Omega Protein (OME): A Different Kind of Oil, Making the Most of Menhaden

Most writers will admit that occasionally the well runs dry, and they run out of ideas. We’ve never had that problem here at Cheap Stocks. Granted, we only publish 4 to 8 times per month, but if this site was our full time job and we could feed our family and pay the mortgage from site generated revenue, we have little doubt about our ability to publish quality research 5 days a week (some of our readers might argue that point).

That being said, we’ll admit that sometimes our ideas for research come from strange situations. This is one of those times.

It so happened that we were on the beach Labor Day morning, a beautiful day, on the New Jersey Island we call our summer home. The plan was for the kids to surf before the lifeguards came on duty. But before anyone could get into the water, we noticed something strange. Dozens of pelicans attacking the water, schools of fish getting closer and closer to the shore. Then some of these fish started washing ashore. Most were still alive, some had a bite or two taken out of them. We threw them back in as quickly as they washed ashore, but we are not sure which fate was worse: suffocating on shore, or being tossed back into the midst of hundreds of mean, angry, and very hungry bluefish—the very reason these fish were so close to shore.

The fish washing ashore were Menhaden, otherwise known as Bunker. These oily fish have no use as food for human consumption (although they are excellent bait for blue claw crabs). As it turns out, they are also an excellent source of Omega-3 fish oil, commonly used to combat high cholesterol.

Omega Protein
That’s where Omega Protein (OME) enters the picture. Fish oil is their business. This small ($151 million market Cap) Houston based company uses a fleet of 32 spotter airplanes to find these fish, and 61 boats to bring home the catch. From there, the company processes the fish into Omega-3 fish oil used as a dietary supplement for humans, and sells what’s left over as animal feed, fertilizer and other products.

We’ve been intrigued by this company for years, but have never owned it-directly that is. We did own shares of Zapata Corp (ZAP), which until last year owned 58 percent of Omega. At the time we bought Zapata, this was the cheapest way to get exposure to Omega. Ultimately, Zapata decided to unload Omega, much to our chagrin, at well below market prices. The buyer of this huge Omega stake? Omega itself, which bought, and retired the shares. There’s where the story gets interesting. On November 28, 2006, the Company purchased 9,268,292 shares from Zapata for $47.5 million, or $5.125 per share. The previous day, Omega closed at $7.61, so this represented a 33% discount, not uncommon in the sale of such a large stake. The purchase was financed by a senior secured financing facility, increasing the company's debt load.

Omega also had the option to buy the rest of Zapata's stake, 5.2 million additional shares at $4.50 per share, but passed on that offer. Instead, those shares were purchased by multiple institutional investors for $5.55 per share, or $29 million. The purchasers included Special Situations Fund III QP, L.P., Special Situations Fund III, L.P., Special Situations Cayman Fund, L.P., Special Situations Private Equity Fund, L.P., Franklin Microcap Value Fund, Wynnefield Partners Small Cap Value, L.P., Wynnefield Partners Small Cap Value, L.P. I, Channel Partnership II, L.P.

The Fundamentals
Fiscal year 2006 sales rose 27% to $139.8 million from 2005s $109.9 million, and net income was $4.57 million, up from 2005s $7.2 million loss. Keep in mind though, that Hurricane Katrina was a factor in 2005s results, and several of the company's processing plants were severely damaged. For the latest reported period (Q2, June) the company netted $2.6 million on sales of $37 million.

As for the balance sheet, the company ended Q2 with $3.8 million in cash and $56 million in inventory. Certainly not a stellar balance sheet, and LT debt at $62 million increased as a result of the share purchase from Zapata. This is a fairly capital intensive company, with nearly $100 million in plant and fishing vessels, net of depreciation. Latest tangible book value per share was just north of $6.


The Risks
This company is not without its share of risks. First, Omega is completely dependent on finding an adequate supply of fish, and there are no guarantees here from year to year. Fish are the raw material, and without them, no product, no revenue. Second, fish oil yields have recently been down, and there is nothing the company can do about it. Lastly, the company has become extremely unpopular in the Chesapeake Bay area, one area where it harvests large quantities of Menhaden. Some believe the company has over-fished the Bay, posing a threat to the ecosystem, and the other fish that utilize Menhaden as a food supply. To that end, the State of Virginia imposed limits on Omega’s annual Menhaden Harvest. Further limits here, or other areas where the company harvests, could mean tough times ahead for Omega.

We view Omega as a company to keep an eye on. The valuations are not all that compelling at current levels, but this is a company in a niche market, and assuming they can continue to harvest an adequate supply of Menhaden, and that more consumers turn to natural methods of lowering cholesterol, and other benefits fish oil supplements are purported to provide, Omega may deserve a look.


*The author does not have a position in Omega Protein. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Top 10 Net/Nets by Market Cap

Admittedly, it's still a bit boring these days in the land of companies trading below their net current asset value. Dr. Bernanke did not help yesterday when he and his band of merry men lowered the Fed Fund Rate (and discount rate) 50bps. (Cheap Stocks, for one, was surprised it was 50bps)

Still, the markets move forward, basking in the glow of the rate cut, and the list of net/nets grows stale. Chock full of "acquisition" companies that have no real businesses, or companies that have sold off good businesses, and have no real plans for the proceeds(we mean you, Zapata)and the primary assets are cash, there's not a lot to get excited about. Just two of the companies are currently profitable--that is, they have trailing 12 month positive net income-- Audiovoxx, (a perennial net/net it seems) and Tandy Brands Accessories.

Top 10 Net/Nets by Market Cap
Audiovoxx(VOXX)
Mkt Cap: 246
NCAV: 279.6
Price: $10.8

Energy Infrastructure Acquisition Corp(EII)
Mkt Cap: 204
NCAV: 206
Price: $10.8

Atlantic Coast Entertainment(ACEH)
Mkt Cap: 170
NCAV: 218
Price: $17.1

Zapata Corp(ZAP)
Mkt Cap: 137
NCAV: 150
Price: $7.1

Media and Entertainment Holdings Inc(TVH)
Mkt Cap: 94
NCAV: 97
Price: $7.4

Columbus Acquisition Corp(BUS)
Mkt Cap: 88
NCAV: 110
Price: $7.4

Transforma Acquisition Corp(TAQ)
Mkt Cap: 80
NCAV: 96
Price: $7.5

MediciNova(MNOV)
Mkt Cap: 79
NCAV: 96
Price: $6.8

Tandy Brand Accessories Inc(TBAC)
Mkt Cap: 73.6
NCAV: 74.4
Price: $4.1

InFocus Corp(INFS)
Mkt Cap: 70
NCAV: 77
Price: $1.7

There you have it. Stay tuned; we'll keep turning over rocks, looking for value.

*The author does not have a position in any companies mentioned. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Playing 20 Questions With St Joes (JOE)

Lost amid the seemingly dim economic news that was released last week and today, all of which is fueling Wall Street's hopes for a 50 basis point cut in the Fed Funds Rate at next Tuesday's Fed meeting (don't bet on 50bps), was an interesting little press release courtesy of St. Joes.

Actually, it was 10 questions, but was no doubt an attempt by the the company to counter recent bearish sentiment about JOE. The press release, admittedly one sided, is still an interesting read. If you want to hear both sides of the JOE argument, read it in conjunction with Greenlight Capital's David Einhorn's recent response to a previous Cheap Stocks post about St. Joes.

For our part, we took advantage of the recent dip below $31 to increase our St. Joes position. We simply couldn't say no at those levels.

*The author has a position in St Joes Corp. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Cheap Stocks Random Notes: The Frivolous Lawsuit of the Week: Jones Soda (JSDA)

The sharks are circling Jones Soda (JSDA) since the stock tumbled from the $30's to $10; yes, here come the lawyers and their class action lawsuits. We owned the stock, (yes, way out of character; search the site for previous posts) we sold it when we thought the valuations were beyond ridiculous and priced for utter perfection, we even received some very nice e-mails from "investors" who not so politely told us how stupid we were.

This particular suit, Hagens Berman Sobol Shapiro , takes the cake. Here is an exerpt from the press release:

The complaint generally charges that Jones Soda and the executives made misleading statements about an expansion into major retailers, such as Wal-Mart, Kroger, Safeway and Kmart, with a new 12-ounce canned soda and a major marketing campaign. The "continued bullish statements" caused the stock price to surpass $32 a share April 16, which more than doubled the company's market value, the suit says. But Aug. 2, the company reported significantly lower-than-expected canned soda sales and said it had difficulty getting the new products on retailers' shelves before the Memorial Day holiday, the suit said. The problems also caused the company to embargo an advertising campaign, and it "essentially bumbled the launch of Jones Soda 12-ounce cans," the suit says. The stock price, following two quarters of poor earnings results, has fallen 67 percent since hitting the record high in mid-April.

Give us a break. Not even flawless execution of the company's strategy was justification for the price of the stock. Whether or not Jones executives made misleading statements, we can't say. But we do know investors make mistakes, we sometimes get greedy, and our vision is clouded by the behavioral biases we struggle with. But we can't keep running to the lawyers everytime we get burned. Especially when we should have known better.

We aren't saying that corporate management is above reproach, and never at fault. We've seen countless examples in the past several years of fraud, and blatant disregard for shareholders. We're not convinced that this is the case with Jones Soda. We are sure, however, that investors need to take personal responsibily for their decisions. And we all make some very bad ones now and again.

*The author does not have a position in Jones Soda. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Two GPT's Report Earnings: Avoca (AVOA) and Bactolac Pharmaceutical (BTCP)

It's back to off-the-beaten path research this week, the kind that has made this site either very original, or painfully irrelevant depending on your point of view. (We won't be mentioning the Fed, Bernanke, subprime, commercial paper conduits, or any of the other more common themes currently being beaten to death in the financial media these days.)

We will disclose recent earnings for two pink sheet companies Avoca, and Bactolac Pharmaceutical (formerly Advanced Neutraceuticals). In recent years, both of these companies went through the process of reducing their shareholder roles below 300 through a reverse stock split. This allowed them to delist, avoid SEC filing and Sarbanes Oxley, eliminating the prohibitive costs associated with each.

Disclaimer
Before we go any further it is important for readers to understand that Avoca and Bactolac are not liquid, in fact they rarely trade. As a result of the reverse splits, each company has less than 9,000 shares outstanding, and very wide bid/ask spreads:

So why write about them? We have followed these companies since before they delisted,(please search the site for previous research) and find the notion of companies effectively going "dark", yet still trading, to be fascinating. We believe that some of these situations can offer opportunity and may have a place in certain investor's portfolios. We took positions in both companies prior to their reverse splits, when liquidity was greater, and spreads were not as wide.

Keep in mind that despite the fact that neither of these companies is required to file financials with the SEC, both continue to update their shareholders; Avoca on a quarterly basis, and Bactolac less frequently.

Bactolac Pharmaceutical (BTCP)
Shares Out: 8613
Bid/Ask: $1350/$1700
Mkt Cap(bid): $11.6 million
Book Value/share: $2478
Tangible Book Value/share: $1600

For the six months ended 3/31/07 (they did not isolate quarterly results) sales rose 26% to $15.6 million. However costs rose as well, and operating margins dropped from 15.8% to 10.4%. The company cited higher material and production costs, higher quality control expenses, and customer resistance to price increases for the margin pressure. Net income was $835,000 or $96.95 per share, down from $117.79. Net margins fell from 8.2% to 5.3%.

One of the more inteesting facets of this report was management's discussion
of stock repurchases. The companies credit agreement does allow for limited stock repurchases from shareholders(as long as covenants are not violated), and they also occasionally purchase shares on the open market.

Of note, the company plans to expand, and will build a production facility on land it currently owns. The project is expected to be completed in the Fall of 2008, will cost $7,000,000, and will be debt financed.

Avoca (AVOA)
Shares Out: 8059
Bid/Ask: $6250/$6850
Mkt Cap(bid): $50.3 million
Book Value/share: $981
Tangible Book Value/share: $981

Royalty Trust Avoca, owner of 16,000 acre Avoca island, reported revenues of $1.45 million for the second quarter, down 51% from the same period last year. Net income
fell to $952,000, or $118 per share from $1.754 million, or $218 per share.

Revenue fell primarily due to the loss of production from one of the companies gas wells, Avoca No. 6-1, which expectedly went off production. Although the price of natural gas increased 1%, five of the six remaining wells saw declines in production. Natural gas production represented 80% of revenue in the quarter.

The balance sheet remains strong, with $465 per share in cash and short term investments, and $434 per share in long-term debt and equity investments. The company has no debt.



*The author has a positions in Avoca and Bactolac This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Levitt Corp(LEV): More Than Meets the Eye, or a Sinking Ship?

We are not big fans of home builders in the best of times (perhaps we are not smart enough to understand the business), and certainly not now given current market conditions. Many of these companies are down 50% or more year to date, and while the carnage can always get worse, we've got to believe there is some value in some of the names in the sector. But, in general, we'll leave that analysis to those that really understand the home building business and instead focus on one interesting story in the sector, that ultimately has little to do with homebuilding.

Levitt Corp (LEV)is a Fort Lauderdale, FL based homebuilder and real estate company that operates in the Southeast (Florida, North Carolina, South Carolina, Georgia). As of 12/31/06, the company had an inventory of 11,700 acres, 6900 of which were considered saleable (4100 in Florida, 2800 in South Carolina). The company's market cap is just north of $50 million, but a rather heavy debt load brings the enterprise value to about $650 million.

Like most homebuilders, Levitt has been crushed lately; from a 52 week high of $15.44, down to its current price $2.72. This company has truly taken a drubbing, as housing sector woes have worsened. Levitt reported a second quarter loss of $58.1 million, including a $63 million hiomebuilding inventory impairment charge.
It was an ugly quarter, as evidenced by these company reported "lowlights":

Second Quarter, 2007 Compared to Second Quarter, 2006
Total revenues of $127.8 million vs. $133.2 million
Net loss of $58.1 million vs. $737,000
Diluted loss per share of $2.93 vs. $0.04 per diluted share
SG&A as a percent of total revenue was 26.3% vs. 23.3%
Homes delivered (units) of 379 vs. 392
Gross orders (units) of 478 vs. 423
Gross orders (value) of $122.4 million vs. $119.6 million
Cancellations (units) of 187 vs. 91
Net orders (units) of 291 vs. 332
Homebuilding Division backlog (units) of 957 vs. 1,799
Homebuilding Division backlog (value) of $297.8 million vs. $609.2 million
Land Division third party backlog (value) of $29.0 million vs. $15.4 million

To add insult to injury, the January 2007 announced merger with BFC Corp was terminated last week, sending Levitt shares down 21%. Can it get any worse? Of course it can.

Bluegreen Corp (BXG)
But there is another side to this story. Levitt happens to own a 31% stake in resort and timeshare company Bluegreen Corp (BXG). At its currect market cap of $281 million, that values Levitt's BXG stake at $87 million, at a time when Levitt's market cap is just over $50 million. Granted, an ownership stake this large would no doubt command a discount if Levitt decided to unload it. But if BXG's price can hold up, this might just put a support level beneath Levitt shares.

Proceed with caution here, though, Levitt has a relatively heavy debt load, and is operating in an industry given up for dead.

*The author does not have a position in Levitt or Bluegreen. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Thanks, Uncle Ben

The markets got a shot in the arm today courtesy of the Federal Reserve's decision to lower the discount rate by .5%. Investors will rejoice today, because finally, the Fed heard their cries to open the discount window.

We are, of course, skeptical. We want the markets to go up. But we also believe that the Fed stepping in is:

A. An acknowledgement that this may get much worse before it gets better and
B. A band-aid that may stop a little of the short term pain, but will ultimately slow the process of the market working out built-in excesses.

So, today may be a good day for investors, but it's naive to believe this situation will abate because of the Fed's actions.

"Stay Calm, Relax, The Markets Always Come Back"

Does our title sound familiar? Perhaps not to avid Cheap Stocks readers, because we rarely, if ever, comment on the markets. You can get that anywhere. But tonight, as much as it goes against our grain, we are going to make a few comments.

Like it our not, what is currently happening in the financial markets is unprecidented. As much as pundits like to compare to the Long Term Capital Management debacle, the Asian crisis, (or insert your favorite era of market upheaval here), it is not the same. That does not mean that this won't ultimately pass, but is a reminder that we are always looking for comparisons, often fooling ourselves in the process. Makes us feel better as we watch our account balances shrink. We may be able to weather a downturn--if we aren't overleveraged, and forced to become panic sellers in the meantime, as long as we believe the return of the bull is just around the corner.

As investors, we have difficulty with down markets, (that's behavioral finance at work) difficulty with uncertainty, and we want downtrends to reverse: quickly. This time, maybe it will turn next week, or maybe it won't. We don't know. Anyone who claims they do, and ends up being right, is probably just very lucky. And, afterall, even a stopped clock is right twice a day.

The bottom line is that the markets, whether fixed income or equity, still run on a very basic principle, supply and demand. The highest quality piece of debt, or equity can languish if no one is buying--as value investors, this is something we know all too well. On the flip side, even a "dog with fleas", to quote Michael Douglas from Wall Street, can appreciate quickly if investors are buying- thats what we saw happen frequently during the tech bubble.

As asset backed securities (or ABS) continue to get crushed (more sellers than buyers)--even those of the highest credit quality that likely have little chance of default, as trouble in the hedge fund world continues, as some "quant" managers see their models failing, and as a small number of funds close their doors to redemptions, it is not surprising that volatilty has returned to equity land. Yes, it will ultimately end. But when? We don't know.

So what's the point of this diatribe? Just a venue for your Cheap Stocks editor to rant...albeit somewhat incoherrently. In all honesty, as painful as it may be, excesses in the markets need to be washed out from time to time, and that's exactly what we are in the midst of.

In all seriousness, if you are not a forced seller, and if you have some cash on the sidelines, folow the quality names you've had your eye on, or already may have a position in. You just might get your chance to buy some high quality names on sale. For what it's worth, in general, equities are not overpriced at this point. After today's action, the S&P trades at less than 15 times forward earnings.

Tootsie Roll Gets Smoked

Its been a wild ride the past few weeks as the markets once again wash out some of the built up excesses, (which however painful, is also very healthy) this time due to the "subprime" event (can we please wipe that word clear from our vocabulary....enough already) and the spectre of a credit crunch. Given the path that under-the-radar Tootsie Roll has taken the past few days, you would have thought it was a BBB rated ABS tranche.

The stock was down 14% today on four times normal volume, on the heels of a disappointing quarter. After hitting a 6 month high of $32.43 yesterday, the stock closed regular trading today at $26.48, for a $6 or 19% swing over just two trading days.

Margins Fall

Second quarter sales were up 7% to $101.9 million, from the same quarter last year. However, cost of goods sold rose substantially, lowering gross margins to 34.2% from 40.1%. The company cited rising ingredient and packaging costs for the margin pressure. Still, the company managed a healthy net margin of 10.2%, although that's down from 11.2%.

On the bright side, the balance sheet remains very healthy with cash and short term investments of $60 million, LT investments of $59 million, and split dollar life insurance of $75 million. LT Debt is negligible at $7.5 million; there is also $13.2 million in post retirment healthcare liabilities.

Disappointing
We've certainly not been happy with Tootsie Roll's performance since we've owned the stock. After considering cash and stock dividends, we are flat after 3 years. We are not rushing for the exits, because we still believe there is value in this very strong brand. However, we believe this company needs to be sold in order for the value to be unlocked.

Previous Cheap Stocks Tootsie Roll Research:
4/21/07

*The author has a position in Tootsie Roll Industries. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

David Einhorn of Greenlight Capital Responds to our Latest St Joe's Post

We were happy to hear from David Einhorn regarding our recent St. Joes (JOE) piece. David thought we were incomplete in our representation of the analysis he presented at the May Ira Sohn Research Conference. We invited him to lay out his case, which is presented in this post.

While we respectfully disagree with his conclusion, and he obviously disagrees with ours, we find this type of debate very healthy. We happen to be long JOE, while Einhorn's firm, Greenlight Capital has a short position.

David Einhorn, Greenlight Capital on St. Joes Corp.

The per acre analyses used by most St. Joe bulls exclude selling expenses and taxes. I believe that the equivalent gross value to the $9,000 an acre used in your analysis is the equivalent of $18,000 an acre, when taking expenses and taxes into account.

As it was, I did not quantify any amount of swampland at the Ira Sohn conference. I simply noted that some of the land is swampland. The weather is much worse than South Florida (just as hot in the summer and cooler in the winter), there are a lot of mosquitoes, there is not a lot to do, and the demographics are poor. I noted that I thought St. Joe overplayed the value of land within ten miles of the ocean and noted that I thought that vacationers would prefer to be "on the ocean." More than a mile is too far for many families to walk to the beach. Finally, I thought the airport development is the type of story often seen in promotional stocks designed to buy years of time to encourage the market to ignore current financial results. The current airport does not operate near capacity. Airports in Jacksonville an Ft. Myers did not spur a lot of development next to their airports and it is odd the St. Joe seems to believe that a lot of people will want to live near the airport, as if that is a residential attraction.

As I pointed out in my speech, since 2001, St. Joe has sold 268,000 acres at an average price of under $2,000 an acre. Since my speech, St. Joe announced another quarter where they sold over 30,000 additional acres at $1,500 an acre. As such, I don't see that it is very challenging to determine a value for most of St. Joe's land. Assuming they haven't sold the most salable stuff first, it appears that undeveloped land is worth on average sub $2,000 an acre before expenses.

I believe that about 680,000 of the remaining 739,000 acres are similarly undeveloped. Assuming St. Joe has no un-salable tracts of swampland and all the undeveloped land could be sold for $2,000 an acre, it would be worth $1.36 billion gross or about $700 million after selling expenses and taxes.

St Joe has just under 20,000 acres in development (some of which has already been sold). They have an additional 21,000 acres "In Pre-Development", meaning they have land use entitlements, but they are still evaluating the development or need additional permits. They have another 10,000 acres they are planning to entitle.

The developed projects have a book value of $800 million. St. Joe is not making good margins on selling developed property. Residential and commercial land sales have not covered its overhead in any quarter since 2005, when it was still in the homebuilding business. St. Joe is one of very few companies that has spent large amounts on residential development and has not taken any impairment in the current environment. To give St. Joe the benefit of the doubt, let's say the developments could be worth 1.5x book or $1.2 billion.

On that analysis St. Joe is worth $1.9 billion. Subtract $400 million of debt, leaves $1.5 billion of equity or $20 per share. I believe that adding in the time value of money would take this analysis down to the $15 number I used at the conference.

Regards,
de

We thank David Einhorn for agreeing to let us publish his response. Why would we agree to have a well-known manager present his views that are contrary to ours in a stock we have a position in? We happen to find the debate refreshing, and even helpful to investors as they seek information.

*The author has a long position in St Joes Corp. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.