Deep Value Letter - Banner Ad / Email Capture

Tuesday, October 29, 2013

Betting Longshots and Turnarounds

I have frequently confessed a strong attraction for longshot stocks in the past. I like these stocks that are ridiculously out of favor and struggling to execute a turnaround. Most of my efforts are focused on safe and cheap stocks with the potential for high returns but I confess to having a few longshots around most of the time. I have advised my son and daughter that they should have an even higher percentage of these stocks in their portfolio than their old man does as the math is just too compelling.

Consider a portfolio of carefully selected long shots with the potential to triple in price over the next three to five years. If you are right about 40% of you selections and just average break even on the rest of the bundle you end up handily beating the markets historical returns. If it takes three years you end up averaging 21% and if stretched out to five you still have a compound annual return a little over 12%. A 30% win rate gives you a  return of between 8 and 14% depending on the time it takes to play out. With the application of a hardy dose of common sense and strong stomach for volatility the 40% win rate should not be difficult to achieve. It is the same mindset that makes private equity and distressed investing so successful.

If you look at the stock I identified as longshots in the second half of 2011 and all of 2012 there were 25 names on the list. 22 of the stock are higher although admittedly with a boost form a strong stock market. The biggest loser is my old nemesis Hampton Roads Bancorp (HMPR) with a nice loss of almost 80%. The biggest winner is Cemex (CX) with a tidy 200% return already. More importantly taken as a group the package of stock is up more than 80% over just an 18 month time frame. I have not graded out 2013s long shots yet but we have already seen some big winners in stocks like Cumulus Media (CMLS) and Cowen Group (COWN) that were long shot portfolio suggestions.

One way of searching for long shots is to set some of my traditional metrics aside and simply look for companies with higher leverage that I normally accept that also have high Piotroski F scores indicating improving fundamentals. I then cut that list down to companies that have tumbled into single digits and have a long way to climb if management is successful in turning the business around.

Skilled Healthcare Group (SKH) operates skilled nursing facilities, assisted living facilities, hospices, home health providers, and a rehabilitation therapy business. This used to be a $14 stock but now fetches less than $5. The stock was over $7 back in July but missed analyst forecasts for earnings and revenue and investors dumped the stock aggressively. The debt to equity ratio is a a daunting 400% but the company does have an F-score of 7 indicating fundamental improvements are taking place and not being recognized by Wall Street just yet. At the first sign of good news this stock could begin a climb back in the direction of the old highs.

Alaska Communications Group Company (ALSK) provides integrated communications services to consumer and business customers in and out of Alaska. The Company's wireline and wireless communications networks extend throughout Alaska. The company recently announced new broadband capabilities for businesses that should help drive future growth. The new service will be rolled out shortly in the Anchorage area and introduced to the rest of the state over the next few years.  Five years ago this stock traded for more than $10 a share and just halfway back to that level would be a huge return. They carry a high debt load with a debt to equity ratio of 500% but the F-score is an impressive 8 indicating better times ahead for the company and hopefully the stock.

Although I do run screens looking for long shots my favorite way is to simply sit down with the new issue of Value Line and electronically thumb through the issue looking for stock with enormous upside potential over the three to five year time frame I find most effective. The list of stock that have performed poorly in the last quarter and those with the highest three to five year appreciation potential as calculated by the research service have been particularly fertile hunting grounds over the years. The longshot and turnaround portfolio break form some of my basic valuation tenets and are more of a distressed/private equity view of certain stocks. This approach suits my son more than it does me at this point in my life but I have an affinity for having a few of these in my personal accounts.

Looking at the list today I see that a few of my recent longshot picks from earlier this year still make the grade. I am a huge fan of both McDermott (MDR) ACCO Brands (ACCO) and Amkor Technologies (AMKR) still make the grade. I am big fan of all three of these issues and am very hopeful that the politicians will gum things up for a few more days and panic the market. I would love to have all three of these in my classic value portfolios and they don’t need to fall that far to trade at a healthy discount to book value.

Central Pet and Garden (CENT) makes the grade as a turnaround as well. The company has seen its share price plummet from over $18 pre-crisis to a little over $7 today. The company has been struggling to get its act together and saw earnings fall again last quarter and the stock was further punished by disappointed investors. The company has turned its attention to cost controls and that should help improve the bottom line. They have already reduced headcount once and may have to do so again before its all said and done.
Unless suburbs suddenly disappear the company will have a market place for their lawn and garden supplies, seeds and insecticides. Most of their revenue actually comes from the pet side of the business with products like treats, toys and animal health products. Many people I know, including my wife, would take care of their pets before themselves so that should remain a solid market for the company as well. With a little attention to costs and margins this stock should have no trouble getting back near the highs in a stronger economy.

Golar LNG (GLNG) is a little higher priced than y usual longshot picks but this stock appears to have enormous upside.I t is involved in the acquisition, ownership, operation, and chartering of LNG carriers and floating storage regasification units and the development of LNG projects. Currently the company owns six LNG carriers and operates Golar LNG Partner LP's fleet of seven LNG carriers and floating units. LNG rates have slipped this year as a result of delays and plant outages and the company actually took two vessels out of service in the second quarter rather than pay the costs of operation. The company is expanding their fleet and other shippers are rushing to get into the LNG business so there may be some excess LNG shipping capacity next year but this is eventually going to be a rapidly growing industry and Golar is positioned to be a leader.

The outlook for the floating storage and regasification units is strong right now. Golar commences a new contract in Jordan during 2015 and is considering converting older vessels to FSRU platforms to meet the growing demand. This stock could easily triple as the LNG industry continues to expand. You get paid to wait with this stock as the shares are yield 5.1% at the current price.

Before moving on from Value Line and the search for longshots with an above average chance of success over the 3 to 5 year time frame these investments usually need to work I like to go to amore familiar section of the weekly edition. Each week the venerable research service publishes a list of stock trading with the widest discounts from book value. While they use sated book and not my preferred tangible book value I find that the list has been an excellent source of stock ideas with longshot potential for a return of several times the initial purchase amount over time. This week’s list did not disappoint and there were several stocks worthy of further consideration.

FUJIFILM Holdings  (FUJIY)has suffered over the past few years as the film and camera business became a buggy whip business. No matter how good the products might be the demand for regular photographic supplies is disappearing as photography moves into the digital world. The company has taken steps to diversify the business and now offers products for the medical imaging markets, optical devices and office equipment. They own 75% of Fuji Xerox and have been developing export markets in other Asian nations for these products. They have restructured their basic photography related businesses and are migrating more towards higher end digital cameras in an effort to slow losses from that product line. It will take some time to get the ship fully righted but there is more than enough potential upside in the stock to justify waiting. The shares trade at just 50% of book value and cold easily double or more over the next few years.

Atlantic Power (AT) is a stock that will either be a big hero or a large zero. The stock trades at about 25% of its 2011 after a weak economy pressured the highly leverage power generator and they were forced ot cut the dividend payout. Even after slashing the payout by 66% the yield at the much lower price is still fairly enticing as the stock yields 8% at todays price. They were able to turn a profit in the second quarter to the surprise of many analysts and the stock has moved op off the lows but us still very cheap. Management is committed to paying down debt and reduced its debt load by $172 million in the second quarter. They are also looking to sell assets considered noncore operation and will use the cash form these efforts to further reduce the debt burden. If the restructuring and turnaround plans are successful this stock could easily double or more over the next few years.

Aircastle Limited (AYR) is in the aircraft leasing business and currently y has a fleet of 158 aircraft. The fleet has a utilization rate of 98% with a portfolio yield of more than 13% so business is pretty good for the company right now. They have been disposing of older aircraft and upgrading he fleet in in 2013. They have sold 11 aircraft so far and spent more than $960 million on new planes. The comonay also recently sold a little more than 15% of the company to Marubeni , Japanese trading company. Aircastle CEO Ron Wainshal said of the deal that “We're extremely pleased to welcome Marubeni as an important new strategic shareholder. Marubeni brings a long-term, globally minded perspective to our business and we believe there are exciting business opportunities for us as we work together."   The stock is cheap at just 81% of book value and the shares sport a yield of 3.7% at the current price. This was the 29th consecutive quarter of dividend payments by the firm. The company is also buying back stock and since 2011 have repurchased 11.7 million shares and still have $30 million to spend under the current buyback plan. Patient investors could collect a nice yield and see the stock double over the next five years.

Investors should spend more time looking for longshots and turnarounds that they do trying to trade the news or predict market direction. Both strike me a futile exercises and are a significant part of the reasons individuals tend to under perform the market.Investing in turnarounds and longshots may not be for many investors but it probably should be. Although the short term volatility of the share prices can be daunting investing in these stocks forces investors to adopt what I call a private equity mind set. By viewing the potential return five years out and not worrying so much about the daily trading of the companies they own most investors would see a substantial increase in their portfolio value Not all longshots work out. However it has been my experience that if you use a little common sense and look for decent companies simply dealing with a rough patch more than you might think work out very nicely indeed. Patient aggressive investing in stocks with significant upside potential should prove to be a far more profitable exercise.

No comments: