George Putnam loves when a company seems to be so damaged that other investors give up on its stock. That’s because Putnam is able to sift through the debris and look for reasons to believe that the company will not just survive but thrive. He is so good at it that over the past 15 years, his model portfolio has registered the best performance of any investment newsletter monitored by The Hulbert Financial Digest.
Bottom Line/Personal spoke with Putnam about how to find the most attractive “turnaround” stocks now…
Most turnarounds trade far below their own historical valuation levels as well as the valuations of comparable companies because they are misunderstood and underestimated by both Wall Street and small investors. I start by looking for companies with solid core businesses that have been devastated by a crisis or bad news. This may include poor or corrupt leadership…overwhelming debt…unexpected shifts in their industries…and/or the stigma of having gone through a bankruptcy.
Because the biggest risk with turnaround stocks is investing too early and watching the stock go sideways or fall even further, I don’t necessarily try to buy companies at what may be their lowest points. I prefer turnaround situations that are showing signs of incremental improvement. I also need to see specific catalysts that already are in place at a company and that I’m confident could help double its stock price over the next few years.
My favorite turnaround stocks now…
Accuride Corp. (ACW) is the largest manufacturer in North America of wheels and wheel components for heavy-duty commercial trucks, buses and military vehicles. It was carrying a large amount of debt when the 2007–2009 recession struck. Sales plummeted, and Accuride was forced to file for bankruptcy. The company suffered a series of production problems that hurt the quality of its products, raised costs and caused the very volatile stock to decline by about 55% in value in 2011 and again in 2012.
Why I think the stock will thrive: The wheel maker finally has corrected its manufacturing problems, upgrading equipment and shutting down inefficient plants. With quality issues behind it, the company is benefiting from two trends—increasing demand for trucking services as the economy strengthens…and fast-aging truck fleets that are requiring more frequent replacements. The stock has begun a modest recovery already, up 16% in 2013 and 19% in 2014 as of March 31. Recent share price: $4.06.
FelCor Lodging Trust (FCH) was a fast-growing hotel real estate investment trust (REIT) in the mid-2000s as it built a portfolio of mid-range properties, including many Holiday Inns. In the 2007–2009 recession, FelCor’s revenue plunged and its balance sheet suffered from carrying high-interest debt. Its stock plummeted 83% in 2008 and another 57% in 2011 as the travel industry rebound remained sluggish.
Why I think the stock will thrive: FelCor is carrying out a dramatic strategic overhaul. It has sold 26 hotels since 2010 and plans to sell another 20 in an effort to raise three-quarters of a billion dollars. In addition to paying off debt, it is using the money to upgrade its remaining hotels and to purchase marquee properties in strong urban and resort markets, partnering with hotel operators such as Fairmont and Hilton. The room rates at higher-quality hotels are rising in part because the supply of hotel rooms has remained static. FelCor also has refinanced much of its debt to reduce interest costs and reinstated a small annual dividend (recently yielding 0.22%), which should rise as revenues improve. This REIT’s turnaround has not gone unnoticed. Its stock rose by 74% last year, but FelCor has a lot more potential for gains. Recent share price: $8.90.
Freeport-McMoRan Copper & Gold (FCX) mines for precious and industrial metals in North America, South America, Indonesia and Africa. It’s one of the world’s largest producers of copper and a major producer of gold. Over the past three years, Freeport-McMoRan’s earnings have suffered as the global economic slowdown depressed the price of copper and the stock lost 12%. Recent news of an economic slowdown in China, which accounts for 40% of global copper demand, sent the stock tumbling 11% this year through March 31.
Why I think the stock will thrive: Copper prices are unlikely to drop much more because global supplies are tight. And purchasing Freeport-McMoRan stock when copper prices are low has proved to be an excellent strategy. The last time copper prices staged a recovery, from January 2009 to April 2011, the stock gained more than 300%. Recent share price: $32.86.
General Motors (GM). Poor product design and staggering labor costs forced the company into a government-assisted bankruptcy in 2009. It emerged much stronger after modifying labor contracts, getting rid of debt and eliminating some brands. Recently, a long-simmering problem erupted when GM announced recalls of 2.6 million autos for an ignition-switch defect that GM has linked to 13 deaths. The Justice Department and Congress launched investigations into why GM didn’t act years earlier to recall cars with the defect, which causes the vehicles to stall at high speeds and air bags to fail. The stock price fell 15% in the first quarter of 2014.
Why I think the stock will thrive: CEO Mary Barra is working hard to convince customers, lawmakers and investors that GM has changed its ways. Lawsuits stemming from the defect may cost GM several hundred million dollars. However, several catalysts can push share prices higher. GM’s current car models are showing their highest quality and design in decades and are on a par with, or even superior to, most competitors. Meanwhile, GM should benefit from increasing demand for new cars. Recent share price: $34.73.
Layne Christensen Company (LAYN) is a global water infrastructure company that serves governments and industrial businesses. It designs and builds wells and reservoirs and recycles wastewater from the oil and gas industry. Management stumbled badly coming out of the recession by bidding too aggressively on major construction projects, then experiencing millions of dollars in cost overruns that created sizable losses for the company. The stock fell by 30% last year.
Why I think the stock will thrive: A new CEO has restructured business divisions to make executives more accountable and created a culture of more disciplined budgeting. But the biggest catalyst simply is the completion of the company’s unprofitable projects. In the third quarter, the construction division of Layne Christensen began turning a profit for the first time since the second quarter of 2011. Layne’s water-management expertise now is in demand in fast-growing and water-intensive hydraulic fracturing (“fracking”) operations for major energy companies. Recent share price: $17.67.
