Advanced Environmental Recycling Technologies

[tucker]

Advanced Environmental Recycling Technologies Inc. (AERTA)
Recent Price: $2.40
Revenue: $87.3mil
Market Cap: $95mil
EPS: $0.19
Shares Outstanding: 39.6mil
P/E: 12.44
Avg. Volume: 130,043
Dividend: --
Book Value: $0.54
Yield: --

Advanced Environmental Recycling Technologies (Company AERT, stock AERTA) is a manufacturer of composite building materials. The company’s main product line is the composite decking material ChoiceDek, but AERT also does a small business in window and door components and exterior trim under the brand name MoistureShield. Composite products outperform pressure treated wood in longevity and durability. Longer product lifespan results in less maintenance and lower replacement input of money and resources. Moreover, composites reduce demand for wood lumber, and production of composites releases fewer toxic chemicals than treatment of wood for exterior use.

The composite lumber industry is highly competitive, with close to 50 small companies involved in the market. However, AERT stands out as one of the few companies working exclusively with recycled materials. In fact, AERT has a direct purchase program for recyclables, allowing cities, towns, and even businesses to sell their recyclable plastics at a small profit. In this way AERT reduces external waste streams while creating a product with a more favorable environmental life cycle. From an economic standpoint, the use of recycled materials reduces AERT’s sensitivity to the price of oil. This may have helped to protect earnings over the past years, but conversely could erode the company’s competitive advantage if the oil becomes cheap.

In the past there have been issues with weathering and staining of composite materials, and there remains a public perception that “plastic deckingâ€

[craig]

Hi Tucker,

Just a couple of quick terminology questions:

1. What does RSI mean? ("Current RSI is over 50")
2. What does ttm mean? ("Trex has ttm earnings of $-0.11")

Thanks,

Craig

[tucker]

"ttm" is just "trailing twelve-month." So, ttm earnings is the total from the last four earnings announcements. Sometimes analysts or companies report earnigs for the most recent fiscal year, which could be nearly a year old if, for example, it is May and the comapny's fiscal year ends in June. At other times, companies or analysts use projected earnings, which may be more relavent than ttm earnings, but are in fact just projections. I used included ttm to be clear as to exactly what I meant when I said earnings.

RSI is an abbreviation for "relative strength index." It is usually not written out becasue there are many ways to measure "relative strength" but only one calculation for RSI, so "RSI" is less misleading. Basically, RSI is a measure of how fast a stock is going up or down.

RSI is calculated over some period, usually a number of days I will call "n." Most analysts use an n of 14 to calculate RSI. The formulae is:

RSI = 100 - 100/(1+RS)

were RS is

_(total price change on all up days in n)_
(total price change on all down days in n)

If the RSI is close to 0, the stock has been going down almost every day in n, while if the RSI is close to 100 it has been going up almost every day.

RSI is usually used as a technical indicator. If the real value of a stock (estimated from fundamentals like earnings, growth, and dividend) hasn't changed, an unusually high RSI can suggest that a stock has become "overbought." This means random movement or unjustified buyer exuberance may have pushed the price too high. Conversely, if RSI is unusually low, the stock may be "oversold."

Traders that move on technicals often take an RSI of less than 20 to be a buy signal, and an RSI of more than 80 to be a sell signal. Myself, I prefer a longer-term strategy based on fair value calculated from fundametals. However, if we have already decided we like a stock's fundamentals, RSI might suggest whether the time is ripe for buying.

You can get RSI in the technical analysis part of Yahoo! Finance. You can link to an RSI of Reuters for a quick example: http://finance.yahoo.com/q/ta?s=RTRSY&t ... &a=r14&c=/. Notice that when RSI touches 80 it has often signalled at least a temporary pull-back, while when RSI has touched 20 it has often signalled a turn-around coming. The currently high RSI may mean the stock remains relatively overpriced now.

[craig]

Thanks Tucker. That makes a lot of sense.

[tucker]

Advanced Environmental Recycling Technologies (AERT)
Recent Price: $2.85
Revenue: $102mil
Market Cap: $125mil
EPS: $0.21
Shares Outstanding: 44mil
P/E: 13.44
Avg. Volume: 298,833
Dividend: --
Book Value: $0.632
Yield: --

The most important update to RainFrog’s earlier research on AERT is the company’s second quarter results announcement, which bordered on stellar. Revenues were $0.64 per share, an increase 34% year-over-year, while earnings were up 88% year over year to $0.04 per share. This is despite the fact that AERT began paying taxes for the first time in 2006. Even more impressive, pre-tax profit margin for the quarter was 10.27%, compared to the 4.2% the company posted in the same quarter of 2005. Results seem to indicate that the company is executing on its business plan, and may warrant a revision of our authorization price.

AERT’s 2nd quarter performance would likely have driven the stock price beyond what RainFrog would be willing to pay had it not been for the company’s 2nd quarter conference call. AERT Chief Executive Joe Brooks is well-known for straight-talking, and the market doesn’t always appreciate straight talk. Currently demand through Weyerhauser and Lowes for AERT’s recycled composite building materials is greater than the company can supply and this allows AERT to keep prices and margins high. In the conference call, Mr. Brooks openly acknowledged that the company will not be able to match last quarter’s margin as production and pricing competition intensifies. He also warned shareholders that the company will be conducting planned maintenance on some of its production lines during this coming quarter, and both revenues and earnings will suffer as a result. However, the company expects to bring two new production lines online in the 4th quarter, and this should result in strong revenue growth during fiscal 2007.

The current maintenance shut-down seems to be holding AERT’s share price in check at the moment, and may lead to some volatility over the short-term. Investors holding the stock when 3rd quarter results are announced in November are likely to see a substantial change in share price, and it is difficult to predict whether that change will be up or down. However, the effect of this quarter’s results on the company’s long-term performance is likely to be relatively minor. Thus, investors willing to tolerate a short-term loss might find AERT’s current price to be a good buying opportunity.

Because AERT is still small and growing rapidly, we might base a fair value estimate on revenue rather than earnings. Trailing 12-month revenue for the company is $97 million, and the trailing 12-month margin before taxes but after special items is 6.0%. (I have included special items in margin to make the estimate more conservative.) I assume 1) a 40% tax rate on all future earnings, 2) zero revenue growth during the current quarter, 3) a long-term P/E of 17.5, 4) a loss of $0.05 per share in potential earnings for the current quarter, and 5) a loss of $0.06 per share on pending litigation surrounding the company’s insurance claim on a March 2003 fire at its Junction, Texas facility. Many of these assumptions may be conservative, but it is possible that some or all will not be met. I also assume that the company can meet its goal of 30% annual earnings growth over the next five years. This certainly won’t happen every quarter, but may be possible on average as new facilities come on line. If these assumptions are accurate, or even accurate on average, a fair current price for the stock might be in the neighborhood of $3.20 per share.