Where To Find Bargains In Over-Extended Equity Markets

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 |  Includes: BIDU, CF, CMRE, DSX, FXI, MOS, NAT, NM, NMM, POT, TNH, TNP
by: BubbleBustInvesting

While not everyone thinks equity markets are over-extended, bargains are hard to find, especially among technology stocks that have revived NASDAQ. That's why investors should look into out of favor sectors -- like shipping, fertilizers, and Chinese Internet companies.

Shipping

Shipping has been out of favor for more than four years, for a good reason: a slow-down in world economic growth, combined with excess capacity, has taken its toll on shipping rates. But lately, the Baltic Index has come back to life, driven by a revival of the Chinese economy. I like Navios Maritime Partners (NM), a diverse operator of dry cargo ships, and believe it has the best appreciation potential. The company enjoys a 37.42 percent operating margin and 4.80 percent quarterly revenue growth. In addition, NMM pays a hefty 11.71 percent dividend.

NM's secret? Long and medium leases that have sheltered the company from the wild fluctuations in the Baltic Dry Index. That's not an accident. NMM is run by an experienced management team (Frangos family), which holds a 20 percent in the company. The Frangos family furthermore has a long tradition in the Greek shipping industry - which leads the industry world-wide, both in terms of number of vessels and tonnage.

Company

Nordic American Tankers (NYSE:NAT)

Tsakos Navigation (NYSE:TNP)

Costamare (NYSE:CMRE)

Diana Shipping (NYSE:DSX)

Navios Maritime Partners (NYSE:NM)

Navios Maritime Partners

P/E

N/A

18.40

8.91

N/A

7.12

24.36

Quarterly Revenue Growth (yoy)

-43.30%

-4.40%

-8.50%

-26.00%

29.20%

0.10%

Quarterly Earnings Growth (yoy)

N/A

N/A

0.80%

N/A

N/A

17%

Operating Margin (%)

-57.89

6.50

39.40

20.66

5.69

40.04

Return on Assets

-3.75

0.63

4.08

1.58

0.52

5.71

Debt/Equity

31.74

154.55

331.70

32.42

117.55

36.05

Cash Flow

-21.23M

N/A

167.57M

N/A

341.82M

170.69M

Click to enlarge

Source: Yahoo.Finance.com

A few words of caution: China's economic growth faces several headwinds both at home and overseas. At home, the headwinds come from a massive waste of economic resources in construction projects, pursued for the purpose of creating jobs rather than serving a felt consumer need. Overseas, the headwinds come from anemic growth in Europe, China's largest export market.

Fertilizers

Fertilizer stocks have been on a rough ride in recent months. At the end of July, they were on an upswing, following news that hedge fund manager Daniel Loeb took a stake in CF Industries (NYSE:CF). A few days later, they were sharply lower, following the news that the marketing cartel which helps the industry maintain high prices for fertilizer products is breaking down. Meanwhile global fertilizer prices and revenues are declining--Potash and CF industries have already seen a double-digit revenue decline (see table).

Company

Dividend Yield (%)

Forward P/E

Operating Margins (%)

Qtrly Revenue Growth (yoy)

Qtrly Earnings Growth (yoy)

Potash Corporation (NYSE:POT)

4.40

14.16

38.33

-12.10%

23.20%

The Mosaic Company (NYSE:MOS)

2.40

--

22.85

-4.5

-4.20

Terra Nitrogen (NYSE:TNH)

7.80

--

74.24

13.80

31.90

CF Industries

0.70

10.33

48.97

-12.50

10.30

Click to enlarge

Now the dust is settling, however. Barron's market commentator Vito J. Racanelli thinks that the correction in the stocks is overdone. "So far, the Russians and Belarusians are still not cooperating, and spot potash trades at about $380; contract prices are probably around $30-$40 a ton lower. Soft demand growth around the world hasn't helped. Nevertheless, since our original piece ran, Potash's stock is up about 10%, to $32.14."

We couldn't agree more, for four reasons. First, a few major players, which enjoy hefty profit margins, dominate the sector. CF Industries, for instance, enjoys an operating margin of 48.97 percent, while Terra Nitrogen is enjoying an operating margin of 74.24 percent, and pays a hefty dividend of 7.51 percent. Second, the sector is subject to economies of scale and strict environmental requirements, which restrict the entry of new competitors. This means that whatever price pressures follow the breaking of the marketing cartel will be limited. Third, cartels undergo periods of crisis that are eventually resolved as soon as overall demand conditions improve. Fourth, Potash and Terra pay a good dividend payout, which makes them an attractive investment in a low-interest environment.

In short, the breaking of the marketing cartel may limit the pricing power in the fertilizer industry, making a dent in the revenues and profits of fertilizer producers. But it won't eliminate the market power of major players.

That's why the sell-off is a buying opportunity for value investors.

Chinese Internet Stocks

Suffering from price wars and accounting woes, Chinese stocks have missed out on the global equity rally. But a few Internet companies deserve a second look. I particularly like Baidu (NASDAQ:BIDU). Recently, the company reported total revenues of $1.453 billion, a 42.3 percent jump - following Google's lead. Net income reached 8.92 billion yuan or $498 million compared to 2.64 billion yuan ($431 million) last quarter. The stock was trading sharply higher (+6 percent in after-hours).

Baidu's stock has been held down by negative sentiment for Chinese equities - as an example, iShares China ETF (NYSEARCA:FXI) is down close to 4 percent in 2013. But after gaining close to 28 percent in the last three months, the question is whether the market has already discounted the good news, and whether investors should take money off the table.

The answer depends on the investment horizon of each investor. Short-term investors may want to take some money off the table. Long-term investors may want to stay with the stock, as the company continues to take strategic initiatives to strengthen its competitive position in the Chinese online market. In late July, the Baidu acquired app maker 91 Wireless for $1.9 billion. This move will allow Baidu to expand the scale and scope of its operation, adding 3 percent, according to Citigroup's analystMuzhi Li.

With 560 million Internet users spending 20 hours a week online, China is by far the largest Internet market in the world -- more than twice the size of the U.S. market. The trouble, however, is that the Internet market is brutal, and most companies in that market fail to monetize their business model. But there is an exception to this rule: Early movers which have amassed economies of scale and scope like Baidu, which has managed to maintain steady profit margins.

Disclosure: I am long DSX, NMM, TNH, TNP. 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.