Editors' Note: This article covers one or more micro-cap stocks. Please be aware of the risks associated with these stocks.
This is a good time of year to accumulate cheap stocks that are probably being pressured by tax-loss selling. Many investors have strong gains in the stock market and with only a few weeks left before the end of the year, this is when stocks that have been "losers" are sold in order to offset gains in other investments. This tax-loss selling pressure often fades in the last days of December and many beaten-down stocks end up experiencing what is known as a "Santa Claus" rally. This provides an ideal buying opportunity in many stocks for investors who are willing to buy depressed names at this time.
Because of this, I am now mostly focused on buying stocks that could be poised to rally into the New Year which is now just four short weeks away. For example, I recently wrote about how the end of tax-loss selling could benefit beaten-down shares of Barrick Gold (ABX) at just over $16 and American Superconductor (AMSC) shares at just around $1.60, (which may also benefit from a settlement over $1.2 billion in legal claims), but there are also high-yielding stocks that could be poised for significant gains.
With this in mind, here are two oversold stocks (see charts below), which appear undervalued after a recent pullback, offer high yields and also could be poised for a rebound into January as tax-loss selling ends:
Eagle Rock Energy Partners, L.P. (EROC) is a master limited partnership or "MLP" that is engaged in the acquisition and operation of oil and gas properties, natural gas gathering systems, and natural gas processing plants. As an MLP, it offers tax advantages and a high yielding distribution to shareholders. A recent cut in the quarterly distribution from 22 cents to 15 cents, caused quite a pullback in the stock. This stock was trading around $7.50 in October, but it has since dropped to about $5.22 per share. However, the sell-off appears overdone and this is creating a buying opportunity for investors who seek either short-term potential gains from a rebound, or a very high yielding stock for the long term. Let's take a closer look at the company and investment potential for this stock:
Eagle Rock has both "midstream" and "upstream" divisions. The midstream division owns natural gas gathering and processing assets in four significant natural gas producing regions which include: the Texas Panhandle, East Texas, Louisiana, South Texas and the Gulf of Mexico. The midstream division has approximately 8,134 miles of pipeline, 20 processing plants and around 787 MMcf/d of plant processing capacity. The upstream division includes long-lived, high working interest properties with development opportunities located in several regions within the United States, which include: Southern Alabama, Mid-Continent, which includes areas in Oklahoma, Arkansas, the Texas Panhandle and North Texas, and the Permian Basin which includes areas in Texas and Mississippi. These upstream properties are comprised of: 559 gross operated productive wells and 1,249 gross non-operated wells. It has proved reserves of 350 Bcfe with approximately 56% natural gas, 22% crude oil, and 22% natural gas liquids.
While the news about the cut in the distribution is a short-term negative, it is in many ways a long-term positive. Many investors and analysts believed that the company needed to cut the distribution and this could have weighed on the stock for a while, but the news is out and the company now has a far more conservative yet still generous distribution that yields around 12%. This recent distribution cut appears to reduce a major downside risk that investors have to consider, especially with high-yielding stocks. Other downside risks to consider are fluctuations in the price of oil and gas. However, Eagle Rock has hedging programs in place which reduce these types of risks.
In spite of the recent distribution cut, there are a number of positives to consider: For the third quarter in 2013, the company reported adjusted EBITDA of $62.8 million. This was an increase of approximately 12% when compared to the $55.9 million reported for the second quarter of 2013. It also reported distributable cash flow of $24.9 million, which was an increase of approximately 10%, when compared to the $22.8 million reported for the second quarter of 2013. Furthermore, the company made these positive comments in regards to the new distribution policy: "Distribution coverage was approximately 1.05x for the third quarter of 2013, and management expects coverage to increase over the next several quarters." This means that management expects the current distribution to be sustainable and that makes the recent pullback look like a buying opportunity as the yield of about 12% is still very compelling.
Another reason why this stock appears undervalued is the upside potential it may have as a takeover target. As one recent article details, there has been a wave of merger and acquisition activity in the MLP sector and Eagle Rock might be more valuable if it were to spin off or sell assets or even put the entire company up for sale. The article states:
"This presents a very compelling buyout thesis for the partnership, however. Theoretically, Eagle Rock could court multiple suitors: E&Ps for its producing assets and pipeline companies for its midstream assets. The biggest weakness in the midstream story is its fee-based revenue, but we've already seen impressive turnarounds in that arena. Consider that PVR Partners -- a recent buyout story itself -- managed to increase its fee-based revenue from 30% to 80% in just three years."
While some investors are selling this stock for tax loss reasons or just out of plain frustration, this appears to be the wrong move to make when considering analyst price targets. For example, a November 16, 2013 report from S&P analysts (which reflects the recent cut in the payout) still sets a 12-month price target of $8 per share for Eagle Rock. Consensus price target estimates are even higher at $8.85 per share. Considering that this stock is oversold, and that it appears cheap with a juicy and now sustainable yield, investors who buy now could be poised for significant capital gains in a rebound and get paid a yield of 12% while waiting for a higher share price. With this stock just around $5 now, investors could see upside of about 60% in capital gains alone if the S&P $8 target is reached.
Here are some key points for EROC:
- Current share price: $5.22
- The 52-week range is $5.05 to $10.52
- Annual dividend: 60 cents per share which yields about 12%
Annaly Capital Management, Inc. (NLY) is a leading mortgage real estate investment trust or "mREIT". This sector has had a very difficult and volatile year due to the concerns about tapering by the Federal Reserve and due to major fluctuations in interest rates over the past several months. These issues have highlighted the downside risks in mREIT stocks and impacted financial results. As such, the company has reduced the dividend. Naturally, this has all caused the stock price to decline well below the 52-week highs of about $16. Annaly Capital shares now trade close to the 52-week low which is $10.30 and this means it is probably getting a fair amount of tax-loss selling pressure at this time of year. This could be creating an ideal buying opportunity for investors who want a stock that can provide a high yield and also has rebound potential into the New Year. In addition, there are other reasons to consider buying this beaten-down stock now:
The recent pullback in Annaly seems to have sparked a round of bargain hunting by company insiders. On November 12, 2013, Kevin Keyes (an officer) purchased 100,000 shares at $10.43, in a transaction valued at $1,043,000. On November 11, 2013, James Fortescue (an officer) purchased 25,000 shares at $10.36 in a deal worth $258,999. On November 8, 2013, Wellington Delehan (an officer) bought 93,000 shares at $10.68, in a transaction valued at $993,248, and this follows up on a purchase of more than 180,000 shares in August for about $11 each, which totaled nearly $2 million. This shows that multiple insiders are investing millions of dollars into this stock at a time when it is trading near the lowest price in years. While many investors may have capitulated and sold this and other mortgage REIT stocks out of frustration, insiders are clearly sending a message of confidence with these significant buys. This is another reason why this stock could be poised to rebound.
Since Annaly Capital has cut the payout to more conservative levels of $1.40 per share, the current yield of about 13% looks far more sustainable. There is always the risk for another cut in the future, however, the insider buying could be a sign of confidence that management does not expect additional cuts any time soon. Other factors might also be signaling that Annaly Capital will be able to produce stable financial results in the future. For example, Janet Yellen is expected to be appointed to head the Federal Reserve and she appears poised to continue the policies that Ben Bernanke has established. That means interest rates are likely to remain at low levels for the foreseeable future and that the Federal Reserve's bond buying program will remain in place which is also good for mortgage REIT stocks. Interest rates could be the single largest risk facing mortgage REIT investors so you should believe that rates will remain somewhat stable (after a recent spike), if you invest in this sector. It is important for investors to remember that since real estate investment trusts pay a large percentage of earnings out to shareholders, any drop in earnings can result in a very quick dividend cut.
Annaly Capital paid the last quarterly dividend of 35 cents in late September, which means the next dividend should be due around the end of December. That means investors who buy Annaly Capital shares now for a potential rebound into January will also be in line for the next dividend payment. This would further reduce an investors "cost basis" and it is one more reason to consider buying Annaly Capital shares as a rebound play into January. Longer term, analysts at Wunderlich have a $12.50 price target, which is close to the book value for this stock, and Compass Point has set a $13.50 price target. Investors who buy Annaly Capital shares at the currently depressed price might be poised for a rebound when tax-loss selling ends in the coming weeks, as well as a very generous dividend yield. With the volatility seen in this stock, it makes sense to average into it over time and keep the position limited to a reasonable level in any given portfolio. This is not a stock to bet the farm on, but investors who average into a position and hold for the long-term income potential, could do quite well.
Here are some key points for NLY:
- Current share price: $10.18
- The 52 week range is $9.86 to $16.18
- Annual dividend: $1.40 per share which yields 13.7%
Disclaimer: Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.