Saturday, February 8, 2014

Special Situation Ideas for week of 10-Feb-2014

Those looking into some catalyst might want to ponder over these names for the week. I have done research on few of them, the other I have read online on Barron’s and other publications.

Constellium (CSTM): CSTM is  a producer of specialized aluminum products. The company went public in 2013 at $15 a share, and is not well known. The firm is 9% owned by Rio Tinto, 20%+ by Apollo, 10%+ by FSI (arm of the French Govt.), about 5% some by the management and the rest is public.  For a more detailed view, you can read CSTM’s F-1 (Click here).
CSTM converts aluminum into specialty products. It earns a conversion spread [the difference between aluminum and finished-product prices] and has minimal exposure to the underlying aluminum prices. It produces aluminum plate for aerospace customers, can stock for beverage manufacturers in Europe, and sheet and crash-management parts for automotive manufacturers. CSTM is a play on structural changes in both the aerospace and automotive markets. The demand for lighter, stronger materials that are environmentally friendly will significantly increase aluminum usage in the years ahead. CSTM enjoys long-term relationships with key customers including Airbus, Boeing, Audi, and Mercedes. These companies require suppliers' plants to be certified, which provides barriers to competitors.
In aerospace, CCTM is the global leader in plate and one of only two producers with certified production plants in both North America and Europe. CSTM signed a 10-year contract with Airbus to use Airware on the A350, and deliveries should start in 2015. Overall, this market is expected to grow by about 10% a year.
CSTM is also the largest producer of aluminum sheet for a vehicle's core body structure, known as Body-in-White, for the premium European auto makers. Next year could mark a significant step-change in demand in North America, with the rollout of the new Ford [F] F-150. Demand in NorthAm could grow to 450K tons by FY15 and a 1 mn tons by 2020 from less than 100K in FY12. The firm announced on 23-Jan-14 that it had formed a joint venture with UACJ to supply Body-in-White to North. America.] This is being driven by federal fuel-economy regulations mandating an average of 55 miles per gallon for corporate fleets by 2025.
CSTM has 105mn shares outstanding. Net debt is USD 225mn. The company is headquartered in the Netherlands and reports financials in euros. Yet, the shares are listed in New York. CSTM is expected to earn about $2 in 2013 with potential to earn more than $2.50 a share in t2 to 3 years. It could start to pay a dividend this year. Firm can go upto USD 35 in 2 years The company estimated that the replacement value of its assets is north of USD 8.2bn, which compares to an enterprise value of USD 3bn today.

 GAP Inc. (GPS): Most of the street is bullish on the stock with people expecting 17% gain in addition to a 2.1% dividend yield. At 12.6x earnings, GAP sells at discount to all of its domestic peers, despite having the best margins; competitors being ANF, ARO, ANN, H&M, Inditex. GAP stores, baby gap and gap kids: 40% of sales, old navy: 38%; Banana republic: 18%; rest by intermix, athleta (competes with lulu lemon) and Piper lime. Operating margins have climbed to 13% from 10%, 3 years ago. Growth will come from stores of Athleta (1st store in FS in FY11), Piper- lime with first store in in Soho, NY in Fy12. GAP’s Athleta is benefitting from Lulu lemon’s mishaps. International expansion should also help the company and justify multiple expansion. Additionally, company has history of buybacks. Fisher family, which controls 40%, is not selling, so slowly the firm is going private because of buybacks. Once the firms is seen as a global player, then at 15x earnings, which is S&P 500 multiple, share should be valued at $49 based on FY15 earnings of $3.27. The company has a ROE of 40%+; 13x P/E; holds USD 1bn cash on the balance sheet with USD 1.25bn debt.

Timken (TKR):
TKR manufactures, markets and sells products for friction management and mechanical power transmission, alloy steels and steel components. The big story here is the imminent spin-off of the company in Summer of FY14. TKR will spin-off its more cyclical steel business from its bearings business which should yield much better return for the long term shareholders.  The company yield about 1.6%. There are two activist investors involved who have pushed for the spin-off. There was a huge pension overhang on the company, which is not a factor anymore. IN the most recent conference call, the company stated that its pension are now fully funded, which in addition to other cost restricting efforts, should free up the cash flow, to be reinvested or returned to shareholders. On the SOTP basis, TKR post spin should trade at USD 69 a share, which is a hefty return from the current $55.  Activist Presentation (click here)

Few Other Names: As i wrote earlier, FY14 will be a volatile year for stocks, and unless something unforeseen happens, i think market this year will trade sideways to modestly up. However, in this stock picker market, we are better off investing in defensive value plays with good dividends that are playing into a growth theme and has some support. Here are few names worth revisiting:  Hess (HES): I wrote about this a while ago, and its coming back into the price range, where this might again be a good buy.  Another two names that are worthy of a look for long term shareholders is ManTech (MANT) and Leidos (LDOS) which spun off SAIC in FY13. Another name for those, looking to play the energy efficient space, might do themselves a favor by reading a really good article on Cree (CREE) which was written in IBD.

 Personal Note: I am invested in GAP, LDOS, MANT, CSTM and TKR.

Sunday, February 2, 2014

Thoughts on the 2014 markets

US markets have done pretty well over the last two years, and by that reason, to some, the emerging and EU markets look much more promising for this year.  That might be so, however, for an investor sitting in the United States, it’s sometimes very difficult to calculate the risks that come with investing in the emerging markets.

EU has done very well, over the last year. If you heard Mark Lasrey, someone I greatly respect, then there have been many turnaround opportunities in Europe which could have generated double digit returns. However, Europe has faced its own crisis, with unemployment still very high in some of the so called richer countries. Spain, France, Italy in particular are worth mentioning. Germany has performed relatively well over the last year or two – however it’s still tied to Europe in many ways. UK is doing well, but its more due to the easy monetary policies of the central bank. Global companies such as Nestle, however, are always a sure and safe bet.

The emerging markets have presented us with lot of opportunities as well, however, it’s very hard to gauge the political risks that comes with investing there. Recent slowdown in China, political opposition in Bangkok, sudden changes in rules ( for example gold) regarding imports in India, problems in Pakistan and Afghanistan, volatility in the Philippines should provide us with a note of caution – especially those sitting in US trying to play the emerging markets. Vietnam and Singapore might be good cases of investments, however, you better be visiting those places before putting your money to work.
Middle-east is a story that speaks for itself.  The markets in Brazil, Argentina, and Venezuela are not doing that great.

So this brings me back to the US and this year seems to be an interesting market – interesting because the Federal Reserve has started to taper and there is a change in guard. Stan Fisher is coming back as the vice-chair of the Federal Reserve and he has been a proponent of intervention in the past and so is Janet Yellen. I believe that those focused on the US markets investing for the medium term should focus on special situation equities.  I believe FY14 will present good opportunities for turnarounds, spin-off’s, and restructurings. Additionally, I also expect that FY14, given the political climate around the globe, will be a year in which stock markets as well as commodity markets will undergo a lot of volatility. Therefore, those who are looking to do well this year, are better off investing in companies that are light on debt (especially those firms whose debt is coming due in FY15, given the cost of debt will rise), have some yield with good margins and solid business model. Furthermore, the same companies, if they have a catalyst attached to them such as major divestitures, restructuring/turnarounds will perform better than the markets in general. This year might not be the year to bet on risky stocks that have done well in the past just because there was ample liquidity created by the federal reserve. I would say, in general, it will be a good year to play names and focus more on solid balance sheets rather than income statement!