Seeking Alpha
Newsletter provider, deep value, long/short equity, commodities
Profile| Send Message| ()  

Introduction

Stocks with an ugly performance or companies that go broke offer lessons for free to all the investors. This is why I am always studying the companies that fail to deliver. These cases school me, and help me evolve as an investor.

In the first part of this series, I analyzed several companies that have more downside than upside, despite the bullish calls of the analysts or the media. One of these companies was GMX Resources (GMXR), which confirmed my bearish call at $3.10 in a record time. The stock dropped 20% in just two days after my bearish call, due to several reasons, including a notification of non-compliance with one of the criteria for continued listing standards from the NYSE and an SEC filing regarding a failure to pay interest on its Senior Secured Second-Priority Notes, due 2018.

No matter what the hype says, I am always focused on fundamentals, which have saved me a lot of money during my 23 years of investing in the markets. For instance, this is the reason why I was also very bearish and shorted Halcon Resources (HK) at $8 just a couple of weeks ago. The comments section of that article shows how the bulls were opposed to my factual analysis back then. Halcon Resources is at $6.5 just 20 days later.

My study of the fundamentals also helped me to avoid investments in Circuit City, ATP Oil, A123 Systems or Delta Petroleum. All of them have filed for bankruptcy.

This being said, I am very bearish on the following companies, which are for investors with a higher-than-average risk tolerance.

The Companies

1) BPZ Resources (BPZ): BPZ drills primarily in Peru, but also has assets in Ecuador. It trades above its book value (PBV=2), which is not justified by its fundamentals. This energy producer has been reporting quarterly losses for four consecutive quarters due to higher costs related to exploration, along with lower production.

I expect losses for Q4 2012, as nothing has changed in comparison to Q3 2012. Moreover, the operating cash flow has been negative on a quarterly basis since Q1 2012, and I expect it to remain negative for Q4 2012. The revenues are also declining, because the production has been in a decline since early 2012.

Additionally, the level of indebtedness does not make me feel comfortable. BPZ was carrying approximately $380 million in long-term debt as of Q3 2012. The company received the remaining $85 million of cash from Pacific Rubiales (OTCPK:PEGFF) in Q4 2012. Assuming all this cash goes to the bank line, the long-term debt will go down to approximately $300 million.

However, BPZ will remain heavily leveraged with a debt to equity ratio of 175%. The company has a projected CapEx at $106 million for 2013. Pacific Rubiales will cover $79 million as part of its recent agreement with BPZ, but the remaining $27 million will have to be covered by BPZ.

The current production of 1,533 bopd is not going to rise significantly, at least for the first half of 2013, due to the lack of any near-term major catalyst, based on today's corporate developments. Due to the natural declines, the production will fall, negatively impacting the cash flow. Eventually, the quarterly operating cash flow will remain negative, and I expect it to go deeper into the red during the first half of 2013.

Thus, a cash-raising strategy will likely take place soon. As the D/CF ratio is already bad, the company will most likely raise cash by issuing new shares. The extent of the dilution remains to be seen, but I expect it to be 10% at least. If the company issues 12 million shares (10% of the total outstanding shares) at the current price, it will receive approximately $30 million.

However, there is a good thing about BPZ. It operates in Peru, where the political environment remains stable and any threat of nationalization is overblown. Humala is no Chavez, and Peru is not Argentina, where the nationalization fear truly exists, as analyzed in one of my previous articles.

2) Bon-Ton Stores (BONT): Bon-Ton is one of the oldest companies of the retail sector. It was founded in 1898, and it currently operates 272 stores, including furniture galleries. It also offers a broad assortment of national and private brand fashion apparel and accessories for women, men and children, as well as cosmetics, fine jewelry and home furnishings.

Bon-Ton is one of the U.S. retailers that has not managed to turn things around yet. The company's long-term debt has been growing during the last few quarters, and it stands at almost $1 billion as of Q3 2012.

In the meantime, the continuing losses have brought the stockholder equity from $131 million in Q4 2011 down to $40 million in Q3 2012. This is a big drop in just 9 months, and this drop boosted the long-term debt/stockholder equity ratio from 6.64 in Q4 2011 to 25 in Q3 2012. Actually, the net tangible assets have already turned negative since Q1 2012, and they stand at $73 million in Q3 2012.

On top of that, the company has negative operating cash flows for the first nine months of FY 2012. It is worth noting that the operating cash flows for Bon-Ton were positive during FY 2009-2011, although they were declining at a 25% pace year over year, which was an ominous sign.

On the revenue front, the top line has also been declining since FY 2011. According to the latest company's projections, total sales in the 14 weeks ended February 2, 2013 increased 3.2% to $1,015.1 million, compared with $983.2 million in the 13-week period last year. This brings the revenue for 2012 to approximately $2.94 billion, which is slightly lower than the 2011 revenue.

Both the operating profit and the EBITDA have also turned negative for the first nine months of FY 2012. The company also projected recently that it will have losses for the entire FY 2012.

Obviously, this is a very bad mix of data, and the ongoing minor restructuring is not enough. This is why I believe that the dividend is at serious stake, and it will most likely be cut in 2013. This may prompt income investors to exit the stock, as happens anytime when a dividend yielding company cuts its dividend.

However, the dividend cut is not the main problem for me. The main problem is that the company will have to either borrow more money or dilute significantly soon to keep its operations moving forward. The company trades well above its book value at PBV=5 currently, but as I explained above, a severe correction is about to come, as the fundamentals do not justify this rich premium.

3) Uranium Energy (UEC): This is a U.S.-based uranium production, development and exploration company operating an uranium mine in Texas. Uranium Energy will continue to face the aftermaths of the disaster in Fukushima. This is a major drawback for its future, and a revival in uranium demand is not on the horizon, at least for the short term. This is why the uranium prices will keep struggling for several years ahead.

If we take into account the ongoing shale gas boom in the U.S. and the upcoming LNG investments, the future for this environmentally friendly fuel looks bright, fading any hopes for the revival of uranium. As a flagship to support their bullish case, the uranium bulls use the recent fact that Japan is thinking of bringing its currently idled reactors back online.

However, there are several substantial reasons opposing this bullish case. While the Japanese government is thinking about bringing idle reactors back online, government changes very often in Japan. Even if Japan proceeds with plans to bring the idled reactors back online, it will take time, and it will not happen overnight. Additionally, Japan's efforts alone are not enough to turn things around for the entire uranium sector and boost uranium prices. Several other countries are not willing to jeopardize their future, even if Japan uses some of its idled reactors. Fortunately, there are other cheaper, safer and abundant fuels.

In the meantime, uranium mines are expensive endeavors, and they are capital intensive investments, including the company's Palangana mine. Uranium Energy will also need cash for the Goliad in-situ recovery project, which is now fully permitted and in construction.

The company has negative operating income, and even the gross profit is marginal, hurting the bottom line. The operating cash flows have been negative, and they are deep in the red currently, eroding the company's cash resources, which have dropped 50% since April 2012.

All this being said, UEC is not going to remain debt-free for long. It is burning cash, and if UEC does not choose to load its debt line, it will need to dilute its shares in order to finance its operations. I am guessing the company does not want to run out of cash. Either way, the balance sheet will worsen significantly during the coming months, and eventually, the current premium (PBV=3) will most likely be negatively impacted.

4) Avalon Rare Metals (AVL): Avalon is a company that is far from potential production. Avalon Rare Metals is a mineral development company focused on rare metals deposits at its project, the 100%-owned Nechalacho Deposit in Canada. Avalon CEO Donald Bubar made it clear that accelerating the production date simply isn't feasible, and production will be on hold until at least 2015.

The company is another victim of the fact that the rare earths industry struggled in 2012 as a flood of new production and reserves from outside China has seen prices significantly drop from their highs in 2011. The Market Vectors Rare Earth/Strategic Metals ETF (REMX) has fallen 7.5% year-to-date, and over 30% in the past year.

This deterioration in rare earth prices, and the eventual shakeout in the industry, are also a result of the industry's attempts to find alternatives. For instance, Toyota Motor (TM) announced that it would look for ways to build hybrids and electric vehicles without rare earth elements.

Avalon is debt-free, and so things are good from a debt perspective. However, the revenues are negligible, the company is losing money and the operating cash flow has been negative for many quarters now. The operating cash flow will remain negative because, as mentioned above, production is not expected anytime soon.

Avalon had $25 million cash as of November 2012. The company seems to be burning cash quickly, because it had $38 million in August 2012. This is why I believe that substantial dilution and/or debt are coming in 2013, and the potential buyers have to be prepared for such news. If a joint venture partner shows up, this will be a boon for the shareholders.

5) Rare Element Resources (REE): Rare Element Resources is another mineral exploration company in the rare earths industry. This is why the majority of my comments above about Avalon also apply to this company. Rare Element Resources was created to develop the Bear Lodge rare-earth-element and gold deposits in northeast Wyoming.

Rare Element Resources does not have any revenue, and there is not likely to be any revenue stream for the next two years, to say the least. In the meantime, the net earnings are actually net growing losses, and the operating cash flows are negative on a quarterly basis.

The company has approved a budget of approximately $25 million for 2013, while the corporate cash was almost $40 million in late 2012. The majority of the budget will be focused on the development of the Bull Hill and Whitetail Ridge rare earth resource areas.

As this company will be burning cash for the next two years minimum, a dilutive event will have to take place in 2013. A financing will allow this Colorado-based explorer to continue funding its exploration costs. This is a typical example of an exploration company without short-term production. This is why further downside is coming, bringing the current market cap of $100 million closer to the steadily diminishing stockholder equity.

Conclusion

This was the second and last part of this series, the purpose of which was to identify hot potatoes, a.k.a. stocks with strong downside potential, based on their fundamentals as of today. All 10 stocks in this series are for investors who have a strong stomach.

That said, I also believe that there are plenty of compelling stocks out there, which have the potential to perform better than the stocks above. For instance, Surge Energy (OTCPK:ZPTAF), which I analyzed in late January 2013, when it dropped below $4. Rock Energy (OTCPK:RENFF) is also another company with strong upside potential, as mentioned in another article. When I recommended Rock Energy, the stock was at $1. However, the list of compelling stocks doesn't end there, and readers will have the opportunity to check out more opportunities in my future articles.

Source: I Told You So: These 5 Stocks Have More Downside Than Upside (Part II)