Sunday, 9 July 2017

AAOI Ran On Friday As Expected; DPW Should Run Next

On Wednesday July 5th we suggested that readers pick up shares or call options on Applied Optoelectronics (AAOI) with our article "Unlocking The Secret To Trading AAOI: Buy Before The Friday Short Covering":

"Here's our recommendation for Thursday, July 6th based on AAOI's close of $60.62 on Wednesday. Buy anything under $59 on Thursday, and if it never goes that low, buy it near the end of the day. If you're looking for just a quick couple of dollars profit, sell on the rip on Friday." 

We have noticed a pattern that AAOI performs very well after a Thursday morning dip as shorts cover on Thursday afternoon and Friday. AAOI hit a low of $59.15 on Thursday, just missing our bids in the morning, but we bought up call options on Thursday afternoon. Let's just say that worked out very well as the stock raced over $68 and ended the day up nearly 10% on Friday. If you like our picks make sure to follow our blog by clicking the follow button on the top of the left hand panel. We are up to 251 followers for a reason.

AAOI is still a long term hold with a core position but we took those massive short term profits and we loaded up more on Digital Power Corporation (DPW). We introduced readers to DPW last week with our article "DPW: An Undervalued NYSE-Listed Microcap Poised For A Run Based On Fundamentals". DPW had dropped down to as low as the mid $0.50's last week after flirting with the $1.00 a couple of times. We took that opportunity to load up even more and by the close on Friday, DPW was up 7% to $0.62.

DPW has been swinging around wildly like many other microcap and low float stocks, including Marathon Patent Group, Inc. (MARA), Delcath Systems, Inc. (DCTH), Spherix Incorporated (SPEX), Cerulean Pharma Inc. (CERU), ImmunoCellular Therapeutics, Ltd. (IMUC), Cerecor Inc. (CERC), Monster Digital, Inc. (MSDI), Moleculin Biotech, Inc. (MBRX), Opexa Therapeutics, Inc. (OPXA), MYOS RENS Technology Inc. (MYOS), Threshold Pharmaceuticals, Inc. (THLD), Avinger, Inc. (AVGR), CHF Solutions, Inc. (CHFS), CytRx Corporation (CYTR), Dextera Surgical Inc. (DXTR) and DryShips Inc. (DRYS). A lot of those stocks have moved on news that is hard to quantify and others have moved on no news at all. That's why they are moving so violently up and down, because nobody really knows a true fair value. DPW on the other hand has recently released a business update that makes the stock unambiguously fundamentally undervalued at $0.62. It may have gotten caught up with the other high-volume big-swingers over the last few weeks but we strongly believe it is the best of the bunch.

DPW closed up 50% to $0.72 on over 10 million volume on Friday, June 30th after releasing the following quarter-end investor update:

FREMONT, Calif., June 30, 2017 (GLOBE NEWSWIRE) -- Digital Power Corporation (NYSE MKT:DPW) ("Digital Power" or the "Company"), a growth company seeking to increase revenues through acquisitions and organic growth, today announced that is customer order backlog has increased to over $65M, an increase of $8M from the prior update issued by the Company on May 17, 2017. The increase was attributed to organic growth from new and current customers of DPW and the consolidation of financial reporting which now includes Microphase Corporation.

Amos Kohn, the Company’s President and Chief Executive Officer, stated, “We continue to see strength in our custom power supply business as our order book grows. With the purchase of Microphase Corporation, we will also see strong cost savings which will increase our gross and net margins. We are very excited about our continuing prospects to reduce costs while expanding production across the enterprise.”

The Company reported that it has received from its customer, MTIX, Ltd., order instructions with production schedules and specifications which have launched the formal production process for the machines that utilize MTIX’s proprietary technology. On March 15, 2017, the Company announced it had been awarded a 3-year, $50 million purchase order by MTIX Ltd., headquartered in Huddersfield, West Yorkshire, U.K., to manufacture, install and service textile treatment systems that utilize MTIX’s proprietary Multiplexed Laser Surface Enhancement (MLSE™) system. The Company confirmed that though production planning and scheduling had been underway, these tasks are now being driven to completion. The Company is fully engaged to incorporate the customer’s final specifications and schedules into the production cycle and implement, execute and manage all aspects of this new revenue stream. The Company disclosed that invoicing for the initial deposits necessary to launch production total $1.5MM and anticipate additional invoicing to support the escalation of production over the coming weeks. The Company stated that revenue from the production of the MLSE machines will be recognized in fiscal 2017 and should measurably impact both the gross and net profitability for the Company.

Regarding the progress made in production with MTIX, Ltd., Mr. Kohn said, “The execution of the general contract with MTIX, Ltd. has resulted in a positive material change to the future prospects of the Company. The added value to shareholders is yet to be understood. Over the coming years, this contract and relationship we believe will provide massive value to our shareholders.”

DPW has 11,789,546 shares outstanding after a small offering of 289,092 shares were made to certain creditors for the cancellation of $159,000 worth of debt earlier in the week. This could explain why the stock has pulled back from over $1.00 on the day of this great news as creditors would take their easy profits with no regard to the company's bright future. Last week was a holiday-shortened week and there are some preferred shares with a conversion price of $0.60 on the books (negotiated at a time when the stock price was lower so this is NOT toxic convertibles) which may have also played a role in the pullback

Those who were able to see past this minimal dilution have been able to take advantage of a very undervalued company. Even with the recent offering, DPW has only a $7.3 million market cap based on Friday's close of $0.62. This is extremely low for a company with over $65 million in backlog. Backlog is also growing quite quickly - an increase of 14% in the six weeks between mid-May and the end of Q2.

Look at DPW's Q1 income statement:

Revenue was $1,628,000 for Q1 and gross margin was $708,000 or 43.5% and a net loss of $1 million. We know that the three year $50 million contract is being deployed right now and will materially impact numbers in 2017.

Let's say the split over the next three years is $10 million in revenue for 2017 and $20 million each in 2018 and 2019. If gross margin is 40%, that means $4 million will be added to the bottom line, taking the company from a million dollar a quarter burn rate to $300,000-$400,000 in net income for the remaining three quarters assuming costs remain static. 2017 would end approximately breakeven under this scenario. This does not take into consideration the remaining $15 million in backlog which could also have a material impact in 2017 though some of that may be baked into the existing $1.6 million per quarter revenue run rate.

2018 would be a very lucrative year. If $20 million in revenue leads to $8 million in gross profits, a $1 million burn rate per quarter would turn into $1 million in net income per quarter. That is an 8.5 cent EPS per quarter or $0.34 EPS for 2018. A P/E ratio of just 10 would imply a $3.40 stock price. We think a target of $2.00 fairly accounts for any risk this deal may have until it materializes. Now that DPW has garnered the attention of many traders, expect it to start trading at a much more fair price to reflect the value of its backlog.

Disclosure: We are long DPW

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