Letter - February 2003





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Saddam's Call

On the geopolitical front nothing has changed since our January letter. In fact, the political climate continues to deteriorate. The United States has made a few more enemies in the eyes of whom this nation has abdicated its role as the world's peacemaker. We are now the bad guys. It is Saddam's word against ours, and yesterday's good deeds are soon forgotten. The strained relations amongst supposed friends continue to rattle the stock market both here and abroad. Domestically, the Columbia tragedy didn't help morale, and the recent blizzard that hit the Northeast over Presidents' Day weekend wiped out the second biggest shopping day of the year. Investors haven't had much to cheer about recently and their anxiety has been reflected in the stock market. To make any money, one had to be long snow blowers and short everything else.

Actually, if one believes government statistics, the economy is not too bad (huffing and puffing yet still on the plus side) but "the war" takes precedence over everything. The cold weather in the eastern and central parts of the country has pushed natural gas prices up sharply; the price of gasoline also has jumped. Surprisingly though, natural gas and oil stocks have responded only half-heartedly. Even gold shares are down, while the metal is trading close to a six year high. Investors, en masse, have withdrawn to the sidelines. … For many investors "corporate governance" is key. Too many CEO's have been putting their personal welfare ahead of the interests of their stockholders. A new set of rules is changing the name of the game, but no one is yet sure how this new scenario will play out…. In the meantime, the butcher wants to be paid so we must anticipate rather than repent.

A year ago, investors were disgusted with the stock market; today they are just confused. Nothing seems well defined. Is a tax cut good or bad for the economy? Should we be concerned about the multi-billion dollar deficit? Will the consumer keep spending? Hopefully, consumers will continue to be the driving force of the economy. The Federal Reserve has kept interest rates low, sustaining the public's appetite, which appears to be insatiable. On the other hand, spending by the corporate sector continues to disappoint. The avalanche of downgrades of corporate debt has had a negative effect on corporate expansion as companies concentrate on cleaning up their balance sheets.

As mentioned earlier, the actual economic statistics are mostly positive, while the intangibles are negative. The short-term outlook for the stock market looks cloudy, but we believe investors should anticipate sunnier days and not denude themselves of common stock. A boom is not in the offing, but, excluding tech stocks, the market is reasonably priced. There are many solid citizens selling at ten times earnings. Bonds, on the other hand, do not appeal to us. There is very little room on the down side for interest rate cuts so the odds now favor a reversal of the trend. For the past four years, bonds have outperformed stocks and, since investors are increasingly shifting from equity mutual funds into bond funds, our thought is also a contrarian's bet.

What do we like? Falling in the crack between equity and bonds are PREFERRED STOCKS, the orphans of Wall Street. "A" rated paper yielding 8% can still be found (if you know where to look). As for common stocks…..

CIT GROUP (CIT,$18) Since every loan of this financial lender cannot be scrutinized, analysts have taken a negative approach to the unknown. However, the company has been able to tap the capital markets and has no trouble putting the money to work. Its expanding railroad freight car leasing operation should prove to be a bonanza. CIT stock price is under book value of $22.50, and estimated earnings for 2003 are around $2.50/share.

DVI (DVI, $7.50) along with GE Capital has a virtual lock on financing high-end medical equipment, e.g. MRI's. However, expansion into South America a couple of years ago proved to be a disaster, which has finally been brought under control. Earnings for the fiscal year ending June 30 are expected to rebound from a $0.28/share loss in 2002 to a $1.20 profit in 2003. Medical equipment is becoming more sophisticated (expensive) and demand is growing. So who could wish for anything more?

CHRISTOPHER & BANKS (CBK,$16) is a specialty retailer of women's clothes in the Midwest and along the northern tier of the country. The company currently operates 380 stores and expects to open 90 more during the coming year with sales projected to be in the $425 million dollar range. Earnings for fiscal year, ending February 28, 2003, should be around $1.40/share growing to $1.75/share in the next 12-month period. The uniqueness of this company is that it has no debt, and, in fact, management has announced a million share buy-back. Many companies are undervalued today, so why not this one?

SEARS ROEBUCK & COMPANY (S, $23) is another out-of-favor retailer. This "once upon a time" blue chip is currently selling at five times 2003 estimated earnings, a figure the president of the company gave out in January. Rumors have plagued the company that its credit card receivables have large losses. The company claims they are under control. Double or nothing… While we are not yet prepared to recommend the stock, we will be monitoring it.

We continue to recommend MARATHON OIL (MRO, $22) as a core position in the oil industry. While oil prices have soared to $37/bbl, oil stocks remain near their lows; the market seems to expect a collapse in oil prices once the geopolitical situation improves. We think, however, that the underlying supply/demand situation will result in oil trading at prices ($25/bbl) higher that anticipated. Meanwhile, companies like Marathon should continue to show strong results as we move into the seasonally strong refining season. Selling under ten times earnings with a 4.2% dividend yield, Marathon remains attractive.

Tomorrow's market? …. Call Saddam.

Philip Herzig

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