Update Polypore International (PPO) after the plunge

02/01/2012 9:33 am EST


Jim Jubak

Founder and Editor, JubakPicks.com

I hate it when this happens. A high-profile short names a stock as his/her pick for the next big short. And then we get just enough bad news to leverage that pick into panic selling.

That’s pretty much what happened yesterday, January 31, to shares of Polypore International (PPO), a member of my Jubak’s Picks portfolio http://jubakpicks.com/ The shares finished down almost 30% today (a drop of $16.26 a share) on volume of more than 26 million shares. Average daily volume for Polypore is about 960,000 shares.

The story of this rout begins on Monday, January 30 with a call by Gordon Johnson, an analyst at Axiom Capital. to short Polypore. The target price for the stock, then trading at $54.34, was an eye-popping $26 a share. Johnson and Axiom had previously been very vocal on shorting thin-film solar panel producer First Solar (FSLR). That call has been very profitable in the global collapse of solar stocks. Online news sources such as TheStreet.com picked up Axiom’s call. The Street’s story was headlined “The next great alternative energy short is…”

I understand the basis of Axiom’s call—although I disagree profoundly. Axiom’s analysis argues that Polypore’s price-to-earnings multiple is based on an exaggerated view of the opportunity in batteries for electric cars—and ignores signs of potential new supply. It also points to very substantial insider selling by Polypore executives. For example, CEO Robert Toth has sold about 89% of his 450,000 shares since January 2011.

I’d differ with that analysis at a couple of points.

First, while investors may be most excited about the electric car and its batteries as a future opportunity for Polypore, the company can’t really be characterized as an alternative energy company. Only about 25% of Polypore’s third quarter sales of $742 million represent membranes for lithium batteries. Membranes for standard lead batteries account for about 59% of sales.

The company has announced $334 million in capital spending to expand its capacity to produce membranes for lithium batteries. I’d point out that relatively few lithium batteries go into electric cars, but the expansion certainly increases Polypore's exposure to the lithium end of its business.

But the company is building new plants in the United States and Asia to serve both the lithium and lead battery membrane markets. Batteries for electric cars are certainly sexier than conventional lead batteries but I’d make a case that Polypore’s traditional lead battery business has its own huge growth potential with the increase in car ownership in Asia as incomes rise. The company’s investment decisions suggest that Polypore isn’t neglecting the growth opportunity in its traditional battery market.

Second, while it’s certainly true that the company has touted the electric car and its batteries as the big growth opportunity of the future (and perhaps over-touted—see the company’s November 2011 presentation at the Robert W. Baird conference http://files.shareholder.com/downloads/PPO/1668903849x0x516152/43639c76-4a66-4101-a0d3-422e9a518fde/PPO_Baird_11.8.11.pdf ) the stock’s multiple is actually relatively  modest at 24 times projected 2011 earnings per share (before the January 31 plunge.) That doesn’t seem excessive compared to the Wall Street estimate for 20% earnings growth in 2012.

When I added the shares of Jubak’s Picks on January 13, I actually argued that the over-identification of the company with the electric car market had hurt the stock in the aftermath of the Chevy Volt fire and investigation. (See my post http://jubakpicks.com/2012/01/13/buy-polypore-international-ppo/ ) The stock at $51.10 on January 12 represented cheap growth, I wrote.

Third, while I never like to see insider selling in a stock I own or am thinking of buying, I’d note in this case that much of the insider selling isn’t especially recent. CEO Toth has indeed sold a lot of shares but the bulk of his selling (400,000 shares) took place in March, May, June and July of 2011, according to MSN Money and Morningstar. So yes, Toth has sold a lot of shares in 2011 but it’s not like the selling has been recent.

None of this would have mattered much, or at least not yesterday anyway, if it weren’t for the juxtaposition of the Axiom short-call and yesterday’s news that Korea’s LG Chem, a big Polypore customer and a big maker of lithium batteries, would start making its own battery separator membranes, perhaps as early as the second half of 2012 although other researchers are saying 2013.

Of course, it’s never good news when a company goes from being a customer to a competitor but as an analyst note from D.A. Davidson said yesterday, making battery membranes isn’t easy and other companies that have tried to enter the business have failed. (As full disclosure Davidson still cut its target price for Polypore on the news to $45 from $73. With the stock at $38, would Davidson now call it a buy?)

And as of today, at least, it’s hard to tell exactly what LG Chem is doing. The company has announced that it is spending $480 million to expand capacity. Some of that will go to building capacity in lithium battery separator membranes, but I’m having trouble finding any breakdown on how much of that spending will go to this effort and how much capacity LG Chem is adding in lithium battery separators. I’m having just as much difficulty in finding a breakdown that tells me what percentage of which of Polypore’s businesses LG Chem represents.

I think this lack of information and the distance between Axiom’s $26 target and the current $38 dollar share price is reason for a cautious approach over the next few days. The huge drop seems over-done but I’m missing a couple of crucial pieces that I need to make a convincing argument that way for buying more. (Or for selling on some schedule.) I’d assume that most other investors who are long Polypore are scrambling for facts too.

I’d think the shorts are happy with their one-day gains and many of them are likely to head elsewhere for bigger gains. I’d watch for that as well. Let’s see what volume is today and tomorrow, for example.

I expect that I’ll post on this again soon.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund owned shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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