The Boring Portfolio

ANN ARBOR, MI, June 4, 1996 -- The Boring Portfolio increased in value by $325 on Tuesday, or 0.59%. That was better than the NASDAQ's +0.40% gain but not as good as the S&P 500, which rose 0.73%.

Borefolio gainers today were Borders, Green Tree Financial, Texas Industries, and Prime Medical Services. Green Tree added some interest to the morning by not opening until 10:19 AM due to a buy-side imbalance. When trading on the stock resumed, Schwab tells me that the first trade involved a block of 220,000 shares. That's over seven and a quarter million bucks, folks. GNT ended the day at $33 3/4, up three-quarters.

PMSI rose $1 1/8 to close at a bid of $20 1/4, thereby achieving the honor of becoming the Borefolio's first double. Figured Foolishly, PMSI has appreciated 101.09% in less than three months. Ta-dah!

After the market closed, PMSI announced the filing of a registration statement with the SEC "for a public offering of 9,907,240 shares of common stock. In the offering, 5,000,000 shares will be offered by the company and 4,907,240 shares will be offered by certain selling shareholders. The proposed offering, upon completion, will increase the company's common stock outstanding to 24,028,600 shares. In addition, the underwriters have been granted a 30-day option to purchase 1,486,086 shares from the company to cover over-allotments, if any."

The shares will be offered by an underwriting group led by Donaldson, Lufkin, and Jenrette and co-managed by Prudential Securities. To obtain a prospectus, write DLJ at 277 Park Ave, New York, NY 10172, Attention: Prospectus Department.

Although this news did not hit the wires until Tuesday evening, I know for a fact that the Street knew the details earlier than that. (I know this because someone alerted me about the offering this morning.) I therefore interpret today's activity in PMSI shares as a strongly favorable response to the proposal.

I'd be delighted to devote the remainder of tonight's column to singing PMSI's praises, but in the interests of Boringness, I'm going to focus on the two Borefolio losers to date: The Shaw Group and LCS Industries.

Recall that SHAW is the largest piping systems fabricator in the U.S., serving primarily the electric power, chemical and refining industries. Shaw does a significant part of its business outside of the U.S.

Although the stock has been hampered recently as a handful of insiders have reduced somewhat their substantial SHAW holdings (insiders control approximately one-third of SHAW shares), the company's business remains strong.

Shaw Group announced today that it has signed a three-year agreement with Vekamaf Holland BV, whereby Shaw will be the exclusive, worldwide distributor of Vekamaf's Cojafex "PB Special" induction pipe bending machines. (Hey, this constitutes a hot news item for the Boring Portfolio!)

Wait, there's more! The press release notes that "Shaw currently has two Cojafex PB Special 16 pipe bending machines in operation, with two others on order, one with an anticipated delivery of October 1996 and the other, which will be the only portable bending machine of its type in existence, has an anticipated delivery of December 1996. The PB Special 16 is capable of bending 3 to 16 inch diameter pipe with wall thicknesses of up to 2.5 inches."

Not only that, "Shaw is also in the process of installing a Cojafex PB-1200 induction pipe bending machine. The PB-1200 model, which is not covered by this distribution agreement, is capable of bending 18 to 48 inch diameter piping with wall thicknesses of up to 4 inches." Cool!

As boring as all this sounds (and is), the point is that rather than messing with a lot of special fittings to fabricate complicated pipe assemblies for refineries, power plants, and so forth, Shaw can custom-bend the pipe to whatever shape it needs. And with this new agreement, the company can make money from marketing pipe-bending equipment as a complement to its core business.

Analysts project that SHAW will make EPS of $0.93 for the FY ending in August, an 86% gain over the previous fiscal year. Estimated EPS for FY97 is $1.38 -- which would be a 48% increase over FY96. At its current asking price of $18 5/8, SHAW is trading at 20 times projected EPS. A steal -- which is presumably why all three analysts who follow the company rate it a "strong buy."

As for LCS Industries, yesterday afternoon I spoke with the company and with an analyst at Oberweis, which had LCSI as one of its top five holdings in its Emerging Growth Fund at the end of 1Q 1996.

According to an Investor's Business Daily story from April 8, the Oberweis Emerging Growth Fund focuses on "companies with the fastest growing revenues and earnings and whose P-Es are half their growth rates," and they "will not buy a stock if revenue and earnings aren't growing at least 30."

Martin Yokosawa at Oberweis informed me that LCS was not currently among the fund's top five holdings. I infer that's because LCS's sales and earnings in the most recent quarter did not attain the fund's benchmarks. Despite that, Yokosawa said he thought the sell-off in LCSI was "probably overdone."

I then had a lengthy conversation with LCS's VP for Finance. We discussed a variety of issues, as noted below.

1) As a matter of policy, LCS does not provide guidance on sales or earnings projections. The company also doesn't go into detail about who its customers are. Partly, that's because of confidentiality agreements with customers; partly, I suspect it stems from the idea that when I call 1-800-RHUBARB to order a pint of "Gramma's Olde Tyme Rhubarb Jelly," Gramma, Inc., wants me to think I'm calling someone's kitchen in Vermont, not a half-million square foot, state-of-the-art fulfillment operation in Delaware.

In its fulfillment operations, LCS's customers include publishers, women's apparel, and "business to business" sales. As noted in the most recent 10-Q (dated 5/13/96), for the quarter ending 3/31/96, fulfillment services increased 22% overall relative to the year-ago quarter; but within that segment, catalog fulfillment decreased 19% due to "a 43% decrease in revenues from an existing customer," which was "partially offset by increased revenues from other customers and additions to the customer base."

LCS does not view that quarter's performance as being indicative of any particular trend for that "existing customer" or for catalog fulfillment operations generally. Presumably, LCSI investors operate under the assumption that catalog fulfillment is a growing business -- or else they probably shouldn't be LSCI investors.

2) Regarding recent insider selling by company co-founders Scheine and Cohen: Scheine is in his late 50s; Cohen in his early 60s. As of 12/31/95, Scheine held nearly 800,000 LCSI shares and Cohen over 500,000 shares. Over the past few quarters, they have been gradually selling some of their holdings to diversify their portfolios and may continue to do so. This activity is public information and has occurred both as the stock has risen and as it has declined. It is independent of anything having to do with the business operations.

3) Regarding approval at the January 23 shareholder meeting to increase authorized shares to 15 million, from 6 million: The old authorization had been nearly used up; should the company make another acquisition later in the year (not unlikely), authorize another stock split, or need shares for other purposes, this approval permits this.

4) About long-term company goals: LCS's financial situation is strong. As of 3/31/96, current assets stood at $41.2 million, while current liabilities were 26.5 million -- for a current ratio of 1.55. Long-term debt of $3.78 million represented only 14% of total equity. Through six months of FY96, cash flow was (by my figuring) $1.05/share. For the full FY95, cash flow was $1.51/share. LCS has grown through acquisitions, and it easily has the wherewithal to make another acquisition in the remainder of FY96 to complement its core direct marketing business.

5) Stock valuation: Although LCS does not provide specific guidance, it has articulated a general goal of "growing the base business" (operationalized in terms of EPS) by 10 to 20 percent annually. According to Morningstar, CAGR in sales over the past three FYs is 19%; CAGR in EPS is 52.8%. Return on equity for FY95 was 23.6%. Net profit margins contracted slightly in the last quarter but remain around 8%.

Fully-diluted EPS for FY95 was $1.25. The "10 to 20%" rule of thumb would yield $1.38 to $1.50 for FY96. Through six months, EPS stood at $0.82 (fully diluted) versus $0.61 for the corresponding period in FY95, or a 34% gain. (Recall that the first fiscal quarter, ending December 31, is seasonally the strongest.) Fully-diluted EPS for 2Q:96 was $0.34. Sequentially flat EPS for the remaining two quarters of FY96 would yield $1.50 for the year, plus $0.094 dividend. Sequentially flat revenues (which I think is excessively conservative) would put the FY in the neighborhood of $93 million (a 17.9% increase over FY95).

At its present purchase price of $16 1/4, LCSI is trading at less than 11 times my projected EPS of $1.50 (plus dividend) for the FY ending in September. And with a market cap of approximately $88 million, the company is capitalized below any plausible estimate of its projected annual sales. Even a sub-market multiple of 15 puts today's fair value for the stock at around $22 1/2. Surely, the sell-off was overdone, and LCSI offers significant opportunities for capital gains at its current fire-sale price.

Transmitted: 6/4/96