"The skying is falling....all life on Earth will soon perish....."
That means that it’s the perfect time to load up on some stocks with high-growth potential. If the world is ending, you might as well take some risks, right? While we experienced a little bit of a reprieve after the early week rally, don't be surprised if we see cries of doom a few more times before things are all said and done.
I’ve picked out seven stocks trading at what I believe to be a steep discount right now. All seven are essentially commodity stocks, many highly cyclical in nature. Many are trading below the book value of their equity and if the apocalypse ends up being slightly delayed, you might be able to wait them out to the next boom and make a nice return.
1. Mosaic (MOS)
Potash stocks have taken a beating recently as concerns over the global economy have gripped the market. Yet, for the next few years, I think the outlook is still very good for potash and the market seems to be overreacting. Analyst forecasts for FY ’09 range from $11.63 - $15.00 and for FY ’10 range from $13.25 - $16.54. That essentially gives this stock a forward P/E of about 2. However, analyst projections might be a bit overly optimistic.
However, we do know that MOS reported $4.67 in earnings (on a DEPS basis) for FY ’08 which gives them a trailing P/E of 7.8. Cash flows per share were $5.71 and free cash flow per share was $4.88. Even if they simply continued that performance for a few years, this might be a steal.
The balance sheet looks fairly good: working capital of 2.34, quick ratio of 1.43, and debt-to-value of 41%. Plus, as already mentioned, they are raking in considerable cash flows. Book value is $17.2 per share. In their most recent quarter, they had earnings of $2.65 per share and cash flows of $1.26 per share and most of the cash flow lag was due to new accounts receivable.
I believe the prospects for potash are still fairly bright extending till 2010 at the very least (when more competition will probably come into the market and create tighter margins) and at the current rate of free cash flow production, MOS’s current price should be roughly equal to the book value of their equity in two to three years, which seems like a good bargain.
This stock traded over $160 as recently as June ’08. While I wouldn’t suggest that I expect this stock to get up that high again, I wouldn’t be surprised if it hit the $60-70 range at the very least sometime in the next few years, which certainly isn’t a bad return if you can get an entry point below $40.
2. Stillwater Mining Company (SWC)
3. North American Palladium (PAL)
Both of these companies are selling at a steep discount. Right now, the main problem for palladium and platinum prices is large-scale demand destruction stemming from the current market environment in the automobile sector. There's also news filtering out suggesting that Nissan, Mazda, and a few other automakers have been working on developing nanotechnologies that could reduce the use PG metals in catalytic converters. This is all bad news for palladium and platinum producers, but perhaps the market has overreacted. Even in the worst-case scenario, prices have to rise at this point because no one is going to be willing to mine for PG metals if they can't turn a profit.
While palladium's future is rather uncertain at the moment, it does have a lot of unique properties that might lead one to believe that its use will eventually be extended to newer products. It’s already used in catalytic converters, dentistry, watch making, surgical instruments, and a handful of other applications. If we ever start using vehicles with fuel cells, it would seem to have some very high growth potential. So while it would be difficult for me to pinpoint what precisely could happen in the next decade, suffice it to say, there are legitimate reasons to believe its usage could eventually grow.
There are also other trends in the industry that could cause prices to rise significantly in the future. First and foremost, there is the issue of the depletion of the Russian palladium reserves. Its unclear how much Pd Russia has left, but don’t be too surprised if their supply is emptied out in the next five years. Top that off with the fact that Norilsk (home of palladium and nickel mining company Norilsk Nickel) is an environmental disaster. Then there’s also the South African infrastructure nightmare that is slowing production of PG metals in that nation. Given all this and the fact that in times past, palladium and platinum mining have been highly cyclical industries, this means there might be consider value to be had in players like Stillwater Mining (SWC) and North American Palladium (PAL).
Taking a look at Stillwater first, the book value of their equity is $5.45 per share. Yet, the stock is trading around $3 to $4. SWC has a working capital ratio of 4.89, which is good. Debt-to-value ratio is 37% --- slightly higher than I like to see, but still fairly solid. All in all, I don't believe they should have any problem paying their bills in the next couple of years.
Onto North American Palladium --- the book value of their equity is $3.49, yet the stock is trading around the $1 – 1.70 range, a very considerable discount. Debt-to-value ratio is very low at 15.2%. Working capital ratio is 5.57 and cash over current liabilities yields a ratio of 1.91. Hence, they appear to be in very sound financial shape and can simply ride it out until things improve.
Given the steep discounts to book value for both of these stocks, you can basically buy in and wait-it-out for another decade. If demand stays static for another decade (which seems somewhat unlikely to me), one might not lose that much given the value of the equity in their assets. On the other hand, if the price of palladium and/or platinum skyrockets any time within the next decade, causing the price of SWC and PAL to spike up considerably, you just made an enormous return on your investment.
Both these stocks are basically commodities stocks that are highly cyclical. If you want to see proof, just take a look at the chart on. Consider the prices of PAL stock at various points in time over the past decade:
- Jan 1999 = $0.79
- Jan 2000 = 5.16
- Jan 2001 = 9.19
- Dec 2001 = 3.89
- June 2002 = 7.10
- April 2003 = 2.55
- April 2004 = 11.78
- Sep 2005 = 4.88
- April 2006 = 11.95
- Jan 2008 = 3.28
- Mar 2008 = 9.29
- Oct 2008 = 1.10
The idea I’m proposing here is that you can buy in now, sit on your investment for another decade (if necessary) and simply play the waiting game. At some point, there is another spike in demand or reduced supply and the price jumps back up. One could easily triple their return, or even make a 6- to 10-fold profit if one got lucky enough. Even if it takes 10 years for that happen, it’s a worthwhile investment still. This is a long-term investment and both these stocks are highly volatile, however, so I wouldn’t advise jumping in if you want a quick profit or have a low risk tolerance.
4. Evergreen Solar (ESLR)
Poor beaten-down Evergreen Solar; you almost have to feel sorry for them. While companies like First Solar (FSLR), Energy Conversion Devices (ENER), and even Chinese solar manufacturers like Canadian Solar (CSIQ) shot up during the past few years, Evergreen has been the ignored stepchild of solar.
Perhaps people are overlooking something --- such as maybe a $3 billion backlog. That’s right, a $3 billion backlog. To put that in perspective, in their most recent quarter, they had revenues of $23 million in their most recent quarter Multiply that by four to get a rough estimate of yearly revenues, and that ends up being about 32 times that number.
Of course, this company looks like it’s underperforming if you look at their income statement. They lost eight cents per share last quarter and broke even the quarter before. Who’d want to buy into a company with no profits, right? Unless of course, that company was simply breaking even due to their currently low manufacturing capacity and they were massively upgrading their capacity and they had a certain technology that gave them an advantage over their competitors and they had a $3 billion backlog and they had an equity interest in a sister company that was doing similar things. That might change things a bit, right?
Evergreen recently added 80 MW of capacity in a new facility in Devins, MA. Around the end of 2009, they plan to expand this upgrade so that they have 160 additional MW of capacity online. Compare that to their current capacity of 15 MW. They have additional plans for expansion and they hope to expand all the way to 850 MW at some point in the future. Of course, all this would be for naught if they didn’t have the sells, but with their current backlog, that does not seem to be a problem.
Assuming that Evergreen can slightly improve their margins as greater efficiencies are realized, they could earn anywhere from 15 to 20 cents per share each quarter; even if you play it conservatively and estimate they make roughly 60 cents per share for the year; at a P/E of 10, that would justify a price of $6. That’s just after the first upgrade. Potentially, this company could earn profits of a few dollars per share with 3-4 years and right now, it’s only selling for about $4 per share. Of course, if there is excess capacity in the industry for awhile, as Goldman Sachs recently predicted, revenues could decline and put a dent in that, so it’s not a sure bet, but nothing ever is in the market. It is worth mentioning that the U.S. government recently extended and expanded the solar tax credits. Plus, crystalline silicon prices will probably decline over the next few years, which might help ease any margin pressure.
The good news is that the book value of ESLR’s equity is around $4.2 per share and the stock is actually selling for less than that. They have a working capital ratio of 2.6 and even if we discount their "restricted cash", they have a quick ratio of 1.6. If I go a step further and factor in their slightly negative cash flows from operations, we still end up with a 1.24 ratio. Total debt-to-value is 30%, so they look to be in fairly solid financial shape and at less than book value for a company for huge potential, that doesn’t seem so bad.
5. Chesapeake Energy (CHK)
Talk about a bad week. Chesapeake CEO Aubrey K. McClendon got a margin call and had to sell off his entire stake in CHK. It couldn’t have come at a worse time given that the stock already looked a bit undervalued. Now, it’s trading in the $17 range, despite a brief jump during the early week rally.
CHK's stock has plummeted even faster than the rest of the market. They were trading at about $70 three months ago and recently dipped below $14. That's a huge drop and only partially explained by the aforementioned margin call. The overall market is still in a panic and downgrading everything down below book values. CHK is particularly susceptible to the current fears because they have a lot of leverage --- a 73% debt to value ratio and 0.44 working capital ratio are very scary. Additionally, CHK has absolutely no cash on its balance sheet.
However, the problem with only using those metrics is that a company can be raking in significant cash flows from operations and Chesapeake seems to be in better shape on that front. One might also consider that natural gas seems to be a very good investment right now, with demand likely on the rise. Then, there’s also the fact that the book value of CHK’s equity is 18.85, they have very valuable assets, and they are operating profitably; and yet, they are trading at a discount.
Earnings forecasts look good. The consensus is around $3.89 per share for FY '08 and $4.14 for FY '09. Cash flows from operations are strong. I calculated $5.28 per share for the previous quarter. While they were cash flow neutral for that quarter, it was largely due to spending on investments, which is probably a good thing.
Overall, even with all of the negative, I'm looking at this as a lower-risk opportunity than it would normally be. Worst case scenario --- their assets are worth more than what they are trading at. They are raking in cash flows from their operations, have significant earnings potential right now, and appear to be in a very good industry at the right time.
6. Titanium Metals (TIE)
The first thing to like about Titanium Metals is that they manufacture titanium (as you were probably able to ascertain). The outlook for the metal looks fairly good for the future.
The second reason to like TIE is that they are profitable, have decent cash flows, and they are selling only slightly above the book value of their equity.
The third reason to like TIE is that insiders are buying into this thing like there’s no tomorrow.
So we’ve got a company with some potential high-growth in the next few years, selling fairly cheap, and everyone familiar with the operations seems confident enough it to believe the stock could create some good returns. Admittedly, my knowledge about the titanium is somewhat limited, but that sounds like a good formula.
7. Zoltek (ZOLT)
Hi, I’m Troy McClure. You might remember me from previous bullish articles on low-cost carbon fiber manufacturer Zoltek, such as “How I Learned to Stop Worrying and Love the ZOLT”.
In my prior article, I wrote about Zoltek’s strong margins and how I liked their market position. Given the fact that ZOLT has been profitable in recent times, it’s sort of strange to seem now trading around the book value of their equity: $11.07 per share. ZOLT has dipped down below $8 for a short time and seems to have leveled off around $10-11. That’s not a bad price for a company with growth potential as huge as Zoltek.
There are, to be sure, some risks. For one, while there’s no evidence for vast demand destruction for Zoltek’s products, there does appear to be lowered demand for higher-cost carbon fiber that companies such as Hexcel (HXL) sell to the aircraft industry. The problem with this is that it’s possible that those companies could start dumping their carbon fiber at cheaper prices, somewhat undermining Zoltek’s margins. However, this might be more a short-term problem and I wouldn’t recommend ZOLT to anyone but a long-term investor. The real potential for this company is at least two to three years down the road after capacity upgrades. It’s not a certain bet, but below the book value of their equity, the risks end up being substantially downgraded and there could be a very big reward at the end.
Hopefully, that apocalypse is delayed for at least another decade and you can buy into some stocks to be had at a discount right now. As my last article on historic post-market crash returns suggested, if you buy when the market is at the bottom, you can make a very sizable return if you stay in for the long-term.
I can’t say for certain that we’ve bottomed out, but there are many companies out there that look very cheap right now one way or another. Hopefully, my seven suggestions might help you onto the right track or give you a little extra insight into companies you were already looking at. Maybe ten years from now, we’ll all have some pretty decent returns. Or maybe that apocalypse will have come and it won’t even matter.
Disclosure: I am long on PAL, SWC, and ESLR.