Just because a company has been on the brink of disaster doesn’t necessarily mean that it’s a bad investment. The stocks of troubled companies that are on the road to recovery often provide great opportunities for investment gains.
Although the best-known wounded giants include names such as General Motors and Six Flags, there may be better opportunities in overlooked gems that have been devastated by bad news, including CEO scandals, lawsuits, crippling debt, even bankruptcy. These are known as “turnaround” stocks.
The most appealing ones now…
A company that enters bankruptcy proceedings and is able to resolve its debts and stay in business may recover strongly. That doesn’t help previous shareholders who lost most or all of their investments, but it’s positive for new investors who buy postbankruptcy shares of stock. Wall Street analysts often underestimate the value of these companies or ignore them until a complete recovery occurs. Although bankruptcy papers are publicly available, few investors are willing to sift through pages of specialized documents to assess how the company may do in the future.
My favorite bankruptcy turnaround stocks now…
Federal-Mogul Corporation (FDML) is a leader in the design and manufacture of engine components, accessories and aftermarket parts for the automotive industry. Its products include Champion spark plugs, Wagner brake products and Anco wiper blades. In the late 1990s, the company made a large number of acquisitions but struggled to integrate them, and it collapsed in bankruptcy in 2001. The bankruptcy took six years to work through.
Why it’s a good bet for recovery: Federal-Mogul emerged from Chapter 11 with reduced debt at the beginning of 2008 — just in time to get walloped by the collapse in global vehicle production. The car industry will continue to struggle for a while, but it isn’t going to disappear, and its near-term problems already are priced into Federal-Mogul stock. The company also has limited direct exposure to the Detroit auto manufacturers and derives the majority of its revenues from foreign sources. The stock has rebounded nicely this year but still is nearly 50% below its one-year high, with room for substantial growth.
Recent share price: $13.14.
US Airways Group, Inc. (LCC) has been through bankruptcy twice in the past decade, first in 2002 due to rapid overexpansion and heavy debt load… then again in 2004, when its pension plan saddled it with almost $3 billion in future payouts. The airline subsequently merged with America West to become the fifth-largest domestic carrier, but its stock price has remained depressed, recently 77% below its 52-week high, because the recession has curtailed travel and hurt all airlines.
Why it’s a good bet for recovery: Boom and bust cycles have characterized the airline industry for much of the last 20 years. Whenever industry conditions improved a bit, US Airways would expand rapidly to try to grab market share. Then, when the economy weakened, it wasn’t able to contract fast enough. This time, however, the airline has been much more disciplined about expansion. As soon as it saw the economy soften in 2007, the company cut back hard, shutting down routes, sending planes out to the Arizona desert for storage and laying off workers. When travel does begin to pick up again, US Airways, with one of the leanest cost structures in the industry, is likely to profit.
Recent share price: $3.57.
Companies hurt by corrupt or ineffective executives who have been replaced by new and talented senior management may prosper. My favorites now…
CA, Inc. (CA), formerly Computer Associates, provides information-technology software that allows companies to better run their businesses and manage their customer data. CA’s many clients include most of the Fortune 500 companies. In 2004, the CEO of the company was indicted on massive accounting fraud, thrusting the business into turmoil. He eventually was sentenced to 12 years in prison and ordered to pay $800 million in restitution.
Why it’s a good bet for recovery: CA replaced all of its senior leaders and hired external advisers to audit its policies and procedures. Its stock price has lost about 7.5% annually over the past 10 years, but I think the worst is behind CA. It has rebuilt its diversified customer base. Its new software products allow companies to improve the security and productivity of their computer resources and have helped CA generate $1 billion in cash flow annually.
Recent share price: $22.60.
Sprint Nextel Corp. (S) brought in a talented new CEO in late 2007 — and he is turning the company around. It is the third-largest phone carrier in the US, serving almost 49 million customers. Sprint has stumbled badly since 2005, when it merged with Nextel, and the company has found it difficult to convince customers of the merger’s benefits. Terrible customer service caused users to defect to competitors. Sprint also failed to market itself effectively. The stock lost 86% in 2008.
Why it’s a good bet for recovery: The new CEO, Daniel Hesse, has taken dramatic steps to regain the company’s footing. This includes overseeing a $5 billion capital investment in a new high-speed wireless network based on WiMax technology… introducing a new smart phone — the Palm Pre… and making consumer-friendly moves, such as offering an unlimited prepaid-service option. The stock has rebounded somewhat this year and should see continued improvement. In addition, because Sprint Nextel is not affiliated with a major traditional phone company like its major competitors, it has the potentially lucrative option of partnering with cable companies sometime in the future.
Recent share price: $3.77.
Sometimes a crisis triggers a company’s terrible performance and stock sell-off. Once that is resolved, the outlook may be bright. My favorite stock of a company whose crisis has passed…
Solutia Inc. (SOA) is a global manufacturer of chemicals and specialty materials for industrial applications, such as transparent films for safety glass and hydraulic fluid for airplanes. The company formerly was part of agricultural biotech giant Monsanto. When Solutia was spun off from Monsanto as a separate public company, Solutia was left exposed to environmental lawsuits over cancer-causing chemicals. As a result, even though it was always profitable and a leader in its field, Solutia filed for bankruptcy in 2003.
Why it’s a good bet for recovery: Solutia took four years to emerge from bankruptcy, but by 2008, it was able to shed many of its legal liabilities. Even so, the newly issued stock fell by as much as 93% in the past 12 months because of the recession and panicky investors. Solutia still is a terrific company and performing much better this year. Its stock will continue to rise as more investors realize that the company’s move into emerging countries will drive strong growth for the next decade or more.
Recent share price: $12.06.
