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Air T Incorporated – An Out-of-Favor Microcap in the Transportation Sector

(Guest Commentary by Bill Rempel – March 8, 2007)

Dear Subscribers and Readers,

As JP Morgan once said “The stock market will fluctuate.”  After over six months of general declining and low volatility, the stock market environment took a turn for the worst last week – as selling across the US, Europe, and Asia witnessed an intensity not seen since the 1997 Asia Crisis or the 1998 Russian, Brazilian, the LTCM crises.  On the NYSE, the ARMS index hit a reading of 15.77 – a reading not seen since October 19, 1987.  Downside volume as a percentage of the sum of advancing and downside volume hit a level of 99% - a level that has only been witnessed 21 times since January 1940 (with 13 of those occurring before 1950).

As I have mentioned in our commentaries and our discussion forum recently – over the last six months – a significant portion of hedge funds has been having a very tough time achieving excess returns (or “alpha”) over the last 12 months or so, as both corporate bond and emerging market yield spreads were at all-time lows and as the Yen and Swiss Franc carry trades were stretched close to a breaking point.  As a result, many hedge funds then decided to “throw in the towel” (especially in light of the May to July 2006 decline in the stock market) and indexed themselves to the S&P 500 instead.  From July to December 2006, the correlation of the entire hedge fund industry to the S&P 500 and the MSCI World Index jumped significantly.  In light of this, it was not too surprising that a decline such as last Tuesday's would eventually come to fruition.  The most important question to ask, for now, is: Has the environment changed?

Depending on how the action goes over the next couple of days and into early next week, this author may or may not trim back on our 100% long position in our DJIA Timing System.  At this point – even should we do trim back – it will most probably be only a scale-back to a 50% long position.  As I am still bullish on the U.S. stock market for the rest of 2007, I will also look to go fully long again given the opportunity, should we cut back.  Moreover, I have posted a tentative “road map” for the financial markets over the next 12 to 24 months in our discussion forum and I would like to invite feedback from our readers.  The gist of the message is this: Given that the amount of assets held by global hedge funds has now topped US$1.8 trillion, the “correct strategy” for investing or trading going forward will be to anticipate what the hedge fund industry is going to invest in going forward.  Just like the late 1990s (when the folks who did very well were the ones who tried to anticipate what retail investors will do next), traditional valuation metrics will take a back seat (even though it is still an “important back seat”).  Again, please read the full piece on our discussion forum and let us know what you think.

For those who had wanted to learn more about individual stocks and the art of stock selection, we have invited back our regular guest commentator, Bill Rempel, to write a mid-week commentary for us.  Bill is current out-of-town on business but was still able to fit this in his hectic schedule.  Thanks for your help, Bill!  Bill is a prolific writing on the stock market and individual stocks and is the author of a very active market blog at: http://www.billakanodoodahs.com/

In this commentary, Bill is going to discuss a microcap in the transportation sector – Air T Inc – that has showed up recently on his value screens and whose value analysts and investors alike may be overlooking.  While investing in a low-float and low turnover microcap may not be for everyone, Bill lays out a compelling case for considering the stock, especially if one is a crude oil bear.

Without further ado, following is biography of Bill:

Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website.  Bill graduated from Caddo Magnet High School (a high school for nerds) back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store.

Post-college, Bill has been in the P&C insurance industry as an actuary, product manager, and pricing manager. Bill and his wife Millie are amateur investors with a variety of holdings, but they prefer to buy and hold value investments. In typical "value" style, they live cheap, driving old cars and preferring to save or invest instead of buying fancy "stuff."

Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice.  Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.

I find myself in an odd situation, as I am writing about a potential long value stock while I (1) don't have a position in it and (2) don't have a single long position on the books!  Oh, bother.

The current market situation has been well-covered by Henry in his previous commentaries.  I think that, in general, we're on the same boat, in that both of us are believers in the bull market for U.S. equities in a larger sense and longer time-frame.  There may be specific differences in the shorter-term analysis, however.  Suffice it to say that I am positioned for further downside at the moment, and not really focusing too much on adding long exposure.  That could change as early as next week, or possibly as late as next month, depending on my interpretation of our current correction the stock market.

That being said, one of the stocks that is on my watchlist from a value perspective is an out-of-favor microcap in the transports sector, Air T Incorporated. This is a 27-year-old company based in North Carolina, and their business model includes transportation of cargo, primarily through leased airplanes but also through some company-owned aircraft; and aircraft ground support and maintenance services, through a subsidiary based in Kansas.

This stock certainly isn't for everyone, and while it's on my watchlist, it may not be for me – I am examining the possibility and sharing it with you, but I have not current position in the stock.  It is a microcap and very thinly traded.  Additionally, there are economic risks posed by the sector the company is in.  One either needs to believe in the value paradigm of "darn the macro, full speed ahead" or one needs to believe the consensus on the sector is incorrect.  I lean towards both, but your mileage may vary. 

AIRT came to my attention through the value screener, and has the following items on its value "brag sheet," per Yahoo!'s business summary:

Enterprise Value less than $22 million

TTM P/E of 9.13

No FW P/E – There are NO analyst's estimates for this stock.

No PEG ratio – see above.

Price/Sales of 0.30

Price/Book of 1.34

Return on Assets of 7.38%

Return on Equity of 15.44%

Debt/Equity of 0.26

Cash on Books is $1.171 per share and the stock trades at $7.65.

Right away it's easy to see why I'm interested.  Any viable business concern that trades close to book and below revenues has value potential; the cash on hand, lack of debt, and low expectations reflected by a P/E under 10 are intriguing to me, as well.

There are technical matters to contend with, as well.  The stock price is seriously beaten down, with a –32% YOY change, and a recent earnings "disappointment" contributing to that, with a price fall from the high eights/low nines into the high sevens/low eights in early February, which incidentally was when the stock hit my value radar.  With a float of only 2.5 million shares, there is tremendous "leverage" if/when any institutional buyer takes notice.  The stock is owned by insiders to a reasonable degree, about 8%, and under-owned by institutions at about 10%, with no appreciable short volume.  Turnover is running at about six months for the float, which is pretty fast for a stock this size.  The last two earnings announcements have contributed to that volume.  Three insiders have purchased decent blocks of the shares at prices above current, in the last months of 2006.

The company is certainly valid as a going concern.  They have a ten-year history of earnings without a losing year, and while the earnings growth is not as consistent as I would like, the general trend has been up, and the dividend has been growing.  Interestingly, they set their dividend rationally, bringing it down or up based on profit levels.  This is not something the Street loves, but if one likes to buy companies this might be of interest.  The dividend is paid annually and is now about 3.2% in yield, with a 2.8% 5-year average yield.  The payout ratio is low at 30%, and the next ex-div date will likely be in June.

Generally speaking, the earnings have been of high quality, with operating cash flow exceeding net income and with negative cash flows from financing.  The kicker has been the last calendar year, specifically the third quarters of fiscal 2006 and 2007, in which the company took changes in working capital that caused net income to exceed cash from operations.  Typically these accruals are signs of potential earnings shortfalls – guess what, the company already had those!  That is the reason for the company's current bargain price.  Is it a coincidence that the company selected a new CFO in October of 2006, not long before the first shoe dropped in November, and half a year before the other shoe dropped in February?  How many shoes could the company have?

The main concerns I have with the company at the moment hinge on customer risk, to a lesser extent, macro risk, and whether all the bad news is out. 

The long-term chart shows what happened to this stock the last time an earnings shortfall was followed by an earnings recover.  EPS fell to $0.13 in fiscal 2003, and recovered to over $2 in fiscal 2004. The leveraging impact of a small float size is readily apparent. 

AIRT (Air T, Inc.)

The most recent troubles include two sets of earnings disappointments following some poor earnings quality and the hiring of a new CFO.  It doesn't take a genius to figure out what macro concerns could have contributed to the earnings problems of a transport company in 2005 and 2006.

AIRT - Earnings miss. Microcap, microfloat, low institutional ownership, contractor for transports.

The stock may be putting in a bottom here in the high sevens.  Given the amount of cash on the books, low debt, and low valuations, this stock could be seen as a value to either a small/micro cap fund, private equity, or a larger competitor.  It is certainly one I will be giving a hard look-over once I become interested in long plays again.

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