The stocks detailed below represent my five favorite turnaround stock opportunities at the beginning of 2013, arranged in alphabetical order. I chose these five stocks not only because I believe that they all have significant gain potential but also because they are a diverse group of companies. They come from different industries, and have different set of opportunities and risks.
That said, even five stocks is not enough diversification for an entire portfolio. While I believe that these stocks will perform well in 2013, there is no guarantee of that, and they should only be purchased as part of a more broadly-diversified investment program.
Stock Pick # 1:
Cypress Semiconductor (NASDAQ: CY)
Category: Mid-Cap ($1.58 Bil.)
Annual Revenue: $995 Mil. (1/1/12)
Earnings: $168 Mil.
12/31/12 Price: 10.84
12 month Range: 19.25 - 8.70
Est. Dividend Yield: 4.0%
Since its founding in 1982, Cypress has been a niche producer of semiconductors. It has migrated away from commodity-type chips to semiconductors for specialized applications. Today its main proprietary products are semi-conductors for touch screens, programmable system-on-chip products and USB controllers. The semiconductor stocks in general tend to be very cyclical, depending on demand for technology products, and Cypress' stock is particularly volatile. The sector in general is out of favor presently as investors fret about a tech slowdown.
Cypress is adept at identifying growing niches for which to develop products. For example, its leadership in touch-screen chips positions it well for the continuing strength in smart phones and tablets. The company is committed to returning value to shareholders in the form of dividends and stock buybacks. Moreover, top management owns a significant stake in the company. CEO T.J. Rodgers owns more than 12 million shares (nearly eight percent of the outstanding stock), and three other top officers each have more than a million shares. The CFO, Brad Buss, bought nearly $200,000 of stock in the open market in November to add to the nearly 1.4 million shares that he already owned. We expect most semiconductor stocks to rebound and Cypress stock to rebound particularly strongly. Of course, we don't know exactly when that will happen. Therefore, we like the fact that the generous dividend compensates you while you wait.
Stock Pick #2:
Felcor Lodging Trust, Inc. (NYSE: FCH)
Category: Small-Cap ($547 Mil.)
Business: Hotel REIT
Annual Revenue: 946 Mil. (12/31/11)
Earnings: ($1.46) Mil.
12/31/12 Price: 4.67
12 month Range: 5.43 - 2.74
Est. Dividend Yield: Nil
Founded in 1991, FelCor Lodging is a real estate investment trust (REIT) that owns 67 hotels located in 22 states. It focuses on upper-scale properties, and it partners with many of the leading hotel operators, including Sheraton, Marriott, Fairmont and Embassy Suites.
FelCor grew steadily during the mid-2000s, and it went into the recession in 2008 with too many hotels in weaker markets and too much debt. As a result, the stock was crushed in 2008-09, and it has rebounded only modestly since then.
We believe that Felcor is poised to benefit from both industry-wide macro trends and company-specific steps being taken by management. On the macro front, construction of new hotel rooms remains at a historic low. This lack of new competition allows existing hotels to raise their room prices as the economy gradually improves.
On the company level, Felcor is repositioning its hotel portfolio to focus on markets with high barriers to entry and good growth characteristics. It plans to sell a total of 39 hotels, 16 of which have been sold to date. At the same time, Felcor has acquired a few upscale hotels in strong urban markets, and is renovating and repositioning several others. These moves should create value by attracting higher paying customers. So far, Felcor has executed well on its strategic plan. As it continues to do so, it should also benefit from rising room prices across the hotel industry. This should boost profits and push the stock price up significantly.
Stock Pick #3:
Hewlett-Packard Co. (NYSE: HPQ)
Category: Large-Cap ($45 BIL.)
Business: Technology Products
Annual Revenue: $120.4 BIL (10/31/12)
Earnings: ($12.7) BIL.
12/31/12 Price: 14.25
12 Month Range: 30.00 - 11.35
Est. Dividend Yield: 3.8%
In what may be the origin of the classic Silicon Valley garage story, Hewlett-Packard began in 1939 when William Hewlett and David Packard built an audio oscillator in a Palo Alto garage. It has grown into one of the world's largest technology companies, with strong positions in many of the key tech markets, including PC's, printers, storage and services.
After a big run-up in the tech bubble of the late 1990s, the stock has bounced around quite a bit ever since, as the company has struggled to maintain growth. Leadership has been an issue, with a frequently dysfunctional board of directors and four different CEOs since 2005. After hitting a post-bubble high of $54.75 in April 2010, the stock has dropped by nearly 75%.
HP has a lot of the things that we look for in a turnaround: solid core business, well-known brand, decent financials and a change in top management. While some of HP's product lines, such as PCs, have become low-margin, commodity businesses, the company still has plenty of good core products to work with. New CEO Meg Whitman is taking her time to figure out the best strategy for the company - unlike some of her predecessors who tried to jump in and make big, splashy, but sometimes disastrous acquisitions. Whitman is focusing on basic blocking and tackling and reducing costs while she figures out how to reshape the company.
Whitman has plenty of financial resources to support her rebuilding effort. Although the company does have a moderate amount of debt, it also has more than $8 billion in cash and reasonably solid cash flow. HP has reinvented itself several times over its history to reinvigorate its growth. We think it can do it again under Whitman's leadership. While our analysis is less than scientific, H-P right now feels to us a lot like IBM did a couple of decades ago when it transformed itself from a mainframe computer maker into a services powerhouse; and like Apple did in the early 2000s before Steve Jobs rebuilt it into a tech juggernaut.
Stock Pick #4:
MGIC Investment Corp. (NYSE: MTG)
Category: Small-Cap ($518 Mil.)
Business: Mortgage Insurance
Annual Revenue: $1.50 Bil (12/31/11)
Earnings: ($4.86) Mil.
12/31/12 Price: 2.66
12 Month Range: 5.15 - 0.66
Est. Dividend Yield: NIL
MGIC is the leading U.S. private mortgage insurer. In fact, the company claims to have founded the mortgage insurance industry in 1957. After many years of relatively steady earnings, the company was forced to sharply increase its reserves beginning in 2007 as more homeowners began defaulting on their mortgages. As a result, the company posted large losses in each of the last three years, which reduced its capital to a precarious level. Almost all of the other mortgage insurers suffered similar fates, with several competitors being forced out of business. MGIC raised new capital in March 2008 and again in April 2010, and it now appears well situated to lead the mortgage insurance industry out of its depression.
The losses are now receding as the legacy business rolls off and is replaced with profitable newly written business. MGIC recently settled a long-festering dispute with Freddie Mac, thereby allowing it to continue to insure Freddie Mac mortgages. The budding recovery in the housing market helps MGIC in two ways. First, the rise in home prices makes it less likely that homeowners with older policies from MGIC will default. Second, an increase in home purchases provides MGIC the opportunity to write more new business at very profitable rates. There is still some risk that MGIC's pre-2008 business will cause regulatory problems, but we believe that risk is small compared to the substantial gain potential in the stock as the housing sector continues to recover.
Stock Pick #5:
The Wendy's Company (NASDAQ: WEN)
Category: Mid-Cap ($1.86 Bil.)
Annual Revenue: $2.43 bil. (12/31/11)
Earnings: $17.9 Mil. (from cont. ops.)
12 month Range: 5.50 - 4.09
Est. Dividend Yield: 3.4%
Wendy's began in 1969 as a single restaurant in Columbus, Ohio, named after founder Dave Thomas' daughter. Now it has more than 6,500 restaurants in the U.S. and 27 other countries. After carving out a niche in the fast-food industry based on good quality food and service, Wendy's has faltered in recent years, suffering from a stale menu and image. The company was acquired by financier Nelson Peltz in 2008, who tried combining Wendy's with the Arby's chain, which he already owned.
Wendy's is another company with a number of the characteristics that we like to see in a turnaround situation: a well-known brand, renewed focus, a new management team with turnaround experience, decent financials and a large shareholder with a lot at stake. After selling off the Arby's franchise last year, the company is now solely focused on the Wendy's brand. In late 2011 the company brought in Emil Brolick as its new CEO. Brolick has a long and successful career in the restaurant business, including a previous stint at Wendy's where he helped engineer an earlier turnaround beginning in the late 1980s. Brolick is committed to restoring Wendy's quality image, with particular emphasis on bringing back adult customers who have been lost in recent years. Early efforts to remodel and re-image certain locations are showing impressive results.
Brolick is also moving into the lucrative breakfast segment, which Wendy's has missed out on until now. Although there is a fair amount of debt on the balance sheet, the financials look solid enough to support Brolick's turnaround strategy. The company recently increased its dividend and initiated a stock buyback program. Peering over management's shoulder is Mr. Peltz who owns almost 100 million shares and has a big incentive to make sure things get back on track at Wendy's.
Additional disclosure: Accounts managed by an affiliate of the Publisher (George Putnam) own Felcor Lodging's stock.