Goodbye to Middleby and Rofin Sinar (MIDD, RSTI)

In the course of making decisions about which shares to release in order to reduce my margin exposure, I found myself thinking carefully about clearing out two small positions that have perfomed well for me over the past year or so -- Middleby and Rofin Sinar.

These two companies don't have that much in common -- they both actually create things, but for very different markets. Middleby is a commercial oven maker, and Rofin-Sinar a small diversified laser company. And while I like both companies, I don't like them enough.

I had earlier sold some of my Middleby shares when they reached a 100% profit, since I thought the unfettered optimism about the company was unlikely to last forever, and I had planned on holding these remaining shares indefinitely.

But I don't intend to add more to my MIDD position, and while I think they have a chance for steady long term growth I think there is certainly some execution risk as they continue to seek out more takeover candidates (even though their offer for Enodis was pulled). So it hardly seems worth holding on to what is now a very small position for me, on margin, in a company that I think is solid but unlikely to again exhibit the extraordinary growth that allowed it to advance by more than 400% in the last few years.

So with some regrets, I'm taking profits in Middleby and clearing the slate -- selling the balance of my Middleby shares today at $79 for a gain of about 70%.

Rofin Sinar is a company I've held for quite some time and am selling today at a decent profit -- earlier this year when I pared back my portfolio because it was simply too diversified, RSTI was one of the candidates I thought about selling. It made the cut then, but not this time.

I can't come up with anything terribly negative to say about the company -- in this case, it's really a matter of selling a company that is fairly difficult for me to analyze, and locking in a profit. I bought these shares after reading a compelling argument in an investment newsletter, but never got a good understanding of how they compare to their competitors in the marketplace, and never was tempted to build this holding into a full position.

It may be a mistake, but I'm just not that interested in RSTI anymore and, while not overpriced, it doesn't seem to be a tiny undiscovered value anymore -- so I'm selling my margined shares and taking a nice profit of a bit over 50%.

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Best Management?

A reader emailed today to ask what I think about Berkshire Hathaway, and, more generall, which management teams most impress me. I thought I'd answer for everyone in case anyone else is interested.

Berkshire Hathaway is still in my portfolio, and has been for about a year and a half ... but it's at roughly the same price today as it was when I bought it. I have the utmost respect for Warren Buffett, and I'm pleased that they have further clarified the Berkshire succession plan.

I like Berkshire because Buffett has done more with "free money" than anyone else -- his use of the "float" to fund long term investments has clearly been brilliant, as evidenced by his trouncing of the S&P 500 over the last several decades. My position on Berkshire is that I expect it to continue to plod along, acquiring solid companies and using their clout to be the insurer of last resort for many high risk enterprises, at significant profit. But I don't expect any rapid growth -- my fear is that Berkshire will end up so large that it effectively works as an index fund with cheap leverage from the insurance float, and even that is a fine scenario. With new money today, however, I'd be more tempted to put additional funds into Markel, as they have the kind of potential growth ahead of them that Berkshire had 25 years ago, assuming they make the right decisions ... Berkshire just can't grow that fast anymore.

And as for management -- perhaps it would be simplest to just list some of the things I like about some of the managers I trust the most:

In terms of trusting someone to make investment decisions for you, I do think it's hard to go wrong with Warren Buffett -- but if I ever sold my Berkshire shares and wanted a similar value-investing exposure in my portfolio I would have no qualms about giving the money to the investment team at Dodge and Cox Stock, which I already have some retirement money invested in, or with Martin Whitman at Third Avenue Value, who I would consider the single smartest long term stock picker available right now (but he's nearing retirement, too, I expect).

In terms of sharing information fully with investors, and making small investors feel they are on the same page as the management team, I'd trust the Oliveira family, controlling shareholders of Gol Linhas Aereas Inteligentes. Without playing a self-serving game with analysts to lowball and then beat their projections, they manage to clearly open up the books and explain their business, including monthly updates on their business performance -- it's rare for an American company to do that with such enthusiasm, and it's rarer still for what most would consider to be a risky emerging market investment.

Another thing I like to see from management is insider buying -- it always encourages me when executives put their own money, not options, into the company they know best. Of course, they know that, too, so it can be self serving ... but when executives aggressively purchase their own stock I think we'd be wise to follow. On this point, it's worth taking a look at Chesapeake Energy, of which I own preferred shares, and see CEO Aubrey McClendon buying up well over a million shares on the open market in the last couple of months at prices right around where it stands today (mostly higher, in fact). Add to that the fact that he has led the company to make strategic natural gas acquisitions now, when prices are relatively low and pessimism high, and I think you have the makings of a manager who's looking out for the long term interests of shareholders.

There are others who I like as well, for some good reasons. I am a big fan of Selim Bassoul at Middleby, who has shown a real talent for bringing focus and drive to a small company that was too diversified ... and then being aggressive about making acquisitions to shore up their core business in commercial kitchen equipment with Nu-Vu and, perhaps, Enodis if they stay in the bidding for that company.

And if you're looking for a management team that is relentless customer-focused, continuing to bring out product lines that their core consumers will buy and treating those customers like royalty, you need look no further than Chico's -- the shares are taking a beating lately, but I'd trust this management team more than any other in retail to recover from their merchandising hiccup and continue delighting customers. I don't think any other CEO cares as much about the soft side of customer service as Scott Edmonds does at Chico's, and their focus on their "lifetime passport members" and on personally writing to their best customers clearly creates some fiercely loyal consumers. I'm tempted to buy more here, now that it's on clearance.

On a more strictly financial point, I also should mention John Fredriksen, whose right-hand-man Tor Olav Troim heads SeaDrill. Often described as a viking raider, Fredriksen is not someone I'd probably like, and I don't know that he's the person I'd want managing my business if it was something I wanted to hold forever, but as a controlling shareholder he has a track record of being extremely aggressive in unlocking value in high priced assets and returning cash flow directly to shareholders ... including himself, of course. Sometimes his massive dividending out of cash might not be the best long term move for the companies he owns, but it certainly benefits shareholders immensely when he times it right, as he did with Frontline a couple years ago ... and as I hope he'll do with SeaDrill over the next two or three years.

Those are just a few things I like about management -- a focus on investing your money wisely, a propensity for insider buying, eagerness to share information with investor without trying to manipulate them with pointless press releases, a strong focus on their customers and a track record of pleasing them, and a desire to return cash to shareholders. It's not often, if ever, that I find all those things in one company ... but even one of those things, if the story fits well enough, can be enough to get me interested,

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Conflicted -- losing money while being right (MIDD, VRTX)

It turns out that my concern was a couple weeks early on the short term valuation of Middleby and Vertex, but I was right (insert sound of patting self on back) to think that a significant amount of optimism was priced into the shares considering their near-term growth prospects.

So I'm a little conflicted -- I don't like to see any stocks that I own going down and I still own smaller portions of these ... but I am somewhat relieved that my thesis played out in the short term, since at least my rationale turned out to be reasonable.

For those who weren't listening, I lightened up a bit on my shares of Middleby (MIDD -- click to register for free RT streaming quote) and Vertex (VRTX) to protect some huge gains a few weeks ago because I thought the market was expecting absolute perfection from both companies -- Middleby because they are very richly valued relative to their current organic growth, and Vertex because they were valued as if both of their top tier compounds were on their way to blockbuster status without a hitch.

Vertex released a report that their phase II studies of VX-702 worked as expected and had a reasonable safety profile, but it sold off because people were hoping for another immediately obvious blockbuster like VX-950, the Hepatitis C drug that's also in Phase II and setting the world on fire. Not yet.

Middleby was exactly in line with expectations, which certainly appears to not be good enough in today's market ... not when the a stock has been bid up to more than double over the past year.

As I type this, MIDD is down about 8% and VRTX about 6%. Not that big a deal for a long term investor, but worth avoiding if you can.

I still like both of these companies and sold less than half of my position in each, which is the disappointing part. I sold some shares to protect a profit and pull my original investment off the table, but I certainly intend to hold on to the remainder for a very long time in both of these cases. I would have been delighted to see them continue to grow without respite, but of course that never happens.

Emotionally, I was frustrated that both of them climbed immediately after I sold them (Vertex climbed more than 10% in the day after I sold it, just to rub it in), but somehow it's reassuring that they're now back below my selling point because I got a short term call right (for once). Not something that happens often ... and as any market psychologist will tell you, sometimes idiots like me are more excited about being "right" than about making money.

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Annual Checkup -- MIDD

I keep getting distracted, so my annual checkup is taking a bit longer than usual this year. Now it's time to take a look at Middleby (MIDD -- click to register for free RT streaming quote). This is a great company that was called to my attention by the Fool more than a year ago, and I've been holding shares for close to a year. It has quietly been a dramatic performer and risen much faster than I would have predicted. I wrote a while back about what the worldwide increase in pizza consumption means for Middleby, a commercial oven manufacturer, and that growth is continuing ... as is the growth in MIDD's business, which has been nicely reflected in the stock price. But as I near the one year holding point and look at a stock that has grown significantly faster than I expected and has seen some dramatic multiple expansion, should I think about lightening my position? Given the performance of MIDD's CEO over the past two years, it's hard to give up any shares -- they have consistently increased earnings, increased efficiency, and handled some challenges very well (such as the rising steel prices). My position was picked up at an average price of just under $48, so I'm sitting on almost a 100% gain, and I wouldn't feel comfortable buying more Middleby at this point even though I think they'll continue to grow well -- I do fear that the growth will tail off a bit and the multiple ought to come back to earth as that happens. I plan to wait until their next earnings report before doing anything, so I'll take the chance that the price may dip if they report any disappointment, but I want to err on the side of caution in selling my MIDD shares because I hate to give up ownership in a company that is so well managed and so well positioned for the big global trend of chain restaurant growth. If it looks to me like the company is likely to have difficulty keeping up this growth over the next couple years when I hear from the CEO next month, I'll consider selling half of my position -- otherwise, this is a hold for me.

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Pizza burning? Get Middleby! (MIDD)

I've written a little bit about Middleby (MIDD) in the past -- this growing and extremely well-managed commercial oven maker is doing everything right, it seems, and their recent earnings and price advances have certainly corroborated that statement.

My position in Middleby was built in the winter and early spring of this year over a couple purchases, with a cost basis of about $47.75. It's certainly not the same bargain today near $70, but it still meets at least one of the criteria of a value-priced growth stock: The analysts are still just discovering Middleby, but with the estimates now in the PEG ratio today still stands at just under 1, a value in anyone's book. The current PE is a little steep at 25, but it's hard to argue with management's track record and I think the analysts are likely to be trailing behind the actual growth of earnings in the next few years.

I haven't bought any recently, but MIDD came to mind today because I just read an interesting little updateover at the Fool on growth in pizza sales overseas and the booming times the big pizza franchisers are experiencing in China and other asian markets. They didn't talk about Middleby, but gave some interesting data on the impact on the big pizza chains themselves.

One thing I don't want to do is buy a pizza chain -- Yum Brands and their Pizza Hut brand notwithstanding, I don't see good reasons why one brand or another should become critical enough and longstanding enough to make a difference in asia, and I don't care to bet on any guesses in that area. Too many pizza chains have disappointed investors, and I'm not that interested in giving them another chance.

But growth in pizza restaurants worldwide?



That seems a much safer bet, and the winner of that bet is definitely Middleby -- the best and most efficient (and patented) ovens, specialization in this important niche, and a long list of relationships with some of the bigger companies that are expanding worldwide in addition to a great sales and service network.

Even if we're only thinking that US restaurants will continue to grow and crave efficiency (energy efficiency is a big deal for ovens, especially with energy costs climbing, and Middleby has some great, efficient products), MIDD is a solid bet for long term performance. But if we really believe this trend toward eating out and chain restaurants and, indeed, pizza, is going to continue to expand internationally, then Middleby is much more than just a solid bet.

Either way, I love management and I love the positioning of the company and the product -- and it's not particularly expensive even now, after all this share price expansion during 2005. I might consider adding to my position if we get a dip during the next few months with earnings, something to keep an eye out for.

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Earnings Updates

About half of the companies I own have reported their quarterly earnings, and it is a decidedly mixed bag. I'm going to do a quick summary of how they did, and what I'm thinking about the companies going forward.

So what has happened of significance so far this earnings season?

First, the best ...

Middleby (MIDD) clobbered the baked-in estimates, and showed that CEO Selim Bassoul is still on top of his game at this maker of commercial ovens and cooking equipment. I was lucky enough to buy into this great company earlier this year when it faltered slightly while the founding family was trying to sell out their holdings -- bought some at about $46 and more later on at around $50 over the winter (I found out about this company because it was a Motley Fool Hidden Gems recommendation, one that has since been re-recommended -- that's a great newsletter and I recommend at least giving it a free trial).

Middleby keeps some of the fun in investing by never pre-announcing their earnings release date, so one day the market closes and a lovely surprise bounces up on your browser, as happened last Thursday afternoon. Sales up 15%, international growth still doing great, earnings well above the estimates of the few analysts who follow MIDD ... even with increased debt, which we knew about due to the buyout of the founders shares, and slightly lower margins and higher costs largely due to the acquisition of NuVu and higher steel prices, it's all good news.

Now, some of that might be overstated -- some of the second quarter growth was backlog from Q1's big order volume that squeezed in before a price increase, some of it was from the NuVu acquisition, but I still like the growth going forward. Middleby's fast, efficient, patented cooking systems are being used by many of the restaurant chains that are quickly carpeting the globe with familiar logos and food products, and that doesn't appear to be anywhere near an ending point. Dining out is an international phenomenon, one that certainly began in the United States but that has legs around the world -- and familiar brands that roll out huge numbers of shops with Middleby cooking equipment are leading the way. Even something as seemingly unrelated as energy prices can help Middleby, because higher energy costs mean that the more advanced but much more energy-efficient Middleby ovens are just that much more appealing for restaurant buyers.

And the worst ...

Great Wolf (WOLF) -- bigger, and unfortunately much badder. I was one of I believe four shareholders to not sell out on their latest earnings release, and that could have been a mistake. Thankfully, my WOLF position was relatively small (and is smaller still now) since it's a pretty new portfolio position that I haven't gotten around to really filling out yet.

Normally, if I saw a stock drop like this that I owned and was confident in it would be extraordinarily tempting to buy ... and when I saw the ticker drop like a stone, that was indeed my first reaction, I thought we might just be dealing with a management team that was having a hard time getting to know the "underpromise, overdeliver" Wall Street culture.

Then I read the earnings release, and while I'm holding on because it's not worth selling such a small position and I still have some hope for the company, this one is not going to rocket back up the charts anytime soon. Not only was this a rough spring for Great Wolf in terms of competition eroding their occupancy rates in the few places where they face competition, but man oh man oh man, their occupancy rates fell EVERYWHERE over this six month period, and they weren't exactly super high to begin with. Check out the earnings release here and scroll down to the individual resort results -- nothing promising there.

Now, the silver lining is that Great Wolf is expanding into some very promising areas -- their Williamsburg location openened recently and is getting pretty high room rates, though occupancy is not great yet, and they have very promising parks opening in their core midwestern region -- a partnership park in Ohio and a franchised location in Niagara Falls, Ontario -- as well as some brand new locations that will really be the test of the concept. If they can succeed in the Poconos and in the Pacific Northwest, where the indoor water park is a heretofore unseen novelty, I'll feel much better about their long term future.

So, it's possible that this is a great buying period (A.G. Edwards downgraded it right before earnings, and upgraded it right after with the stock almost 40% lower) ... but not for me, not yet. I'll revisit this holding next year around this time and see how they're doing. The guy who recommended Great Wolf for the fool's Rule Breakers around the time I bought in, has a writeup on his disappointment here, and there's a news article with some quotes from management that are a little less gloomy (though they also give weight to the concern that dependence on leisure spending from the midwest may be a problem for a while with automaker troubles).

And all the rest ...

Akamai (AKAM) reported a great quarter and it looks like the acquisition of Speedera is going to be just as good a decision as we had hoped, though short term cash flow and margins might be a little lower than some were dreaming of. AKAM bumped up a bit on the solid but not breakout news, and I'm happy to keep holding on. Quarterly numbers from the Fool here. Guidance upped about 10%, so it's trading at a pretty fair PE of 30 or so for the current year -- not bad for the growth I expect we'll continue to see.

Marvel (MVL) reported a slightly disappointing quarter, and fell a small amount -- really not significant in the grand scheme of things. Earnings were a little lighter than last year and the spiderman 2 licensing cash flow wasn't quite as long lived as some analysts had hoped -- hard to get worked up about it. They're still backing earnings estimates of a bit over a dollar for the year, which means they're pretty close to a market multiple even in a year when they don't have a blockbuster franchise release (F4 has been a solid hit so far, but it's certainly neither an X-men nor a Spiderman when it comes to blockbuster ticket sales or licensing -- we'll see the next X-Men next year, and Spidey 3 the year following ... plenty of reason to buy huge potential at a fair price right now if you're interested).

MEMC Electronic Materials (WFR) reported a slight drop in earnings, but what I'm looking for from them is in the future -- the next 6 months to a year. Now that the backlog is almost worked out of world semiconductor inventories and business is beginning to boom again, what kind of advantage will WFR be able to gain from having their own low-cost supply of polysilicon? And even without the impact of that, world demand for wafers should be very strong. Earnings made the shares drop slightly, but investors, including me, are mostly interested in what happens for the next year -- is the semiconductor recovery for real? If so, WFR and FORM will boom. According to MEMC's CEO, the company's results may indicate "the bottoming quarter" after a 9-month industry slowdown due a surplus of inventory. I hope he's right.

Formfactor (FORM) reported just a few days after I did my company writeup, and altough the stock tumbled a bit due to delays in the new plant going online, my opinion hasn't changed -- I'm still happy with them, and the market has already found some of the love it had lost for FORM, it has recovered about half of it's earnings-miss fall.

Vertex Pharmaceuticals reported too ... but I don't much care about their quarterly earnings, for this one and all my other biotechs the earnings matter much less (they're all still losing money, though PDLI is close to going cash-flow-positive) than the results of their ongoing clinical trials. The trial results will move the stocks, the earnings almost never do unless they're wildly surprising. VRTX's report was pretty much as expected, and, most importantly, all of their trials for potential blockbuster drugs are on schedule -- nothing pending that should be a big surprise or impacton the stock in the next few months as far as I can tell.

Next Week

I'll have to do this again in a week or two -- I'm taking a no-market-info vacation, which is painful for info addicts like me, and during that time earnings should come out for Click Commerce, CV Therapeutics, Exelixis, FARO Technologies, Lions Gate Films, Protein Design Labs, Rofin-Sinar Technologies, Shanda, Taser and Universal Display. Almost all of these companies are reporting on either Monday or Tuesday of next week, so I'll at least have to read a paper or two while lounging at the beach.

And to add to that, Netease reports tonight (preview from ChinaStockBlog), and Overstock and Radyne tomorrow ... and the biggest quarterly non-event of all, the Berkshire Hathaway quarterly earnings release, is coming at the end of this week. This is way too much to absorb if you're planning on acting on the information that all these companies release, so I guess it's a good thing that I almost never react to quarterly earnings -- my account isn't big enough that I can afford to do much active trading, and I generally use a long time horizon when evaluating my portfolio companies (with some exceptions).

Unless management loses my confidence, or I see a trend developing that counters my long-term investment thesis for a particular company, I'm not going to buy or sell based on whether they hit or miss their numbers (though I am often tempted to buy when companies have short term problems that impact their share price -- as I wrote about in Catch a Falling Knife -- it turns out I should have jumped on FARO when they fell, and on Formfactor when it fell a bit later ... Shanda's still roughly where it was when I wrote that, and I have bought a small position in Jan 06 $40 call options in lieu of more shares to leverage my firm belief that it's got to eventually stop being the most undervalued tech company in China and break out of the top of this trading range it's stuck in).

But that's not to say that I don't watch earnings pretty closely, and still get excited to read up on what my companies are doing and have my choices reinforced by good news or challenged by bad news -- that's just human nature. So here's looking forward to a strong week of earnings releases, and a dozen or so good conference calls with enthusiastic, optimistic management teams. I'll write about what I think of what happened in about two weeks.

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