News Analysis date published New: 
Thursday, September 6, 2012 - 09:45
New Date created: 
Thursday, September 6, 2012 - 09:51
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Thursday, September 6, 2012 - 09:45

Buy or Sell? Thursday's Losers: PAY, OCZ

Thursday, September 6, 2012 - 9:45am

Among the biggest losers in Friday's early trading are VeriFone Systems (NYSE: PAY) and OCZ Technologies (NYSE: OCZ).

"Please swipe here" is a phrase you've heard at countless checkout counters, and when you look down, you've often seen the name VeriFone. The company's card-swiping machines are so ubiquitous in the United States that management has been venturing abroad in recent years in search of growth. That strategy surely paid off, and sales shot up 30% in fiscal (October) 2011 to around $1.3 billion. Growth in fiscal 2012 has also been impressive: based on third-quarter results that were released Wednesday evening, Sept. 5, sales are on track to exceed $1.8 billion.

Yet a combination of factors has conspired to derail that growth path in the fiscal year that begins in November. Rising competition and a still-weak global economy have led management to expect a slow-down in sales growth in fiscal 2013, perhaps to around 10%. That outlook led to a double-digit drop in the stock this morning, to near its 52-week low of $30.10. This was a $55 stock as recently as late April.

Yet you need to take the longer view here. VeriFone still dominates the niche, and should benefit from the ongoing migration to a cashless world. Visa (NYSE: V) and Mastercard (NYSE: MA) are pushing into new markets, so you can expect a resumption of 15% to 20% growth when the global economy mends. Meanwhile, shares now trade for less than 10 times management's projected 2013 profit forecasts.

OCZ's weak hand
The solid state drive (SSD) market is scorching hot. It's so hot that a wide range of players now aim to capture meaningful market share. These drives offer better performance -- and a higher price-tag -- than traditional hard disk drives. They all rely on flash memory, or NAND, and the industry's leading players either make their own flash memory in house (such as Samsung), or need to get in line with others to secure their share of the NAND chips and modules that will go into their own products.

For OCZ Technologies, relying on external suppliers for its NAND memory has been a longstanding problem. Whenever NAND is in short supply, bigger SSD players are typically better equipped to secure a steady supply of these modules, leaving OCZ to hope there will be enough left over to meet the company's needs.

In the company's fiscal second quarter (ended August), a shortage of NAND led to a big shortfall in sales: Revenue will likely be around $20 million less that the previously guided range of $130 to $140 million. And on a call with investors on Wednesday evening, management conceded that the NAND woes will continue.

Even if the NAND shortage wasn't an issue, the company's margin structure is. OCZ's status as a second-tier SSD player means that it has no pricing power, which helps explain why this company has generated negative operating margins in each of the past four years.

It's hard to see any upside left for this stock, even after Wednesday's 25% drop. And if anything, more downside may lay ahead. That's because OCZ continues to generate negative free cash flow (a cumulative $125 million over the prior two fiscal years). And with further free cash flow losses in the current fiscal year, the company's balance sheet could soon start to feel the strain. So short sellers are likely to start focusing intensely on this stock to see if OCZ is headed for financial distress.

Action to Take --> Verifone is a classic test of investor psychology: The company's stock looked like a smart investment when it was surging past $50 this past spring, but now that it has tumbled into the low $30s it seems like a poor investment choice. Yet a chance to buy this stock -- after it has fallen 40% in five months -- is really the more appealing entry point, especially considering the company's industry positioning and low forward multiple.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of MA, V in one or more of its “real money” portfolios.