Company Focus
Recent articles:
• Invest today in the fuel cells of tomorrow, 2/5/2003
• Winners in a can't-win earnings season, 1/29/2003
• 5 ways to profit from the falling dollar, 1/22/2003
More...
| | Company Focus
3 dark-horse stocks ready to ride
Each of these turnaround plays has the potential to bounce back in an economic recovery -- and the strength to hang on until that happens.
By Michael Brush
Ironically, in a treacherous market like this one, some of the best places to hide are the worst stocks -- those troubled companies where problems have beaten shares down so low that they probably cant go much lower.
You cant be in just any bad stock, of course. You need to own the ones where ongoing changes or a catalyst on the horizon will translate into strong returns over time -- the true turnaround plays.
Turnaround plays are the specialty of deep-value analysts, so thats where we looked to find a half dozen or so stocks with promise, consulting with managers at the highly respected Evergreen Special Values Fund (ESPAX) and the Al Frank Fund (VALUX), as well as with George Putnam, author of the Boston-based Turnaround Letter.
Among their favorite turnaround plays are a beaten-down chip supplier, a hotel chain and a basket of stocks that trade under their cash levels. But before getting to the names and details, its important to note that all the stocks identified below meet three key criteria.
- They typically serve a cyclical sector (such as semiconductors, travel or business services) thats down right now but should bounce back when the economy recovers.
- Since its still not clear when an economic rebound may occur, they all have sufficient financial strength to sidestep bankruptcy while you wait.
- The companies have very little Wall Street analyst coverage. Trust us, thats a good thing . . . not because Wall Street analysts are bad. But rather, it's because as business improves and theres greater potential for investment banking business, more brokerage houses will pick up coverage and attract new investors -- to bid up your shares.
Without further qualification, here are the top turnaround plays we found:
Cypress Semiconductor
Chip supplier Cypress Semiconductor (CY, news, msgs) is like a good house in a bad neighborhood. It specializes in proprietary semiconductors -- products that are unique to the company, aimed at very specific uses, and thus targeted to fetch substantially higher profit margins than less-specialized, or commodity, chips.
Cypress also has well-respected management and plenty of cash to see it through these hard times. Putnam likes Cypress management for its discipline on costs, openness, and ability to plot a sensible long-term strategy. The company has decent financial strength, with $225 million in cash. Thats about $1.80 per share, a lot more than the amount on hand that carried it through the last two chip sector downturns in the 1990s.
Heres the problem: The chip industry is still in the tank, with excess capacity and soft demand putting downward pressure on prices for the third straight year. The companys chips are used in everything from digital cameras, printers and game boxes to components used in wireless and networking systems. Demand has been strong for Cypress chips used in computer storage devices. But almost all the other product sectors Cypress serves are slumping right now. Customers in the wireless and networking areas, such as Motorola (MOT, news, msgs), Cisco Systems (CSCO, news, msgs), Lucent Technologies (LU, news, msgs) and Nortel Networks (NT, news, msgs), have been especially hard hit.
Things are so bad that Cypress is currently trading at about $5.30 per share, or roughly one times trailing 12-month sales. Thats not far from the 0.6 price-to-sales ratio that marked the ultimate lows for the stock at the bottoms of previous semiconductor cycles. On average, Cypress has traded at a price-to-sales ratio of 2.65. This, of course, is the good news. To George Putnam of the Turnaround Letter, the companys advantages -- solid management, financial strength, long-term potential -- far outweigh its disadvantages at the current stock price.
Meantime, when demand bounces back (it always does), Cypress will be better positioned to benefit due to a key strategic move: Even in this downturn, the company has been increasing the mix of proprietary chips in its portfolio. We have done a number of acquisitions of companies with proprietary products, says Ralph Schmitt, the chief of sales and marketing. That was our strategy, to leverage our commodity position into proprietary position. That is the fundamental shift in the company, and the one that will make us grow.
When might a rebound occur? Typical chip sector downturns last about three years -- suggesting things could start to improve by the end of this year or 2004, says Schmitt. But given the absurd heights of the technology bubble, dont be surprised if it takes longer for tech stocks to get through the hangover.
La Quinta
Troubles for La Quinta (LQI, news, msgs), a chain of moderately priced hotels in 33 mostly western and southern states, began in the late 1990s when it was bought by a health-care real estate investment trust (REIT) that wanted to diversify. The REIT, called Meditrust, was poorly run. It eventually had to sell off the health-care holdings, drop the REIT status and bring in new management to handle the hotel chain. In the confusion, La Quinta alienated customers by letting hotels and their reservation systems deteriorate.
During the past year or so, the company has improved its computer-booking system and carried out long-needed renovations. It also has tweaked the guest loyalty program and built up its Internet-based reservations. All thats needed now is a rebound in economic growth and travel, says Jim Tringas, a money manager at the Evergreen Special Values Fund, which holds shares in the chain.
Once business picks up, La Quinta earnings should rebound a lot faster than those at other hotel chains, in part because big tax loss credits of around $340 million will protect the company from taxes for years, says Tringas. That will bring a huge amount of free cash flow that can be used for acquisitions, or to pay down debt or buy back stock, says Tringas.
Meanwhile, the downside is limited because the hotel chain already trades at a scant 30% of book value. The company has manageable debt levels and decent free cash flow -- expected to be about $70 million this year. La Quinta has around $655 million in long-term debt, with $401 million maturing over the next four years. But the company has enough cash and free cash flow to cover this.
Exactly when the economy and travel will bounce back is anyones guess, given the sluggish rebound so far and the looming war, which tend to make people stay home and travel less. Tringas doesnt mind waiting, though, because he thinks the upside potential for the stock is big, while the downside is limited.
Infonet Services
Like many companies in the telecom space, Infonet Services (IN, news, msgs) has seen its shares get crushed. The stock fell hard from a high of $32.69 in the first quarter of 2000 to below $2 currently.
That alone doesnt make it a buy.
But Infonet looks attractive at this low level because, unlike so many other telecom services providers, it has the financial strength to stick it out until business picks up again, says Putnam of the Turnaround Letter. He advises his newsletter clients to buy shares up to $5.
Infonet provides highly reliable, private, secure networking services. Companies use Infonets private Internets to connect work sites and run important business applications. The company brings in about $500 million a year in revenue, an amount that actually has been growing modestly despite the economic slowdown. Its not clear, of course, when the economy will get better. But once it does, businesses are likely to go back to spending more on private internet services.
Although a $1.90 price tag on a stock often signals possible bankruptcy, Infonet has no debt. It has about $450 million in cash, or about $1 per share. The company trades at such a low price in part because it has so many shares outstanding after several stock splits during the bubble days.
Chief Executive Jose Collazo doesnt fear the competition looming from WorldCom (WCOEQ, news, msgs) once the former nemesis emerges debt-free from bankruptcy. Even when WorldCom was using irrational pricing, we could still compete with them, says Collazo. And they wont be using irrational pricing when they come out of bankruptcy.
Weak pricing will continue to be an issue, however, because of the excess capacity in the space. Another obstacle: Most of the shares of Infonet are held by telecom giants in Europe and Japan. With only about 8% of shares publicly traded, Infonets limited float reduces interest in the stock among many big institutional investors.
A basket of cash-is-king stocks
As a value manager with The Al Frank Fund, John Buckingham has plenty of hard-core turnaround names in his portfolio. Like other deep-value players, he digs deep into the details of companies to pinpoint good dark-horse candidates.
But he supplements that work with another strategy: buying a group of stocks that are trading at or below cash levels but appear to have good enough business model to survive. A few within the group may flame out. But one or two likely will be big winners, more than making up for the losses. Six or seven stocks is enough to make up a basket. If you try this yourself, just be sure not to have more than 15% of your equity portfolio locked up in this strategy.
"I like the relative insulation you get on the downside because of all the cash, and there is potentially enormous upside if things go in the companys favor," says Buckingham. Several months ago, for example, he bought shares of SINA Corp. (SINA, news, msgs), a Chinese Internet stock, at around $1.50. Then the stock had a huge run thanks to some good business trends in the group and a mini-mania for Chinese portal stocks. SINA advanced more than sixfold, and Buckingham took profit around $9.
When you have a stock in a basket of cash is king names go up sixfold, you have to lose six just to break even, he says. But with so much cash on the balance sheet at these companies, seeing that many go to zero is unlikely. So you can do extremely well if you buy a basket of these stocks, he says.
One of Buckinghams favorite cash-is-king baskets right now focuses on business software stocks. Among those recently owned by Buckingham that trade at, or far below, cash levels include the following: Tanning Technology (TANN, news, msgs), which has about $2.12 per share in cash; American Software (AMSWA, news, msgs), which has $2.45; Keynote Systems (KEYN, news, msgs), which has $9; ValueClick (VCLK, news, msgs), which has $3; and Net Perceptions (NETP, news, msgs), which has $2.36. Another tech company in the cash-is-king basket: wireless broadband component maker Endwave (ENWV, news, msgs), which has $3.50 per share in cash.
Another positive scenario for stocks trading well below cash: Management simply decides to close up shop and hand the money to shareholders. Thats what happened with a tiny tech stock called Previo (PRVOZ, news, msgs), which Buckingham bought last year at $1.20. Management chose to throw in its hand and give shareholders most of its cash -- or $2.30 per share -- a handsome gain for Buckingham. You have several ways to win here, he says.
|
