(Editor's note: A version of this article appeared in
What's the Trade?
newsletter of Nov. 16.)
There are always values in the stock market. One place to find them
is among sectors and companies that have been distressed and hated
for a long time--especially those with lots of debt. They tend to
be underowned and heavily shorted, which can provide some nice fuel
for a rally.
Many of the gains we enjoyed coming off the lows in 2009 resulted
from these kinds of melt-up trades, especially financials and
auto-part makers. Plenty of other companies, however, enjoyed only
a fleeting bounce and continued to struggle. Some of these now look
The first are
ocean shipping companies
. Many of these stocks, such as Frontline, Overseas Shipholding,
and Eagle Bulk Shipping, are now trading far below their 2009 lows.
This is not a surprise because shipping rates remain far below
their peaks in early 2008. And, after an initial bounce in 2009,
they trended lower for more than a year.
Now the situation is quietly turning positive. The Baltic Dry
Index, a key metric of shipping rates, has been trending higher all
year and made higher lows at the same time that the S&P 500
dropped in early October. Reports this month also suggest that
demand is improving and a glut of ships is easing.
This improvement is visible on our new
service, which makes it easy to follow dozens of industry groups.
Headlines in the last week have an average bullish-to-bearish score
of +1, meaning that they're all positive.
This stands in contrast to a +0.5 rating in the previous month,
indicating that sentiment is getting better. Stock performance
matches this improvement because shippers are up 14 percent in the
last month versus a gain of just 4 percent for the S&P 500.
Another consideration is that the some of these companies are now
at truly distressed levels, thanks to their messy balance sheets:
EGLE and OSG are trading for less than 0.3 times book value while
FRO is at 0.65 times. DryShips is at 0.36 times book value.
While investors have a reason to fear companies with too much debt,
they can still rally hard simply by failing to go bankrupt.
seem to be turning as well. Several companies in this industry,
such as Beazer Homes, D.R. Horton, and Toll Brothers, cited better
orders this earnings season. Margins have also been improving for
others, including PulteGroup.
In a related story, famed investor Kyle Bass recently bought a
stake in mortgage-guarantor MGIC Investments. Bass made a fortune
betting against mortgages back in 2008, so it's noteworthy that
he's now taking the other side of the trade.
The final idea is a single company,
, which has been a punching bag for better-run competitors such as
CVS Caremark and Walgreen for years. But headlines have been
showing more optimism in the last few months, as new
customer-loyalty programs result in better same-store sales and
earnings estimates inch higher. RAD also trades at less than 0.05
times sales, about one-tenth the multiple for its rivals.
Let me end with a reminder that these are ideas, not
recommendations. Back-from-the-dead companies can significantly
outperform the market when they turn. However, because they're
beholden to forces in the credit market, it's a good idea to learn
more about their obligations.
When are their next big bond maturities, and do they have any
covenants (strings attached to loans) that might hurt equity
investors? Do they have pension obligations?
Some work does need to be done, but it can be well worth the
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