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FCStone Poised to Break Out?


Evaluating the commodity player.


I was asked recently by Minyan Scott whether or not FCStone (FCSX) could be breaking out. It's very difficult to guess where FCSX may trade if things go well.

Right now everything looks to be lining up roses for it: Volatility in the commodity and energy markets is out of control (FCSX's lifeblood) and the credit markets are coming back to life - hence reducing the leverage risk inherent to its business. How much the company can earn quarter to quarter is a total guess, in my opinion. The key here is what multiple investors are willing to pay given the company's risk profile. In August, at the beginning of the credit crisis, FCSX sported a trailing P/E of 30. On March 21 it had plunged to 12. Right now it's trading at 20x Aug '08 FY estimates. If risk appetites return, it's perfectly possible to see the P/E climb back in the 30's; but, I repeat, I suspect it'll be more a function of the overall market tone than the company's performance.

Along the same lines, I'm circling back to fellow competitor GFI Group (GFIG). GFIG got slammed not only because of the credit turmoil, but because another competitor raided its credit-trading department and got away with a whole chunk of its brokers. These kinds of "attacks" are a big deal, and a big problem for companies in this business: when they happen, the target not only loses revenue generating employees, but compensation costs for the rest of the brokers are forced up so that the remaining brokers won't jump ship. Also, compensation costs are the largest expense item, hence any changes will pressure margins big time.

My thinking about GFIG is this: if the credit environment improves, its forward P/E of 12 is way too cheap even GFIG has trouble rebuilding its credit-trading business. If they're able to replenish their desks, then estimates for FY '09 are way too low. Lastly, given the competition and scarcity of quality brokers, one has to think that the company as a whole could make a very nice and accretive acquisition for a competitor sporting a more expensive equity-currency. In other words, I'm talking myself into thinking that while the reward in GFIG's stock is uncertain, the risk at this point seems rather low, as long as the credit markets continue to behave.

I have no position in GFIG yet, but it's certainly on the radar.

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Position in FCSX.
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