Craig Hodges
Craig Hodges is portfolio manager of the $396 million Hodges Fund (HDPMX) and co-portfolio manager of the $1.3 billion Hodges Small Cap Fund (HDPSX), Dallas. HodgesFund.com
With the stock market hitting record highs this year, it has become increasingly difficult to find bargains. But Craig Hodges says he’s spotting plenty of undervalued and out-of-favor stocks of companies ranging from a paper manufacturer and a cement maker to a flooring retailer and an airline.
Hodges, whose Hodges Fund is up an impressive 25% this year as of August 30 and ranks in the top 2% of midcap growth stock funds over the past 15 years, calls himself a contrarian. He says that now is an ideal time for contrarian investing if you are willing to take some chances. That’s because most of the market gains this year have been driven by a narrow group of fast-growing large-cap technology stocks and dividend-paying blue chips, leaving many pockets of the market unloved and much cheaper.
Bottom Line Personal asked Hodges how investors can find attractive contrarian stocks and to share some of his favorites now…
I typically look for companies that have performed well in the past, had solid balance sheets and dominated their markets—but that have fallen out of favor due to setbacks that I think will be temporary. These setbacks could include poor strategic decisions by management, legal troubles, a slump in the industry and/or other missteps. With this type of negative sentiment, investors sometimes overlook strengths that can propel stock prices. Of course, it’s not enough that these stocks just are cheap. I also need to see clear catalysts that are likely to reverse investor sentiment, improve earnings and raise the share price over the next 18 months.
Example: In 2008, United States Steel traded as high as $191 per share. But the collapse in global demand for commodities and the flood of cheap steel from China, which produces half the world’s steel supply, annihilated the stock. Early this year, I purchased the stock at about $8.65 per share after noticing that US Steel was able to raise prices because so many steel-producing competitors had gone out of business. Additionally, the US government decided to levy steep duties on Chinese steel. US Steel shares rose 146% this year through August 30.
The six stocks below should be reserved for the aggressive part of your portfolio, since they are likely to be more volatile than the overall market.
American Airlines Group (AAL). Fierce price competition forced three major airlines to file for bankruptcy protection over the past decade, including American, which filed Chapter 11 in 2011 and emerged in 2013 after a merger with US Airways. The combined company has struggled to integrate systems, and the stock, which lost 20% in 2015, is down another 12% this year. Also, investors have been concerned that heightened terrorism fears could lower demand.
Why I’m buying it: Four major airlines (American, Delta, Southwest and United) now control more than 80% of the domestic market versus nine airlines back in 2000. That kind of reduced competition is producing fuller planes and greater ability to raise fares. I expect American Airlines to successfully complete its integration with US Airways by next year. Recent share price: $36.17.
Eagle Materials (EXP) produces construction materials such as concrete, cement and crushed stone at more than a dozen facilities in such states as California, Kansas and Texas. Company earnings were decimated during the 2007–2009 recession, and the company has struggled to recover because government spending on infrastructure repair, including fixing highways and bridges, has stagnated. Its stock price, which was as high as $104 per share in 2014, was recently below $84.
Why I’m buying it: The federal government is finally starting to take America’s deteriorating infrastructure seriously. That could mean robust earnings growth for building materials and construction companies. Last December, a five-year, $305-billion federal measure to repair highways was enacted. And both presidential candidates—Hillary Clinton and Donald Trump—have promised further infrastructure spending. Recent share price: $83.64.
EnLink Midstream Partners (ENLK) processes and transports natural gas and crude oil for US energy companies engaged in hydraulic fracturing (fracking). It has 9,400 miles of pipeline in many of North America’s most productive oil and gas regions, mostly in Texas and Oklahoma. Although the company has little exposure to oil’s price fluctuations because it has guaranteed long-term contracts for its services, its stock has been dragged down by the energy sector’s bloodbath as oil prices plunged. The stock lost 38% last year.
Why I’m buying it: EnLink was able to produce consistent earnings and cash flow even when oil prices dropped below $27 per barrel in February. Reason: The majority of EnLink’s business is with the strongest, most stable US energy companies in the Permian Basin in Texas, where the costs to extract oil and gas are the lowest in the fracking industry. These companies are unlikely to go out of business or default on their contracts even if oil prices stay low for years. At the stock’s recent price, you could get a 9% annual yield while waiting for the sector and investor sentiment to eventually rebound. Recent share price: $17.80.
JC Penney (JCP). This stock has fallen 77% since a disastrous decision by top management back in 2012. Losing sales to other department stores, JC Penney decided to radically rebrand itself. It redesigned its stores to look more sleek and upscale and eliminated its popular coupons and discounts. But the new strategy failed, driving away what was left of JC Penney’s loyal customer base and saddling the company with $5.2 billion in debt. The company seemed as if it was headed for bankruptcy.
Why I’m buying it: Former Home Depot executive Marvin Ellison has made impressive progress with JC Penney since he took over as CEO last year. He has reduced debt, brought back coupon-focused discounting, is taking back market share from its brick-and-mortar peers and is fending off e-retailers by emphasizing products that consumers still prefer to purchase in person. For example, JC Penney has started selling home appliances such as refrigerators and washing machines for the first time in 33 years. I expect these big-ticket items to become a billion-dollar business for the company in the next few years, especially since its main competitor—financially troubled Sears—has been closing hundreds of stores around the US, many of them in the same malls as JC Penney stores. The stock has rallied 45% this year, but there is plenty more upside left. Recent share price: $9.81.
KapStone Paper and Packaging (KS). Weakness in international markets has put pressure on container-board prices and raised concerns that demand for cardboard boxes and other paper-based packaging would suffer. KapStone, which operates plants in 15 states, has seen its stock fall 22% in 2015 and another 20% this year.
Why I’m buying it: Many investors don’t realize how effectively KapStone is adapting to the new digital environment. For example, thanks to the popularity of e-commerce, it focuses on supplying online retailers with containerboard, corrugated brown boxes and unbleached paper used in packaging. Consolidation in the industry means that KapStone and a handful of competitors now control more than 75% of the US corrugated-board market, allowing pricing and profit margins to rise. Recent share price: $17.42.
Lumber Liquidators (LL). Investors have shunned this specialty flooring retailer ever since last’s year exposé on 60 Minutes alleging that the company sold Chinese-made flooring containing dangerous levels of formaldehyde. Beyond that problem, the company has since pleaded guilty to charges that it imported illegally logged wood and will pay more than $13 million in fines. Sales have fallen for five straight quarters, and the stock, which was as high as $119 per share in 2013, has plunged below $17 as of August 30.
Why I’m buying it: The worst news is behind the company. Although it still faces class action product-liability lawsuits in various states, the US Consumer Product Safety Commission ruled in June that Lumber Liquidators did not have to recall its China-made flooring after air-quality tests in more than 17,000 households found no adverse formaldehyde levels. And the former CEO was replaced. Recent share price: $16.06.
