With the end of the first quarter approaching, it is time to adjust the names in our Watch Lists. We will price all the new lists as of the close on Friday, March 30. Today we present our planned updates to the Mid Cap Watch List (Track at Marketocracy).

As with the Small Cap Watch List (Track at Marketocracy), we were surprised at the amount of turnover in our screens. Only 7 of the original 29 names made the cut for the new list (which comes in at only 24 names.) Part of the reason for the turnover was to reduce the overlap between the Small Cap and Mid Cap Watch List (Track at Marketocracy)s. Now there is only one-third overlapping names rather than two thirds. Furthermore, given the level of outperformance we saw in the first quarter (actually just two months) and the fact that much of those gains were achieved early, perhaps the turnover is warranted.

So without further ado, the names on the chopping block from the previous list are:

Silgan Holdings (SLGN - Annual Report); Middleby (MIDD); Olin (OLN); Vector Group (VGR); Sanderson Farms (SAFM); Tesoro (TSO); Downey Financial (DSL); Waddell & Reed (WDR); Gamco (GBL); Apria Healthcare (AHG); Quest Diagnostics (DGX); ITT Educational Services (ESI); Equifax (EFX); Delhaize Group (DEG); Papa John’s (PZZA); Rent-a-Center (RCII); Cato Corp (CTR); Dassault Systemes (DASTY); Ingram Micro (IM); Energy East (EAS); South Jersey Industries (SJI - Annual Report); and American States Water (AWR).

The new list is:

With the end of the first quarter approaching, it is time to adjust the names in our Watch Lists. We will price all the new lists as of the close on Friday, March 30. Today we present our planned updates to the Small Cap Watch List (Track at Marketocracy).

Frankly, we were surprised at the amount of turnover in our screens. Only 9 of the original 29 names made the cut for the new list (which comes in at only 24 names.) Still, given the level of outperformance we saw in the first quarter (actually just two months) and the fact that much of those gains were achieved early, perhaps the turnover is warranted.

So without further ado, the names on the chopping block from the previous list are:

Silgan Holdings (SLGN - Annual Report); Steel Dynamics (STLD - Annual Report); NVR (NVR - Annual report); Middleby (MIDD); Vector Group (VCG); Sanderson Farms (SAFM); Downey Financial (DSL); Waddell & Reed (WDR); Wilshire Bancorp (WIBC); Harrington West (HWFG); Gamco Investors (GBL); Apria Healthcare (AHG); Papa John’s (PZZA); Cato Corporation (CTR); Meredith Corporation (MDP); CSG Systems (CSGS); Energy East (EAS); Dynamics Research (DRCO); Ingram Micro (IM); and Dade Behring (DADE).

The new watch list will be:

Small Cap Watch List (Track at Marketocracy) and Mid Cap Watch List (Track at Marketocracy) member Energy East (EAS) plans to issue more shares:

Energy East Corporation [NYSE: EAS] today announced it will seek to issue up to 10 million common shares generating gross proceeds of approximately $240 million. These common shares are to be offered by a group of underwriters led by Morgan Stanley under Energy East’s effective shelf registration statement filed with the Securities and Exchange Commission.Proceeds from the offering will be used for the redemption of debt and for general corporate purposes, including regulated construction expenditures. The company plans to invest over $3 billion through 2011. Major planned investments include:

* $500 million for advanced metering infrastructure in New York and Maine. This investment will provide customers with pricing information throughout the day, promote conservation and improve operational efficiencies
* $500 million in transmission investments, predominately in Maine, which will improve electric grid reliability and promote renewable generation
* $500 million for the repowering the Russell Station power plant using clean coal technologies.

The company estimates that these efficiency investments could result in CO2 reductions of close to 1 million tons annually, the equivalent of taking 175,000 cars off the road.

We’d prefer taking 175,000 shares off the public market, but let’s leave that aside for a moment. The company is talking about spending $3 billion “through 2011,” which gives them a five year window to do it. That translates into approximately $600 million per year in capital expenditures, compared with $305 million, $334 million and $412 million over the last three years. It is also clear that those three years suffered from under-investment, as annual depreciation was higher than capital expenditures by a cumulative $130 million. The under-investment, furthermore, may have affected sales, which grew more than 10% in 2005 but actually declined in 2006. So adding all this together, we concur that the company needs to invest more in its business.

The problem is, it can’t afford to make such large investments. Cash flow generated from operating activities was greater than $500 million in only one of the last three years, and then only barely. On top of that the company is paying out $150 million or more each year to fund its dividend payments, which are looking increasingly fragile. The only way the company can pay for the incremental $100-$200 million it will need in each of the next five years to fund its spending plans is to eliminate the dividend or raise capital by either issuing new debt or issuing shares.

Over the last three years the company chose the former, adding a total of $450 million to the company’s total debt load. Now it appears it will be balancing that with new shares. The problem is, without a reduction or elimination of the dividend, this will mean tying up even more capital in the dividend payments.

Energy East looks to us like a company that needs to tighten its belt to the last possible notch and cut its dividend while funding the capital expansion that is underway. Until they can consistently generate more cash flow than is needed to operate the business and pay for capital improvements, the dividend looks like a luxury.

It just goes to show - given a mild enough winter even stable utilities can fall short. Case in point: Small Cap Watch List (Track at Marketocracy) member Energy East (EAS):

Earnings per share basic for the 12 months ended December 31, 2006, were $1.77 while earnings per share for the quarter ended December 31, 2006, were 53 cents.Earnings per share basic for the 12 months ended December 31, 2006, increased 2 cents as compared to earnings per share for the 12 months ended December 31, 2005 of $1.75. The increase in earnings per share was primarily due to higher margins on electric sales of 18 cents and 7 cents from a lower effective income tax rate and differences in the 2005 filed tax return compared to the 2005 book tax expense. Earnings per share also increased by 5 cents due to a write-off in the fourth quarter of 2005 related to the termination of operations of the South Glens Falls generating facility. These increases were partially offset by higher storm related repair costs of 11 cents, higher bad debt expense of 7 cents and 5 cents for the write-off of unamortized issuance costs resulting from the redemption of our trust preferred securities in July.

Consensus estimates called for $1.46 billion in revenue and $0.56 in EPS for the quarter. If global warming is for real they may actually be in trouble. However, with a median analyst rating of “Underperform” and a 4.7% dividend yield, it will probably be easier for the company to exceed expectations than to truly disappoint.

We asked, but no one answered. So we are taking our own counsel and breaking our Watch List into three portfolios: Small Cap, Mid Cap and Large Cap. Each will be tracked against the relevant S&P index going forward from their collective inception date of January 31 (priced at the close of market trading that day.)

For your viewing pleasure, the Mid Cap Watch List (Track at Marketocracy) (to be measured against the S&P 400) follows.

Astute observers will notice a significant overlap between the names in the Small Cap Watch List and this one. In fact, of the 29 names on the Small Cap Watch List (Track at Marketocracy), 19 are included among the 29 names in the Mid Cap Watch List (Track at Marketocracy). The main reason is that we ran our screens against the criteria in the relevant indices rather than the names in the indices. Since the largest market cap in the S&P Small Cap is $3.5 billion and the smallest market cap in the S&P Mid Cap is $600 million, there is room for a good deal of overlap if one is willing to accept it.

In addition, we will provide a “quick and dirty” analysis of each name, with a goal of one such analysis per day. As the name implies, the quick and dirty analysis will be incomplete. We are hoping you will join in the debate and fill the gaps in our analysis.

We asked, but no one answered. So we are taking our own counsel and breaking our Watch List into three portfolios: Small Cap, Mid Cap and Large Cap. Each will be tracked against the relevant S&P index going forward from their collective inception date of January 31 (priced at the close of market trading that day.)

For your viewing pleasure, the Small Cap Watch List (Track at Marketocracy) (to be measured against the S&P 600) follows.

In addition, we will provide a “quick and dirty” analysis of each name, with a goal of one such analysis per day. As the name implies, the quick and dirty analysis will be incomplete. We are hoping you will join in the debate and fill the gaps in our analysis.