Amcon Distributing (DIT)

AMCON DISTRIBUTING (AMEX: DIT)

AMCON Distributing owns a wholesale consumer products distribution network principally serving convenience stores and small retailers in the Great Plains and Rocky Mountain regions of the United States, and also owns two smaller subsidiaries respectively engaged in health food retail and bottled water manufacturing. I believe that the significant earnings power of its profitable core distribution business is currently being masked by recent reported losses and one-time charges at its water and health food retail subsidiaries and a recently discontinued sports beverage marketing and distribution business, and that the company's current plans for a sale or spinoff of its unprofitable business units could unlock a great deal of hidden value over the next several years.

Amcon's annual revenues of $1,230 per share compared to its current share price near $20 are remarkable even for a low-margin distributor with some debt. Interestingly, Amcon's distribution business alone generated pretax income in excess of $7.6 million in each of the last two fiscal years, a figure representing over 70% of the entire firm's current $10.75 in million market capitalization. Although this earnings power is currently not perceived by most investors, the spinoff or sale transactions currently being planned could soon allow the profitability of the distributing business to come to light. Even without such a transaction, the distribution business unit could make an very attractive acquisition at higher prices for either a financial or strategic buyer. Amcon's reported book value may also be understated due to the use of last-in, first-out (LIFO) accounting on a significant baseline stock of cigarette inventories throughout its entire operating history.

The company has recently placed all assets of its beverage and retail subsidiaries into a new corporate entity named The Healthy Edge, Inc., and the board is currently considering several measures intended to separate Healthy Edge from Amcon itself, including a spinoff of Healthy Edge or its direct sale, either to an outside buyer or to DIT CEO William Wright in an arm's-length transaction approved by independent board members.Once separated from the loss-reporting Healthy Edge entity, I believe the core Amcon distribution business will have market value as an independent entity greatly exceeding the current DIT market capitalization as a whole.

CORPORATE WEBSITE

COMPANY PROFILE

AMCON Distributing Company and its subsidiaries engage in the wholesale distribution of consumer products in the Great Plains and Rocky Mountain regions of the United States. The company sells approximately 24,000 consumer products, including cigarettes and tobacco products, candy and other confectionery, beverages, groceries, paper products, health and beauty care products, frozen and chilled products, and institutional foodservice products. AMCON also operates 13 retail health food stores that offer health and natural food products, including natural supplements, groceries, health and beauty care products, and other food products. In addition, it engages in the nonalcoholic beverage business that includes natural spring and geothermal water bottling operations in Hawaii and Idaho, as well as marketing and distribution operation of water and other specialty beverages. AMCON was incorporated in 1986 and is basedin Omaha, Nebraska.

Crown Crafts (CRWS)

CROWN CRAFTS, INC (OTCBB: CRWS)

Crown Crafts is a marketer and distributor of infant bedding and other products throughout North America. After a major recent restructuring involving a debt-for-equity swap, CRWS trades at an extremely low multiple to trailing earnings even after accounting for the dilutive warrants issued during this transaction.

With net income of $2.5 to $3 million in each of the last two fiscal years and EBIT of $7 million in each of the last three years, CRWS can be bought for a trailing P/E of 4.3 after including warrant dilution, and a reasonable EV/EBITDA ratio of approximately 4.6 including the impact of debt. Although the debt load is still substantial and could create some risk, I believe free cash flows will be sufficient to meet near-term maturities and refinance any remaining balance.

Value-oriented firm Wynnefield Partners has accumulated a position of over 2.8 million Crown Crafts shares. CRWS is certainly among the smallest and least liquid securities included in this letter, recently trading anywhere from $0.42 to $0.65 on average daily volume of 24000 shares; based on the extremely low current P/E, CRWS should make a worthwhile portfolio addition for individual investors able to gradually accumulate shares at opportune prices close to the current range.

CROWN CRAFTS, INC (OTCBB: CRWS)

Recent Price: 0.56
52-Week High (11-Feb-04): 0.90
52-Week Low (27-Dec-04): 0.43
Market Cap: 5.32M
Enterprise Value: 34.68M
Trailing P/E: 4.34
Price/Sales (ttm): 0.06
Price/Book (mrq): 0.27
Enterprise Value/Revenue (ttm): 0.40
Enterprise Value/EBITDA (ttm): 4.55
Revenue (ttm): 85.69M
Revenue Per Share (ttm): 4.485
Gross Profit (ttm): 19.59M
EBITDA (ttm): 7.63M
Net Income Avl to Common (ttm): 3.04M
Diluted EPS (ttm): 0.129
Earnings Growth (lfy): 24.80%
Average Volume (3 month): 14,681
Average Volume (10 day): 24,000

CORPORATE WEBSITE

COMPANY PROFILE

Crown Crafts, Inc. (Crown) operates indirectly through its subsidiaries, including Hamco, Inc., Churchill Weavers, Inc., Crown Crafts Infant Products, Inc. and Burgundy Interamericana in the infant products segment within the consumer products industry. Infant products include crib bedding, diaper stackers, mobiles, bibs, receiving blankets, burp cloths, bathing accessories and other infant soft goods and accessories. The Company also produces hand-woven throws for infants and adults, which are manufactured and imported in a variety of colors, designs and fabrics, including cotton, acrylic, cotton/acrylic blends, rayon, wool, fleece and chenille. Crown's products also included two additional groups: bedroom and bath products. It also imported and jacquard-woven throws. Bedroom products included comforters, comforter sets, sheets, pillowcases, sheet sets, pillow shams, bed skirts, duvets, decorative pillows, coverlets and jacquard-woven bedspreads.

DXP Enterprises (DXPE)

DXP ENTERPRISES (DXPE)

Industrial equipment distributor DXP Enterprises is certainly one of the most extreme microcap value stocks currently available. The P/E of 3.09 is truly eye-opening, as is DXPE's price to book value ratio of 0.43 and price to sales of just 0.03. While the company is currently being completely ignored by investors, this kind of undervaluation won't stay unnoticed for very long -- it certainly hasn't escaped DXPE CFO Hugh McConnell and Chairman David R. Little, who have bought more than 25,000 DXPE shares in the past two years.

DXP's business is heavily tied to the general level of economic (particularly manufacturing) activity. If the company is capable of earning over $0.30 per share in 2002 with the manufacturing sector in a serious slump, it's not unreasonable to believe that even higher levels are in store once the economy eventually returns to historically normal growth.

Part of the reason for the undervaluation is a successful restructuring effort that took place at the company last year, including the recent sale of an unprofitable electrical contracting outlet that had been depressing earnings for some time. While the benefits of these positive developments are clearly already starting to pass through to the bottom line, a small company like DXPE is completely off of analysts' radar screens, and few people have noticed the dramatic change in the company's prospects. As a result, the stock remains completely undiscovered by investors at the present time.

Like CHMP, any economic recovery will have a dramatic effect on this company's bottom line; and the already undervalued stock means that potential long-term price appreciation is even greater. DXPE was trading for $10 per share just five years ago, and if current earnings progress keeps up, it could certainly see that price again in another five years.

DXP ENTERPRISES (NASDAQ: DXPE)

Recent Price $0.95
52-Week Low (18-Nov-2002) $0.70
52-Week High (28-May-2002) $2.24
52-Week Change -24.0%
Market Capitalization $3.87M
Book Value (mrq) $2.18
Earnings (ttm) $0.31
Earnings (mrq) $0.09
Sales (ttm) $34.24
Cash (mrq) $0.16
Valuation Ratios
Price/Book (mrq) 0.44
Price/Earnings (ttm) 3.09
Price/Sales (ttm) 0.03
Income Statements
Sales (ttm) $151.8M
EBITDA (ttm) $5.06M
Income available to common (ttm) $1.31M

BUSINESS PROFILE

DXP Enterprises, Inc. is engaged in the business of distributing maintenance, repair and operating (MRO) products, equipment and service to industrial customers and a broad range of electrical products to electrical contractors. The Company is organized into two segments, MRO and Electrical Contracting. The MRO segment provides MRO products, equipment and integrated services, including engineering expertise and logistics capabilities, to industrial customers. The Company provides a wide range of MRO products in the fluid handling equipment, bearing, power transmission equipment, general mill, safety supply and electrical products categories. The Company offers its customers a single source of integrated services by being a first-tier distributor that can purchase products directly from the manufacturer, and also provides integrated services, such as system design, fabrication, installation, repair and maintenance, for its customers. The Electrical Contracting segment sells a broad range of electrical products, such as wire conduit, wiring devices, electrical fittings and boxes, signaling devices, heaters, tools, switch gear, lighting, lamps, tape, lugs, wire nuts, batteries, fans and fuses, to electrical contractors; carrying a broad range of products from over 100 vendors.

RECOMMENDATION

Buy DXPE under a dollar, planning to hold for several years.

General Bearing (GNRL)

After the announcement of a management-led tender offer, I believe GNRL stock remains an attractive opportunity below the announced buyout price of $3.50 per share. With earnings of $0.90 in the past year before the impact of one-time charges; the stock should be worth much more than $3.50 if the tender fails to attract a majority of public shareholders and GNRL remains a public company.

GENERAL BEARING CORP (NASDAQ: GNRL)

General Bearing Corporation manufactures and distributes roller and ball bearings for the automotive, railroad, and industrial markets. Reported earnings for the past several years have been impacted by persistent operating losses and asset writedowns at the company's former European machine tool manufacturing subsidiary, and GNRL stock has declined from 1998 highs of $30 to trade at recent lows near $3. The current level represents half of tangible book value and a price to sales ratio of 0.19. By comparison, publicly-traded competitors Timken (NYSE: TKR) and NN Bearing (NASDAQ: NNBR) are valued at much higher multiples. GNRL has recently been buying back a significant amount of stock at below book value. Over the past three years, the company has repurchased and retired over 410,000 million GNRL shares at a total cost of $1.47 million, with 125,000 of these bought during fiscal 2003. 3.7 million shares remain outstanding.

While GNRL appears fairly priced based on an 15 multiple to trailing earnings, reported income over the past two years has been heavily impacted by operating losses and impairment charges at two unprofitable subsidiaries which have now been disposed of; going forward, GNRL's actual earnings power appears to be significantly higher. Reported earnings for FY 2003 totaled 1,162,000, or $.30 per share. Before the impact of a non-cash writedown for the closure of a manufacturing joint venture in New York, 2003 net income would have totaled $3.45 million ($0.90 per share), for an adjusted trailing P/E ratio of just 3.3. The company enjoyed positive cash flow from operations of $7.8 million in fiscal 2003, and achieved significant debt reduction, paying down its credit line by $5.8 million. Book value of $22.5 million is entirely tangible, and the company has $2.2 million in deferred tax assets, $1.4 million of which is currently excluded from the balance sheet under a valuation allowance and should be recognized as additional income as the company's current profitability continues.

The book value of GNRL's former European machine tool subsidiary (World Machinery Works, or WMW) was written down to zero in late 2002 with a $ million impairment charge, and the division was sold in December of 2003. GNRL recognized an initial payment of $500 thousand last year, but is still entitled to a total of $6 million of additional consideration, payable quarterly as the greater of 2 percent of WMM's gross revenues or percent of its EBITDA.

The founding Gussack family owns a majority of the common stock, and is currently increasing this stake through the ongoing buyback. Executive options and salaries appear to be reasonable, but two related-party transactions are a potential source of concern: leasing of the headquarters building from the founder, and the recent sale of WMW to a management-led team. With an end to writedown expenses at former subsidiaries coinciding with a nascent North American economic recovery and an ongoing Chinese manufacturing boom, GNRL's reported earnings over the coming year should materially exceed prior figures; and the significant share buyback will enhance the impact of these results.

GENERAL BEARING CORP (NASDAQ: GNRL)

Recent Price: 3.04
Market Cap: 11.41M
Enterprise Value: 37.31M
Trailing P/E (ttm): 14.98
Price/Sales (ttm): 0.19
Price/Book (mrq): 0.50
Enterprise Value/Revenue (ttm): 0.61
Enterprise Value/EBITDA (ttm): 5.79
Revenue (ttm): 61.43M
Revenue per Share (ttm): 16.237
Gross Profit (ttm): 17.86M
EBITDA (ttm): 6.44M
Net Income Avl to Common (ttm): 862.00K
Diluted EPS (ttm): 0.203
Total Cash (mrq): 2.18M
Total Cash Per Share (mrq): 0.58
Total Debt (mrq): 28.08M
Total Debt/Equity (mrq): 1.22
Current Ratio (mrq): 1.864
Book Value Per Share (mrq): 6.132
Cashflow From Operations (ttm): 7.86M
Free Cashflow (ttm): 4.93M

CORPORATE WEBSITE

COMPANY PROFILE

General Bearing Corporation manufactures, sources, assembles and distributes a variety of bearings and bearing components, including ball bearings, tapered roller bearings, spherical roller bearings and cylindrical roller bearings. Under the Hyatt and The General trademarks, the Company supplies original equipment manufacturers (OEMs) and the industrial aftermarket, primarily in the United States and Asia. Its products are used in a range of applications, including automobiles, railroad cars, locomotives, trucks, heavy-duty truck trailers, office equipment, machinery and appliances.

RECOMMENDATION

Accumulate GNRL below $3.50. Decline to participate in the tender.

Industrias Bachoco

INDUSTRIAS BACHOCO, S.A. DE C.V. (NYSE: IBA)

After the announcement of a management-led tender offer, I believe GNRL stock remains an attractive opportunity below the announced buyout price of $3.50 per share. With earnings of $0.90 in the past year before the impact of one-time charges; the stock should be worth much more than $3.50 if the tender fails to attract a majority of public shareholders and GNRL remains a public company.

Industrias Bachoco is a NYSE-listed Mexican livestock producer with farming and processing operations in chicken, table eggs, pork, and animal feed. After an increase in grain prices pressured profit margins over the previous year, IBA trades at extremely low levels compared to its current tangible assets and recent historical earnings power, while grain prices have recently receded to levels that should allow IBA's previous earnings track record to resume. An industry comparison of long- term profitability reveals that IBA consistently earns profit margins significantly superior to those of its competitors, likely due to sustainable advantages in cost and distribution that haven't yet been recognized in its sharply below-market valuation. Furthermore, IBA could now be nearing the onset of several significant catalysts that could amplify these cost advantages and lay the groundwork for a successful long-term investment.

According to the July 2004 report on SEC Form 6-K stated directly in US dollar terms, IBA has cash of US$146 million and $15 million in total debt, for a net cash position of $2.62 per NYSE-traded American Depository Share, over one fourth of the current share price. IBA's current shareholder's equity of $879 million translates to a tangible book value of $17.58 per ADS, for a current price/tangible book value ratio of approximately 0.58. The company has established a $19 million reserve for the repurchase of public shares, and currently pays a generous dividend yielding 4.59%.

I've included a table of IBA's historical reported income, with the relevant figures translated into dollars per NYSE-traded ADS based on the prevailing average US/Mexican exchange rates. During five of the six last fiscal years, IBA earned from US$2.14 to $3.10 per share in net income, again a significant fraction of the current share price. During 2003, sharply rising soybean and corn prices had a significant impact on the cost of chicken feed, depressing earnings to $0.93 per ADS. However, both soybean and corn prices have recently declined to approximately their average levels during 2002. As IBA has not recently employed grain futures hedging, it should soon return to its high historical profit margins. Assuming a 25% gross profit margin is reachieved, earnings over the next 12-month period could reach approximately $2.50 per ADS, for a forward P/E ratio close to 4. Taking IBA's $2.62 per share of cash into account, the current P/E multiple on historical earnings would range from 2.5 to 3.5 on a net-of-cash basis.

1998 1999 2000 2001 2002 2003 12m est
U.S. GAAP (millions of pesos):
Net Sales 7188 6785 10140 10202 10358 10773 11204
Cost of sales 5181 5039 7244 7468 7684 8746 8403
Gross profit 2008 1746 2896 2734 2674 2027 2801
Operating income 1292 897 1655 1363 1255 467 1436
Comprehensive financing cost 23 129 119 92 11 116 116
Net income 1128 1019 1378 1157 1498 503 1410
Net income per ADS 22.60 20.46 27.90 23.28 30.18 10.08 28.20

Avg exchange rate (pesos/US$) 9.242 9.561 9.471 9.327 9.74 10.79 11.30 Earnings (US$ per ADS) 2.45 2.14 2.95 2.50 3.10 0.93 2.50

1998 1999 2000 2001 2002 2003

Gross profit margin 27.90% 25.70% 28.60% 26.80% 25.80% 18.70%
Operating margin 18.00% 13.20% 16.30% 13.40% 12.00% 4.00%
Net margin 17.20% 14.40% 13.30% 11.20% 14.40% 5.00%
Below is a table comparing IBA's historical long-term
profitability together with three comparable publicly-traded US
firms: Pilgrim's Pride (NYSE: PPC), Tyson Farms (NYSE: TSN) and
Sanderson Farms (NYSE: SAFM). As you'll see, IBA consistently
earns gross profit margins more than double those of its
competitors, and its net profit margins are greater by over 3 to 5 times.

IBA PPC TSN SAFM

Gross profit margin (5yr avg) 25.3% 9.4% 9.9% 9.9%
Operating profit margin (5yr avg) 11.9% 4.3% 4.3% 5.7%
Net profit margin (5yr avg) 11.2% 2.6% 1.9% 3.0%

The majority of IBA's sales come from whole or "public market" chicken provided fresh to its network of local distributors and to the numerous roadside roast chicken vendors who are a major source of Mexican "fast food". It currently does not compete extensively in the urban markets for supermarket frozen chicken products which would be most vulnerable to export pressures from the US. Due both to a strong consumer preference for fresh over pre-frozen chicken and the limited availability of refrigeration in many of the areas IBA serves, there appears to be a significant and durable demand for fresh poultry products with reliable daily distribution at the local level. Competitors and importers will likely have substantial difficulty entering IBA's principal markets without large-scale investments in local production and distribution of whole fresh-to-the-consumer chickens. IBA should maintain its dominant position as the low- cost producer and distributor of fresh poultry products within Mexico itself, and as it is currently making significant recent investments in plants along Mexico's northern border geared specifically toward export, could begin to make inroads into the lucrative US market while remaining dominant in its current domestic niche. Due to trade barriers due to be gradually phased out under NAFTA by 2008, corn prices in Mexico have generally exceeded those in the US and Canada. As free trade increases over the longer term, feed prices on the Mexican market could fall even below the levels historically experienced by IBA.

Because of its low valuations to tangible book value and historical baseline earnings, its attractive current dividend yield, and the potentially significant future benefits of expansion into the US market and reduction of present grain trade barriers, IBA shares should currently provide an attractive opportunity for low-risk international diversification.

INDUSTRIAS BACHOCO (NYSE: IBA)

Recent Price: $10.25
Market Cap : 512.50M
Enterprise Value: 379.29M
Total Cash (mrq): 147.66M
Total Cash Per Share (mrq): 2.95
Total Debt (mrq): 15.46M
Total Debt/Equity (mrq): 0.017
Current Ratio (mrq): 4.216
Book Value Per Share (mrq): 17.58
Annual Dividend: 0.47
Dividend Yield: 4.59%
Average Daily Volume: 6,727

COMPANY PROFILE

Industrias Bachoco, S.A. De C.V. (Bachoco) is a poultry producer in Mexico. During the year ended December 31, 2003, the Company produced approximately 7 million chickens per week. As a vertically integrated producer, Bachoco controls virtually all aspects of the production and distribution process. With over 700 production and distribution facilities dispersed throughout Mexico, the Company's operations include preparing feed; breeding, hatching and growing chickens, and processing, packaging and distributing chicken products. Sales of chicken products accounted for 77.6% of the Company's net revenues in 2003. Bachoco is also a producer of commercial animal feed. In 2003, the Company sold approximately 6,000 tons of feed per week to external customers, which amounted to 7.1% of its total sales in 2003. Bachoco is also a producer of eggs with a weekly capacity of approximately 3.5 million dozen eggs. Egg sales accounted for 11.1% of the Company's net revenues in 2003.

CORPORATE WEBSITE

RECOMMENDATION

Gradually accumulate IBA near the current $9 to $11 range, planning to hold for 2 to 4 years.

Medcath Corporation (MDTH)

An important study by Rice University economist David Ikenberry (available at http://www.deepvalue.com/pdf/buyback.pdf ) has shown that the market underreacts significantly in the shorter term to the completion of share repurchases by undervalued firms. The study found that 4-year buy-and-hold returns for portfolios of undervalued stocks undergoing a buyback were a full 45.3% above even those of similarly undervalued stocks that aren't experiencing a buyback. While it may take considerable time for these stocks' prices to readjust to their improved fundamentals, it is clear that value investors can take advantage of this slow reaction as a golden opportunity to earn exceptional long-term returns.

In partnership with local physicians, Medcath Corp develops, builds, and operates a network of specialty hospitals focused on cardiology and cardiothoracic surgery. Although cardiac care has historically been among the most profitable mainstays of any hospital's operations, a series of short-term disappointments have turned Wall Street wildly negative on the stock, culminating in a 75% decline that has left MDTH trading at compellingly cheap levels in relation to book value, 2002 earnings, and its actual cash account.

Low initial Medicare reimbursement rates for several cardiac treatment technologies, brief partial closures at two Medcath facilities, and a concentration of one-time startup costs for several hospitals currently in construction have combined to bring 2003 estimates down to a slight loss compared to fiscal year 2002 earnings of $1.34 per share. Book value stands at $18.13 per share, more than three times the current price. $7.37 of that total is attributed to non-tangible goodwill; but I believe a large part of this represents the fair market value of the established hospitals, each of which required significant noncapitalized startup costs to develop. Even after subtracting goodwill, MDTH's balance sheet has a solid tangible book value of $10.76 per share, of which $5.86 comes directly from cash.

Earnings have recently suffered from the high cost of implantable pacemakers and drug-coated arterial stents compared to current Medicare reimbursement rates. With the recent approval of their Cypher stent, Johnson & Johnson currently holds a monopoly on the drug-coated stent market; initial pricing has been high, but upcoming products from Boston Scientific and other firms should bring significant price relief within several years. Medcath's high degree of specialization also multiplies its buying power: it consumes volumes of cardiac equipment equivalent to a much larger number of general hospitals of similar size, allowing it to negotiate with suppliers from a much stronger position than its competitors. During the initially severe shortage of coated stents, the cardiology site heartwire.org reported that Medcath hospitals had a full supply -- and these were undoubtedly obtained at a significant volume discount. Medcath is currently the only company developing specialty heart hospitals nationwide. As its portfolio of facilities grows, this market power advantage will become continuously more important.

Some analysts fear that the long-term effectiveness of drug-coated stents in preventing re-clogging of unblocked arteries will reduce the need for repeat angioplasties and coronary artery bypass grafts performed at MDTH facilities. While this is potentially true, the perception that the availability of coated stents will severely and permanently reduce the demand for heart hospital services appears largely overblown. Besides the continuing need for angioplasty and stent insertion, there are a wide variety of cardiovascular surgery needs that aren't met by stenting, such as valve replacement and aneurysm repair. MDTH hospitals are far from saturating the total market for cardiac care.

The Wall Street community has also been spooked by recent hints of hostility on Capitol Hill toward specialty hospitals and physician- owned hospitals. Proponents of traditional general hospitals have accused more specialized institutions of "cherry-picking" the least severely ill patients, failing to offer adequate emergency services, and creating conflicts of interest when physicians refer patients to hospitals in which they have partial ownership. To defuse the possibility of regulatory attack, Medcath retained the Lewin Consulting Group to complete a series of two objective studies on patient results at Medcath instutions. Using raw outcomes data collected directly from Medicare itself, the studies were able to demonstrate clear, specific advantages in the quality and cost of care provided at Medcath hospitals. Unlike many highly-specialized treatment centers, Medcath hospitals are licensed as general acute- care facilities, and have fully-functioning emergency rooms that can treat non-cardiac cases. While the final regulatory outcome is still uncertain, the Senate version of the Medicare prescription drug bill carries an amendment by Sen. John Breaux that would continue to allow physician ownership in "comprehensive inpatient and outpatient facilities" where the referrals of each physician are "insignificant in relation to the overall scope of services", language that would appear to favor MDTH's position.

Six officers and directors have recently bought over $1 million of MDTH stock, some of this at much higher prices, and the board has just approved a $7.5 million buyback plan that could repurchase up to 8.5% of the company. The buyback has been taking place at below cash value per share -- for each share repurchased at under cash, the cash value of each of the remaining shares will actually increase. While it's true that a part of Medcath's current cash position will soon be invested in new hospital construction, this still represents an incredible discount with very real benefits to shareholders. At less than a third of book value and barely 4 times 2002 earnings, the buyback effects on the price/book ratio and the future P/E will be even more extreme.

Medcath has a particularly interesting history as a public company that may give some insight into one of this scenario's possible outcomes. First formed in 1988 as a network of mobile cardiac catherization centers, Medcath began an expansion into specialty heart hospitals and went public for the first time in 1994. While the company continued to perform well, investors lost enthusiasm for the stock during the late 90's technology mania, and when valuations became too cheap to pass up it was bought out in 1998 by the private equity firms Kohlberg Kravis Roberts (KKR) and Welsh, Carson, Anderson and Stowe. Medcath continued to expand as a private company, and then re-entered the public markets with a July 2001 IPO at $25 per share. KKR and Welsh Carson still own roughly a 65% position, and are now passively increasing their stake through the company's share buyback. If current valuations persist for any length of time, an eventual second buyout offer by these firms becomes a definite possibility.

Although a small-cap stock with market capitalization of just $77 million, MDTH is liquid and tradeable with an average daily volume of nearly 115,000 shares. Unfortunately, a strong rally on Monday as I was writing this piece has brought MDTH to nearly $6 per share, but the valuation story still appears quite compelling. Due to this year's price decline, MDTH is being removed from the Russell 3000 index on the first of July, which could generate some pressure as small-cap index funds that track the Russell will be forced to sell. While index fund selling could be largely offset by the continuing share buyback, the current situaion appears to present an good initial buying opportunity for new MDTH investors.

MEDCATH CORPORATION (NASDAQ: MDTH)

(data as of 6/27/03)
Recent Price $5.46
3 Month Avg Daily Volume 114.6K
Market Capitalization $98.3M
Shares Outstanding 18.0M
Book Value (mrq) $18.13
Earnings (ttm) $0.34
Earnings (mrq) $0.03
Sales (ttm) $26.97
Cash (mrq) $5.86
Price/Book (mrq) 0.30
Price/Earnings (ttm) 16.30
Price/Sales (ttm) 0.20
Sales (ttm) $487.2M
EBITDA (ttm) $72.1M
Income available to common (ttm) $6.03M
Current Ratio (mrq) 1.46
Debt/Equity (mrq) 1.02
Total Cash (mrq) $105.5M

CORPORATE WEBSITE

PROFILE

MedCath Corporation focuses primarily on the diagnosis and treatment of cardiovascular disease. The Company designs, develops, owns and operates hospitals in partnership with physicians, most of whom are cardiologists and cardiovascular surgeons. While each of MedCath's hospitals is a freestanding, licensed general acute care hospital that includes an emergency department or chest pain clinic, operating rooms, catherization laboratories, pharmacy, laboratory, radiology department, cafeteria and food service and is capable of providing a full complement of health services, the Company focuses primarily on serving the needs of patients suffering from cardiovascular disease. As of September 30, 2002, the Company owned and operated eight hospitals, together with its physician partners who own an equity interest in the hospital where they practice, as well as other investors. On October 2, 2002, MedCath opened its newest hospital in Harlingen, Texas, which increased its total number of owned and operated hospitals to nine. The Harlingen Medical Center focuses on cardiovascular care, as well as orthopedics, neurology, obstetrics and gynecology. The Company's existing nine hospitals have a total of 577 licensed beds and are located in Arizona, Arkansas, California, New Mexico, Ohio, South Dakota and Texas. MedCath provides cardiovascular care services in diagnostic and therapeutic facilities located in eight states and through mobile cardiac catheterization laboratories. The Company's mobile diagnostic facilities are typically leased to hospitals and used by physicians to evaluate the functioning of patients' hearts and coronary arteries and serve areas that do not have the patient volume to support a full-time facility. It also provides consulting and management services tailored primarily to cardiologists and cardiovascular surgeons.

RECOMMENDATION

Buy MDTH in the current $5-$6 range.

MGP Ingredients (MGPI)

SUMMARY

Grain processing firm MGP Ingredients (MGPI) is currently trading at an extreme discount to book value due to the impact of an explosion at one of its distilleries in September 2002, even though the facility was insured and all damage from the incident is expected to be fully repaired by the end of this year. More importantly, I have discovered that a $20 million USDA cash grant received by MGPI during the last two years hasn't yet been recorded in earnings or book value -- its benefits will start to be realized in 2004, when the new plants it was used to build begin to come online. MGP's management are personally invested in the company, and have quietly launched an effort to repurchase huge amounts of stock while it trades at this temporary low (1.8 million shares have already been bought back, and buyback of a further 1 million of the 8 million shares remaining was begun in December.) When the business returns to normal in early 2004, earnings will be significantly higher and the pool of available shares will have drastically shrunk -- within two years, MGPI could easily trade at or above its historical $15 to $20 level.

MGP INGREDIENTS, INC. (NASDAQ: MGPI)

52-Week Low (10-Oct-2002) $5.86
52-Week High (3-May-2002) $14.64
Market Capitalization $65.2M
Annual Dividend (indicated) $0.15
Book Value (mrq) $13.66
Earnings (ttm) $0.99
Earnings (mrq) $0.01 Sales (ttm) $23.77
Cash (mrq) $3.36
Price/Book (mrq) 0.50
Price/Earnings (ttm) 6.86
Price/Sales (ttm) 0.29
Sales (ttm) $193.1M
EBITDA (ttm) $15.8M
Income available to common (ttm) $8.10M
Profit Margin (ttm) 4.2%
Operating Margin (ttm) 0.7%
Return on Assets (ttm) 4.70%
Return on Equity (ttm) 7.65%
Current Ratio (mrq) 2.23
Debt/Equity (mrq) 0.17
Total Cash (mrq) $26.8M

CORPORATE WEBSITE

COMPANY PROFILE

MGP Ingredients, Inc., formerly known as Midwest Grain Products, Inc., is a fully integrated producer of wheat-based products and distillery products and has two reportable segments, wheat-based products and distillery products. Wheat-based products consist of specialty (value- added) ingredients, including wheat starches and proteins, as well as commodity ingredients, including commodity wheat starches and vital wheat gluten, and mill feeds. Distillery products consist of food grade alcohol, including beverage alcohol and industrial alcohol, fuel alcohol (ethanol) and distillers grain and carbon dioxide, which are by-products of Midwest Grain's distillery operations.

RECOMMENDATION

Buy MGPI at current levels, planning to hold for 2-3 years.

MGP Ingredients, formerly Midwestern Grain Products Inc., is an integrated producer of processed wheat proteins, starches, carbon dioxide, animal feed additives, fuel-grade and consumption-grade alcohols, and a variety of other products derived from the milling and fermentation of wheat and other grains. The combination of several temporary business impairments and the complex accounting treatment of a significant corporate asset are now causing MGPI to trade at dramatically less than its actual value.

Firstly: A September 2002 explosion at the company's Atchison, Kansas distillery complex significantly damaged the facility and forced a shutdown of operations. Repairs are forecast to take 9 to 12 months, after which time the facility will return to full production. Management is now projecting break-even earnings for FY 2003 due to reconstruction charges, freight costs, and operating inefficiencies caused by the temporary lack of use of the Atchison facility.

MGPI now trades at $8 a share, representing a $65M market cap, price/book of 0.50, P/S of 0.29, a 6.86 trailing P/E, and dividend yield of 1.87%. Debt is low at $18 million, or 0.17 of equity. The company has cash and equivalents of $26.8 million, equivalent to $3.36 per share or over 40% of the current price. Enterprise value is $44 million, and 2002 EBIT is $11.3M for an EV/EBIT ratio of 4.02. The company has recently completed 1.8 million shares of a 2 million share common stock buyback and begun on a further 1 million share program approved by the board in December. Currently just 8 million shares remain outstanding.

Reported book value of $13.66/share appears to be substantially all tangible. MGP does carry a $14 million insurance receivable related to the Atchison damage, but management believes this will be collectible. Book value also includes an at-cost accounting for a $6.5 million textured wheat protein and biopolymer facility acquired on favorable terms from a 2001 bankruptcy proceeding. Management believes this facility provides significantly more space, capacity, and product versatility than their previous plans to build such a facility at similar cost.

Now here's what the book value *doesn't* include:

MGPI has been the beneficiary of a particularly generous US Department of Agriculture program designed to stimulate investment in grain- processing technology and offset direct European Union subsidies on commodity wheat gluten production. In June 2002, the DoA's Commodity Credit Corporation (CCC) completed disbursement of the final $14M of a total $26 million in outright cash grants to the company. * 25% of the total was earmarked for R&D and marketing programs, and is reflected in MGP's earnings during the quarters it was received; we'll have to back those payments out to arrive at baseline earnings. * The other 75% of that total, earmarked for capital investment, will be recognized as income over the lifetime of the assets it is used to build. This represents a total $20 million in cash already received by the company and currently being invested in new plants and equipment -- none of which has ever been reflected in earnings or book value. When compared to current market cap of just $65M, the effect of this $20M off-the- books windfall is dramatic.

Using the funds from the CCC grant, MGPI plans to de-emphasize their commodity wheat gluten business (under pricing pressure by even more heavily-subsidized European competitors), and focus on its portfolio of higher-margin branded specialty wheat products, which are derived by further processing of the original gluten. Due to the fully-integrated nature of their grain products operations, old gluten production capacity won't be wasted -- the gluten previously intended for sale will be used as an input for increased production of their final niche products. Earnings for FY2002 already include the impact of the June 2001 elimination of US quotas on commodity wheat gluten and the company's concurrent decision to substantially reduce basic gluten output and sales. While sales of specialty wheat products rose by 30% by the end of fiscal 2002, management is projecting continued growth.

So to get an idea of very conservative baseline earnings, let's look at FY 2002. For fiscal 02, ending the June 30 before the Atchison explosion, net income was $6.3 million. These figures included $3.1 million of after-tax income related to the non-capital 25% portion of the USDA grant, and a net hedging loss of $1.8 million ($1.1 million after tax), giving us roughly $4.3 million or $0.52/share baseline. As new plants become operational in 2003 and 2004, MGP's $20 million in off-balance-sheet assets will begin to be recognized as income -- even spread over a 10-year period, we have roughly $0.25 annually on top of that baseline figure. And that's *still* before any of the earnings that the new plants themselves will generate. Using an average 8% RoE, we might expect $1.6 million, or a further $0.20 per share per year.

A number of other factors make this baseline value look even more solid:

* In recent years, many fuel-grade ethanol producers, MGP included, significantly increased production in anticipation of California's January 2003 ban on the MTBE gasoline additive in favor of ethanol-based fuels. However, the CA governor postponed the state's MTBE ban until January of 2004, causing fuel ethanol prices for FY2002 to fall sharply below even their prior levels. California refiners now plan to adopt the ethanol additives by late 2003, and fuel ethanol spot prices began to recover in late Q4 of 2002. The Atchison plant accounted for 67% of the company's food-grade alcohol production, but only 19% of fuel-grade alcohol output -- and substantially all of that capacity should be fully returned to production by Q4 2003. As a result, the company should be in a good position to immediately benefit from the expected continuing recovery in fuel-grade ethanol prices. Any future movement toward increased use of ethanol-based fuels, whether for environmental, economic, or political reasons, would provide further unforeseen upside to the already compelling MGPI story.

* 2002 grain prices were also significantly above normal due to continuing drought in much of the Midwest. Drought conditions remain in effect, and prices are expected to edge higher during 03, already reflected in management's break-even expectations. Any return to average rainfall patterns over the longer term would bring a welcome decrease to cost of goods sold.

* With the recent passage of the Farm Security and Rural Investment Act of 2002, Congress returned to a policy of increasing subsidies to wheat and other grain producers. Annual spending is projected at $15-20 billion on crops alone, representing a 70% increase over the more austere FAIR Act of 1996. While the farm bill revives many earlier subsidies, it includes none of the old methods for controlling production; most observers expect a significant and sustained depressive effect on world grain prices. As production builds over the next few years, the long-term average cost of MGPI's inputs could fall substantially below recent baselines, leading to increasing margin on virtually all products.

The company's concentrated ownership structure is a potential source of concern. The former CEO and current management own all of a poison pill 5% non-convertible preferred issue giving them the right to name five of MGP's nine directors, making a takeover highly unlikely. However, substantially all of management's economic interests are linked to long- term performance of the common stock. Director and former CEO Cloud L. Cray owns 27% of MGPI, current CEO Ladd Seaberg owns 7%, and the company's Employee Stock Ownership Program owns a further 11%. Through a combination of direct ownership, stock options at significantly higher prices (net potential effect on book value is anti-dilutive), and heavy management participation in the company's ESOP, insiders together own a total 49% of the common. Management's aggressiveness with the recent buybacks has been wonderful. This is simply a very savvy effort to permanently shrink the pool of available shares at a time when multiple factors are pushing the stock to a temporary low-price extreme. If the current 1 million shares get done this year, everything good about this stock -- including the off-balance-sheet $20 million asset -- will just have been amplified another 12 percent.

CATALYST

Even a return to baseline earnings from a break-even 2003 would leave MGPI shares conspicuously undervalued as its significant off-balance- sheet assets begin to be recognized; both from inclusion in income of the unrealized $20M in book value, and from the actual earnings the facilities themselves will generate. The return to normal pricing for fuel ethanol and/or grains and the heavily accretive effects of the company's aggressive stock repurchases should magnify the situation further. As of this writing these catalysts are over a year away -- the Q2 report out in several weeks is likely to show a loss, so shares could get still cheaper from here and allow management to repurchase more stock. Value investors accumulating MGPI shares during the 2003 earnings downturn will pay dramatically less than their true worth.

Point.360 (PTSX)

POINT.360 (NASDAQ: PTSX)

Point.360 is a provider of a variety of media post-production, duplication, reformatting, distribution and archival services to clients in the television, advertising, and motion picture industries. Down over 50% from its 52-week high on recent revenue weakness and sluggish growth prospects within the industry, PTSX has seen significant recent insider buying and now trades at remarkably low levels related to the cash flows historically produced by its businesses.

Cash flow from operations at Point.360 totalled approximately $10 million in each of the last three fiscal years, with free cash flows after capital expenditures ranging from $5 million to $9 million annually during the period. With a current market capitalization of under $24 million, an investment in PTSX shares would represent a historical free cash flow yield of at least 25%, and a present ratio of enterprise value to trailing 12-month EBITDA of just 2.66.

Point.360 CEO Haig S. Bagerdjian has purchased 94,200 PTSX shares on the open market during the last several months, adding to an already substantial position together with 1.4 million shares purchased directly from the outgoing former CEO during 2002. Including 370,000 options, Bagerdjian now owns approximately 2.4 million shares or 25% of the company.

Although earnings this year have been weaker due to a slowdown in distribution and promotional business, and revenues would have declined significantly before the impact of the recent acquisition, comparisons for the first half were partially affected by completion of a significant film remastering project during the previous year. Almost all of PTSX's business occurs on an on-demand schedule with short lead times, making forecasts difficult and leading to some degree of expected revenue and earnings volatility. Because of the significant recent insider buying and because internally-generated cash flows appeared relatively stable during previous periods when acquisitions did not occur, I believe that Point.360's current fundamentals are likely sustainable without further use of cash for acquisitions, and that the extreme discount to the firm's consistent historical levels of cash flows should compensate investors for the appearance of recent weakness.

To further control costs, the company is planning to consolidate its four existing Los-Angeles area archival vaults into a single 65,000 square foot warehouse facility as their leases expire in the near future, and recently acquired a smaller competitor, International Video Conversions, in its first acquisition in four years. A previously planned acquisiton of several Canadian post-production studios owned by Alliance Atlantis (NASDAQ: AACB) was called off in mid-2003 after careful due diligence, generating over $1 million in one-time charges in both 2003 and 2004. A number of outstanding lawsuits related to the cancelled acquisition were successfully settled out of court by PTSX in November of this year. There are approximately 2 million options outstanding with an average exercise price near $3, but new option issuance appears to have moderated significantly under current management.

The long term outlook for the post-production service industry has been the subject of some uncertainty, contributing to Point.360's sharply below-market valuation. Modern digital video technologies may have enabled some customers to take more distribution and archival functions in-house, reducing demand for some of PTSX's legacy film-based services. Nevertheless, PTSX provides a very wide variety of media processing and post- production services, the aggregate demand for which has grown consistently over decades of constant technological change. In fact, demand in areas such as analog-to-digital transfer, DVD authoring and digital video compression, electronic queueing and delivery of advertising content, foreign language remastering, and high definition (HDTV) remastering may be poised for significant secular growth. Notably, Federal Communications Commission mandates currently in place are expected to rapidly accelerate market penetration of HDTV technology in the United States over the next decade, providing significant eventual opportunities for the company's modern HDTV center in California.

Particularly considering significant recent insider buying activity, the overall outlook for PTSX does not appear as dire as its extremely low cash flow valuations are anticipating. Point.360's recent adoption of a "poison pill" anti-takeover share purchase rights plan should limit the likelihood of any near-term acquisition, but over the long term, new investors will likely be well rewarded for following the example of the PTSX CEO.

POINT.360 (NASDAQ: PTSX)

Recent Price: $2.46
Market Cap: 22.65M
Enterprise Value: 28.49M
Trailing P/E (ttm): 6.32
Price/Sales (ttm): 0.40
Price/Book (mrq): 0.60
Enterprise Value/Revenue (ttm): 0.49
Enterprise Value/EBITDA (ttm): 2.66
Profit Margin (ttm): 6.44%
Operating Margin (ttm): 8.29%
Return on Assets (ttm): 6.02%
Return on Equity (ttm): 9.91%
Revenue (ttm): 57.63M
Revenue Per Share (ttm): 5.92
Revenue Growth (lfy): -5.10%
Gross Profit (ttm): 25.23M
EBITDA (ttm): 10.72M
Net Income Avl to Common (ttm): 3.71M
Diluted EPS (ttm): 0.389
Total Cash (mrq): 2.23M
Total Cash Per Share (mrq): 0.24
Total Debt (mrq): 7.88M
Total Debt/Equity (mrq): 0.207
Current Ratio (mrq): 1.461
Book Value Per Share (mrq): 4.147
Average Volume (3 month): 29,272
Average Volume (10 day): 126,000

CORPORATE WEBSITE

COMPANY PROFILE

Point.360 is an integrated media management services company providing film, video and audio post production, archival, duplication and distribution services to motion picture studios and television networks, advertising agencies, independent production companies and multinational companies. The Company provides electronic and physical distribution using fiber optics, satellite, Internet and air and ground transportation. It delivers commercials, movie trailers, electronic press kits, infomercials and syndicated programming, by physical and electronic means to broadcast outlets worldwide. Point.360's value-added post-production services are Film-To-Tape Transfer, Video Editing, Standards Conversion, Broadcast Encoding, Audio Post-Production, Audio Layback, Foreign Language Mastering, Syndication and Archival Services. It also services national television networks, local television stations, corporate/instructional video providers, infomercial advertisers and educational institutions.

RECOMMENDATION

Accumulate PTSX shares below $2.75.