Buy These 4 Cheap 'Turnaround' Stocks For Major Upside Potential In 2013

Includes: CHK, DVR, VALE, WFT
by: Trade In Mexico

Buying undervalued and depressed stocks can be very rewarding, especially if you buy just before a potential turnaround occurs in the financial prospects for the company, and/or before a major shift in investor sentiment towards the company reverses and goes positive. In the past year or so, we can look back at numerous examples of very undervalued stocks that many investors viewed negatively and sold or simply refused to buy. Just consider Bank of America (NYSE:BAC) shares, which made major gains in 2012, or Genworth (NYSE:GNW), which has more than doubled in recent months. These companies (in various ways) created a turnaround in the stock price, and investors who bought before investor sentiment turned very bullish made lots of money. With that in mind, here are four stocks that could be poised for a similar turnaround in 2013, and potentially much higher share prices:

Cal Dive International, Inc. (NYSE:DVR) shares appear to be trading at dirt-cheap levels at just around $2 per share, as of this writing. This company was hit hard by a couple of major events in the past few years, which decimated the stock price. However, now could be the perfect time to buy cheap before the rest of the market recognizes the turnaround potential that seems likely for this stock and company.

First of all, there was the financial crisis that started in 2008. This created a major recession, and caused oil prices to drop by about 50% from the highs set just before the crisis. Lower oil prices reduced demand for drilling and new exploration projects. Next came the oil spill in the Gulf of Mexico, which resulted in the hasty decision by the U.S. Government to ban new drilling in this region. That created another round of pain for just about every oil company that operated in the Gulf of Mexico, including Cal Dive. However, drilling in the Gulf is now returning to normal levels, and the economic pain caused by the financial crisis appears to be fading. While these past events were very tough on Cal Dive and other companies, the company has survived, and this may have created a huge opportunity for investors who buy this stock now, before a potential turnaround is recognized by the market.

Cal Dive provides a number of key services to the oil and gas industry, which include offshore construction, inspection, maintenance, repair and decommissioning of pipeline infrastructure. Major oil and gas companies need Cal Dive's manned diving, derrick, pipe installation and other services on a regular basis for both maintenance and new projects. Cal Dive has been in business since 1975, and before the financial crisis, it was solidly profitable, and the stock traded for more than 10 times the current price. Unless another global financial crisis and a Gulf of Mexico shutdown occurs soon, the bad events of the past seem to be behind this company. Because of this, it makes sense to look at the earnings power this company might have going forward, so let's look at what the company earned (or lost just after the crisis) in the past several years. (This gives us a chance to see how the financial crisis and the drilling moratorium impacted the company, and also consider what the company earned in the "normal" years before):

2011: A $66.9 million loss, or 73 cents per share loss.
2010: A $315.85 million loss, or $3.47 per share loss.
2009: A $76.63 million profit, or 81 cents per share.
2008: A $109.50 million profit, or $1.03 per share.
2007: A $105.60 million profit, or $1.24 per share.
2006: A $119.41 million profit, or $1.91 per share.
2005: A $37.73 million profit, or 61 cents per share.

Now let's look at a recent earnings report, which shows major signs of improvement and indications that management is serious about a turnaround, as they plan to implement expense reductions and the sale of non-core assets, which could raise an estimated $9 million.

For the third quarter of 2012, the company reported losses of $15.9 million, or 17 cents per share. This is a big improvement when compared to a loss of $34.4 million, or 37 cents per share for the third quarter of 2011. Furthermore, the third quarter loss of $15.9 million for 2012 is even better news than it seems after you consider that it included a $14.8 million after-tax, non-cash impairment charge related to certain non-core assets that are part of the restructuring plan. The third quarter loss also included a $5.4 million after-tax non-cash benefit related to the adjustment of the fair value of the derivative liability associated with the company's convertible debt. If you back out these one-time charges, it appears that the company would have actually posted a solid profit for the third quarter of 2012. That means the company could be poised to report profits soon, especially since it expects the restructuring plan to lead to savings of about $15 million annually.

Guidance for the fourth quarter was positive, and indicates profits could likely be seen soon, as the company said: "We currently expect our fourth quarter 2012 consolidated EBITDA to exceed the third quarter." If the company would have reported a profit in Q3 without certain charges, it seems likely to report a profit in Q4, as it expects higher sales. It also stated more good news, which is that contracted backlog was around $224 million as of September 30, 2012. That is a significant amount of future revenues for a company that has annual sales of about $450 million.

Now let's consider some valuation metrics that also make this stock look incredibly cheap: With about $450 million in annual sales, that is equivalent to almost $5 per share in revenues. The debt load is just around $139 million, which is conservative for a company with about $450 million in annual sales. It is trading below book value, which is about $3 per share. Another big positive is that this company presumably has some major tax losses it can carry forward due to the losses it had in the past couple of years. That could temporarily eliminate or reduce taxes in the future.

According to, there are about 15.6 million Cal Dive shares short. With about 765,000 shares trading on an average day, the short position is equivalent to about 20 days worth of trading volume. The shorts have certainly been right on this stock for the past couple of years, and risks do remain since the company has not recently reported consistent profitability. However, the future is looking much brighter and unless the Gulf of Mexico is shut down again, and/or if another global financial crisis hits, shorts could now be living on borrowed time and see a reversal of fortune. With less than $2 worth of downside in this stock and with the signs of profits coming, this stock appears to have an extremely positive risk to reward ratio for longs.

If this company reports a profit in the next couple of quarters, the shorts could fuel a major short-squeeze rally. In addition, I think the shorts are underestimating the potential for Cal Dive as a takeover target. There are quite a number of cash-rich companies that might consider this company as an attractive acquisition, and with a current market capitalization of around $162 million, it is very affordable, especially with low interest rates and money sitting around earning next to nothing for many corporations.

While it is still too early to call a complete turnaround for this company, there are strong signs that it is now at a major inflection point. With a dirt-cheap valuation, a stabilization in sales after the financial crisis and the Gulf of Mexico moratorium, a restructuring plan underway, a very strong backlog, and a history of significant earnings power, this stock could become a multi-bagger. I believe if management executes, there is no reason why this stock can't head back to over $10 (as it has in the past), and earn $1 or more per share in annual earnings in the not too distant future. The global offshore drilling industry is expected to post strong growth through at least 2016 due to a drilling recovery in the Gulf of Mexico and increased demand for oil. That means Cal Dive could once again have the wind at its back and see good times ahead.

Chesapeake Energy Corporation (NYSE:CHK) shares once traded for over $60 per share in 2008, but the financial crisis of 2008 and weak natural gas prices have taken a toll on this stock, which now trades for about $17. Some investors also became even more soured on this stock in 2012, after it was disclosed that CEO Aubrey McClendon had interests in some of Chesapeake's projects. That put further pressure on the stock, but it also caused the board to take action, and it added industry veteran Archie Dunham as a director. This and other factors could make this stock a turnaround play for 2013.

The drop in the stock price also attracted billionaire investor Carl Icahn to buy a significant stake, as he now owns about 9% of the entire company. Mr. Icahn is known to be an activist investor, and he is likely to use his involvement and investment in this company as a way to push for asset sales, a takeover of the company, or other events that could unlock shareholder value.

Chesapeake shares look undervalued when considering a number of valuation metrics and its oil and gas reserves. The stock trades below book value, which is $19.03 per share. Analysts expect earnings to turn around and jump from about 48 cents in 2012 to $1.24 in 2013, and as the company focuses on increased production, earnings could continue to rise in the coming years. The company is also focusing on cutting costs, which could help boost profits in the coming quarters. For example, Chesapeake has announced a voluntary separation program for 275 employees in an effort to reduce expenses.

Chesapeake has some of the most valuable oil and natural gas assets in the United States, with high potential projects in the Eagle Ford, Marcellus, Haynesville and Bossier ranges. As such, it is the second-largest producer of natural gas, and also one of the largest producers of oil and natural gas liquids. The company is expected to consider asset sales to reduce debt and boost shareholder value. Some analysts believe that a major oil and natural gas company like Exxon-Mobil (NYSE:XOM) could be a likely suitor for Chesapeake's assets, and Exxon has a strong history of buying assets and companies that it finds attractive.

Chesapeake investors do face some risks, including the possibility that natural gas remains weak. That seems to be the biggest risk to a sustained turnaround now, however, with the recent signs of improvement in the U.S. housing and jobs market, it seems less likely for natural gas to see a major drop from current levels. Another risk factor is debt. This company has about $142 million in cash, and a debt load of about $16.46 billion. That can lead to increased risks for shareholders, but so far, the company has managed this level of debt. If it succeeds in raising cash through asset sales, it can reduce this debt load to more conservative levels. With Carl Icahn involved, the possibility for asset sales, and the board seemingly more focused on creating shareholder value, 2013 could be the year when Chesapeake shares see a sustained turnaround.

Weatherford International Ltd. (NYSE:WFT) provides offshore drilling and other services to the oil and gas industry. This stock was making new highs in 2008 as oil prices surged and investor interest in the oil services sector was strong. Weatherford shares went over $40 that year, just before the financial crisis hit. However, it has been a tough ride for many investors ever since, and the stock now trades around $12, as of this writing. However, some of the issues that have impacted the company and the stock negatively over the past few years seem to be fading, and that means it could be a turnaround stock in 2013.

Last year, the company announced a restatement of earnings, which could involve about $225 to $250 million in adjustments, and a $100 million charge related to multiple government agency probes, which include investigations for Iraq's oil-for-food program, as well as possible non-compliance with the Foreign Corrupt Practices Act. These announcements were not welcomed by many investors, and the stock drifted lower into late 2012. However, it seems that investors are willing to look past those issues now and focus on the future. The stock has started to trend higher in 2013, and it is now well above the 52-week lows that it hit in late 2012.

While potential accounting and other risks remain for this company and the stock, it could be poised to rise once investors get beyond the restatement and other issues that have kept a lid on the share price. It is also important to consider that Weatherford has about $365 million in cash and around $8.9 billion in debt. This is a significant debt load that should be considered as an increased risk factor, even if industry conditions are improving and indicating a potential turnaround. However, this company has managed that debt under difficult conditions during the financial crisis, so it does seem manageable. This stock could be an ideal turnaround pick as Weatherford puts some of the company-specific issues it announced last year behind it, and as the global economy shows signs of improvement.

Analysts at Macquarie recently named Weatherford a top pick for 2013 due to its earnings power and margin growth potential from drilling, construction, and formation evaluation. The analysts gave the shares an outperform rating and set a $17 price target. That would give investors buying now gains of nearly 50% if the target price is reached.

Vale S.A. (NYSE:VALE) shares were in a downtrend for much of 2012, but the stock has started to show signs of a turnaround, and it looks like an ideal investment to buy on dips going forward. Vale is a leading producer of iron ore, which is a key component in manufacturing steel. When the global economy was looking weak in 2012 due to the European debt crisis, the U.S. Fiscal Cliff, and slowing demand in China, iron ore prices dropped significantly. That has caused margin pressures for companies like Vale, and investors soured on the stock.

China is one of the world's largest consumers of steel since it is used for infrastructure, construction, autos and much more. The slowdown in China was a leading cause of demand reduction for iron ore in 2012. However, the Chinese Government responded quickly by lowering interest rates to boost economic activity. Plus, government officials also approved $156 billion worth of infrastructure projects in 2012, which is likely to result in higher demand for steel and iron ore as these projects get underway.

Europe is one of China's top export markets, and since the worst case scenario has not played out in Europe, it seems that exports to the region should remain at least stable in 2013. This stabilization might reduce investor concerns that China could be hit by a hard landing in which internal growth takes another leg down. Of course, risks remain, but the main risk of declining iron ore prices seems to be fading rather quickly. That means management execution and possibly regulatory or political risks could remain (such as perhaps a China import duty on Brazilian iron ore).

Analysts at Citigroup (NYSE:C) are now predicting that investor interest in gold will decline, and that investors could get more excited about industrial metals like iron ore. A recent Barron' article said the rebounding economy in China is a catalyst for investing in iron ore.

Citigroup is not the only leading investment bank that is expecting a major turnaround in iron ore demand. Goldman Sachs (NYSE:GS) recently pointed to the rising price of iron ore, and feels that Vale shares are undervalued. It set a price target of $29.30 for Vale, and it believes the company could be poised to raise its dividend in 2013. Vale offers a current dividend yield of about 3.1%, which is above average, and this will pay investors to hold the stock while waiting for a complete turnaround in iron ore and a higher share price in the future.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DVR, VALE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.