.
When Reitzes upgraded Apple in early 2004, there were 800,000 iPods in use; when Apple’s fiscal year ended in September 2005, there were 22.5 million. Reitzes estimates that that number will more than double this year.
At the end of December 2005, Apple shares had reached $71.89, for a return last year of 123.26 percent. The gain since Reitzes’ initial, early 2004 recommendation? Some 533.39 percent. Despite a first-quarter sell-off that dropped the stock to $66.23 as of mid-March, Reitzes advises investors to stick with Apple because of a new product cycle for Macs and new strategies to load content onto iPods.
New York–based Reitzes, 33, a 1994 graduate of Vanderbilt University, started out covering imaging technology and added information technology hardware in early 2003. He is a four-time II first-teamer in Imaging Technology (including the 2005 team) and a third-teamer in IT Hardware on the ’05 team.
Note: Apple was a home-run stock last year too.
John Kreger
Wm. Blair & Co.
Express Scripts (Nasdaq: ESRX) +119.26%
John Kreger didn’t discover Express Scripts; he inherited coverage of it and other pharmacy-benefit-management companies in 2001 from an analyst who left Wm. Blair & Co. “But the PBM space appealed to me,” he says.
Kreger viewed the sector as part of the solution to the health care crisis: PBMs contract with health care plans to efficiently administer and process pharmacy services. And he liked that PBMs had a business model that put a premium on predictable cash flow. “Especially in a Reg FD world, predictability is good,” he says, referring to the Securities and Exchange Commission’s fair disclosure rule, which bars company managements from giving privileged information to analysts. Kreger began his coverage of Maryland Heights, Missouri–based Express with a buy rating on May 24, 2001, at a split-adjusted price of $23.24.
For the next couple of years, the 37-year-old analyst says, “we had our conviction tested.” The PBM business came in for tough regulatory scrutiny, vocal criticism from rival retail pharmacies and negative press. But every time Kreger did more due diligence, his resolve grew. He upgraded his rating to a strong buy in July 2002. Management changes in 2004 confirmed his optimism, as the company moved to cut costs and renegotiate contracts upward, raising Express’ earnings growth trajectory from 20 percent to 30.
The analyst says “2005 was a breakout year.” The shares ended the year at $83.80, up 260.59 percent since Kreger’s May 2001 initial buy (and 119.26 percent for ’05). Still, the analyst doesn’t see that as the end of the Express ride. The company has lower margins — $1.53 in earnings before interest, taxes, depreciation and amortization per pharmaceutical claim — than competitors MedcoHealth Solutions ($2.05) and Caremark Rx (2.86), Kreger says, so it has scope for further upside; the shares traded at $90.12 in mid-March.
Kreger got his first taste of the health care industry while doing a student job at the University of Michigan Medical Center. “I got to witness the bureaucracy from the inside,” says the 1990 graduate. Before joining Chicago-based Blair, Kreger followed biotech stocks and health care services at Vector Securities International, which became part of Prudential Securities in 1999.
Leonard (Larry) Benedetto
Howard Weil
EOG Resources (NYSE: EOG) +106.26%
Long before supplies of natural gas became tight and prices skyrocketed, the management of Houston-based EOG Resources positioned the exploration-and-production company to take advantage of new technologies that made drilling in “tight” — that is, semipermeable — gas sands economical, says Leonard (Larry) Benedetto, E&P analyst for New Orleans–based Howard Weil. He recommended that investors accumulate EOG shares in October 2001, when their price was $13.87, and he raised his rating to a formal buy in March 2002. Investors that heeded his advice from the start saw EOG’s price rise 428.70 percent through December 30, 2005 (106.26 percent in 2005 alone).
“The first things I look at are the management team and the acreage,” says Benedetto. “I have a lot of respect for EOG’s management.” Led by CEO Mark Papa, EOG amassed holdings in unconventional gas sands, such as the Barnett Shale area outside Fort Worth, Texas, and used still-developing drilling technologies to tap their natural-gas wells horizontally. Success at that endeavor plus higher natural-gas prices enabled the company to increase free cash flow and pay down debt.
EOG’s managers used their “expertise and knowledge” to position the company well, the analyst says. He remains bullish on EOG, setting a target price this year of $85; the stock was trading at $70.39 in mid-March.
Benedetto’s background in law and in industry — he spent 15 years working in land management for Freeport McMoRan — is a plus. The 55-year-old University of New Orleans and Louisiana State University Law School grad has been at Weil ten years and says the firm’s concentration on the energy industry gives him an edge.
Irene Haas
Sanders Morris Harris
Burlington Resources (NYSE: BR) +99.35%
In summer 2002, with the U.S. economy hitting bottom, the oil business arrived at an inflection point, says Sanders Morris Harris analyst Irene Haas. Coming off a recovery in 2000, oil companies “got aggressive with spending and overproduced,” she says, causing a pricing “hiccup.” The result was an opportunity for brave energy investors.
Burlington Resources, a big Houston exploration and production outfit (which was absorbed into ConocoPhillips in March), had lately begun to shift its exploration efforts from expensive and risky deepwater areas in the Gulf of Mexico to more-reliable and hence profitable onshore sites in the U.S. and Canada in “slow and deliberate steps,” says Haas.
In 2000, Burlington named a new CFO, Steven Shapiro, for whom Haas had a “high appreciation.” (He went on to become one of three executives occupying the company’s office of the chairman.) Burlington “did a lot of internal reengineering and reincentivized on cost controls and margins,” says Haas. She recommended the stock on July 19, 2002, at $17.16 — which turned out to be its low point.
Burlington’s shares began to climb in the fall of 2002, in part on anticipation of rising earnings. Then in December, ConocoPhillips agreed to acquire the company for $92 per share; Haas accordingly downgraded her rating to hold. All told, investors that bought Burlington shares in 2002 on her recommendation have realized a more than 400 percent gain (99.35 percent in 2005).
Haas, 49, who is based at Sanders’ Houston headquarters, ought to know the nitty-gritty of energy exploration. After earning a degree in geology from Rice University and doing postgrad work in marine geophysics at the University of Delaware, she spent 13 years with Exxon Co. working as a geophysicist in frontier exploration areas, such as Africa and offshore Alaska. Haas, who earned her MBA from Rice in 1996, worked on Morgan Stanley’s highly ranked E&P analyst team for a year and a half before joining Sanders in January 1998.
Harris Hall
Singular Research
Hansen Natural Corp. (Nasdaq: HANS) +332.90%
Hansen Natural Corp. is the kind of company analysts dream about: highly profitable, fast-growing, largely ignored by Wall Street — and cheap, says Harris Hall, director of research for Singular Research. He began coverage of the Corona, California–based beverage maker with a buy on October 12, 2004, when its shares were trading at a split-adjusted $12.50.
Two years ago the 72-year-old company had “just begun to penetrate its markets,” Hall says. Hansen’s chief growth stimulant — its wildly popular Monster Energy drinks — helped propel sales upward by 94 percent in 2005; earnings rose from 2004’s $0.86 to $2.59 per share.
Although Coca-Cola Co. and PepsiCo have competing energy concoctions, Hansen’s market share is growing faster than the category average, says Hall. He adds that management excels at marketing and advertising and has created tie-ins for Monster products at extreme-sports events.
“I tend to be conservative, but they have beaten my estimates every quarter,” says the 34-year-old analyst. Since he put a buy on the stock in fall 2004, the shares have soared 530.48 percent (332.90 percent in 2005). Hall says the company still has opportunity to expand abroad as well as at home and could be a takeover candidate. The shares were at $113.40 in mid-March, and Hall’s target price for 2006 is $120.
Hall, who graduated from Colorado College in 1995 with an economics degree, worked at a savings & loan and then at a quantitative money manager, Pasadena, California–based First Quadrant, before enrolling in New York University’s Stern School of Business. He took a leave to co-found a distributed-computing company that bought idle computer time from corporations and tried to sell it to other enterprises. The business didn’t fly, and he finished up his MBA in finance. Hall’s first job out of B-school was covering footwear and apparel for Wedbush Morgan Securities; he moved over to Singular in Woodland Hills, California, in June 2004 to head its research effort.
Richard Repetto
Sandler O’Neill & Partners
Nasdaq Stock Market (Nasdaq: NDAQ) +244.90%
Richard Repetto developed the skills for covering stocks while flying helicopters in the U.S. Army from 1985 to ’89. The 47-year-old Sandler O’Neill & Partners analyst credits his experience in whirlybirds with teaching him the discipline and steadiness needed to follow a fast-evolving industry like Internet-based finance.
New York City–based Nasdaq Stock Market is Repetto’s kind of moving target. The first publicly traded U.S. stock exchange, Nasdaq had been demutualized but was illiquid until a secondary offering in February 2005. (Sandler O’Neill was a co-manager.) Nasdaq had slashed its costs from 2002 through 2004 by an average of 12 to 15 percent per year, Repetto says.
He initiated coverage on March 22, 2005, with a buy at $11.48. By the end of the year, Nasdaq’s shares had more than tripled, to $35.18. (The full-year gain, reflecting a dip early in 2005, was 244.90 percent.)
Repetto remains bullish on Nasdaq, specifying a $45 12-month target price; the stock was at $44.77 in mid-March. The exchange’s December acquisition of Instinet Group has improved its technology, and the SEC’s new Reg NMS (to modernize the National Market System) lets Nasdaq trade shares once listed only on exchanges — an opportunity that its CEO, Robert Greifeld, has vowed to embrace enthusiastically.
Stock market consolidation remains a big question mark, which Nasdaq underscored by withdrawing its $4.2 billion bid for the London Stock Exchange late last month (see story, page 9). But Repetto believes the company is “pretty well positioned” for whatever evolves.
The analyst covers all six publicly traded U.S. exchanges, along with electronic brokerages and execution service companies. Before joining Sandler O’Neill in 2003, Repetto followed e-finance and e-brokerage at Putnam Lovell NBF and, before that, at Lehman Brothers, for six years in all. He also spent ten years at Mobil Oil Corp. (now Exxon Mobil Corp.) in sales and marketing. Repetto got an engineering degree in 1980 from the U.S. Military Academy at West Point and earned an MBA in finance from the Wharton School of the University of Pennsylvania in 1997.
Neal Dingmann
Pritchard Capital Partners
Arena Resources (AMEX: ARD) +224.71%
In November 2004, Neal Dingmann became the first analyst to follow Arena Resources. The microcap oil-and-gas exploration-and-production outfit in Tulsa, Oklahoma, had revenues of just $8.5 million and earnings of $2.5 million; last year its profits were $9.5 million on sales of $25.8 million.
“One of the key strategies that attracted us” to Arena, Dingmann wrote in his research report initiating coverage, “was management’s desire to delay exploration or development activities on certain property interests until they have a base of producing properties that will provide sufficient cash from operations to undertake further exploration or development activities.” That is a big advantage over micro E&Ps that have to rely on expensive outside financing, he explained.
His due diligence turned up positive comments about Arena from reservoir engineers and competitors. He recommended it on November 11, 2004, at $7.15. His target price at the time: $10.
The analyst lauded the company for its ability to be profitable with oil prices in the low $30s a barrel and for its financial strength, which allowed it to make acquisitions. By the end of last year, the shares had risen to $27.60, for a 224.71 percent gain in 2005, and 286.01 percent since his initial, November 2004 call. The shares were at $28.37 in mid-March.
When he made his buy call, Dingmann was working at Phoenix-based boutique M.S. Howells & Co. In February he left Howells for Mandeville, Louisiana–based Pritchard Capital Partners (he himself works out of Houston). Although Pritchard does not award ratings to stocks, Dingmann remains bullish on Arena.
Following his graduation from the University of Arkansas in 1992, Dingmann, 36, became a bond trader but then went on to the University of Minnesota to get an MBA. There he was one of the leaders of a multimillion-dollar equity fund run by students. Dingmann next covered the merchant energy group, utilities and master limited partnerships for Dain Rauscher in Dallas, then moved to Banc of America Securities’ oil field services team in Houston before joining Howells in 2004.
Frank Bracken
Jefferies & Co.
Parallel Petroleum Corp. (Nasdaq: PLLL) +215.58%
Frank Bracken had known Parallel Petroleum Corp. CEO Larry Oldham for a long time before he began covering his company. As the CFO of Garrity Oil & Gas Corp. for two years and then as the portfolio manager of Fidelity Select Energy Fund for five years, the Houston-based Jefferies & Co. analyst, now 44, had developed a 360-degree view of the oil industry and gotten to know many of its leading figures.
“Being on the inside gives you a handle on what the business is really like,” he says. “This allows me to empathize with management and to bring to bear an insider’s knowledge of accounting and regulatory issues.”
Midland, Texas–based Parallel was “a Gulf Coast explorer that had achieved excellent rates of return but less-impressive reserve growth,” Bracken says. Then in 2000 the company shifted its focus to take advantage of opportunities in west Texas’s Permian Basin, an area overlooked by many other companies.
Parallel augmented its technical management team, restimulated existing fields and made strategic acquisitions. The plan proved successful, but no sell-side analysts were paying attention. Bracken was the first, initiating coverage on June 3, 2004, with a buy at $4.00 per share. His target price: $6.
Parallel boosted production by 29 percent between fourth-quarter 2004 and fourth-quarter 2005; carried out key acquisitions, for instance in the Permian Basin; and better exploited new and existing fields. Bracken conservatively projects 15 percent annual output growth.
Wall Street began paying attention; three analysts, including Bracken, now track Parallel. Its shares have appreciated significantly, closing 2005 at $17.01, for a 215.58 percent spurt last year. They were at $17.29 in mid-March. Bracken says the company could trade at $25 two years out. He himself has a new career at New York–based Jefferies: banker.
Meredith Adler
Lehman Brothers
Great Atlantic & Pacific Tea Co. (NYSE: GAP) +210.05%
Wall Street tends to regard family-controlled businesses as potentially more dysfunctional than families themselves. And in the fiercely competitive, low-margin supermarket industry, winning stocks can be as hard to find as decent tomatoes.
Shares of Montvale, New Jersey–based Great Atlantic & Pacific Tea Co., which is controlled by the family of Christian Haub, executive chairman of the board, lagged throughout the 1990s. But Meredith Adler, 51, saw change coming for the parent of supermarket chains A&P and Waldbaum’s. The company had closed underperforming stores in unpromising markets, and management had begun to talk seriously about cutting overhead and reducing debt. What’s more, rumors circulated that A&P might sell its profitable Canadian division, a long-bruited move.
Adler brought her underweight rating up to equal weight in February 2005, then began to dig deeper into A&P. A Boston University comparative religion grad with an MBA from NYU, she had been a high-yield-bond analyst for a decade before being recruited by Lehman in 1996 to research equities. Adler says she “ran some more numbers and determined that [investors’] math had been backward-looking — not taking into effect the cost-cutting and the potential to pay down debt if A&P sold assets.” Her analysis showed that the stock, then trading at $12, was worth $18. She upgraded her rating to buy on March 24, at $12.19.
Less than two months later, A&P said it would indeed sell the Canadian business, for nearly $1.5 billion, and use the proceeds to pay down debt. The stock soared to the low 20s. But when Lehman was brought in to advise A&P on the deal, Adler had to restrict herself from discussing the company. By the time the conflict-of-interest restriction was lifted, A&P’s shares had run up to $30. For the whole of 2005, the stock gained 210.05 percent. The shares were at $33.54 in mid-March.
