At the end of every year, we all want to know what will be the hot stocks the next year. While nearly impossible to predict, one thing we can see is patterns in stocks that breakout year/year. The potential reasons to see big gains include new product hitting the market, reversal from previously negative view, or momentum carrying stocks into richer valuations. Today, we are identifying four of these stocks that we believe have the potential to make significant moves - Quiksilver (NYSE:ZQK), Facebook (NASDAQ:FB), Reed's (NYSEMKT:REED), and Blackberry (NASDAQ:BBRY). ZQK and BBRY are in the midst of turnaround stories that we believe could come into fruition in 2014 with valuations that suggest lots of potential upside. FB is a momentum name that we believe can continue its incredible run, and Reed's is a company on the brink of being behind what we believe could be a major food fad in 2014 that could lead to significant upside.
In this article, we will lay out the current makeup of each company's stock, the reasons we like it for 2014, and do a simple valuation for you on what could lead to 100% in potential gains.
ZQK is in the midst of a multi-year turnaround after the company found itself struggling significantly in the Recession and out of it. The company was mismanaged, had over 10,000 different designs, added unprofitable subsidiaries, and was struggling to turn a profit. In May of this year, the company laid out a multi-year turnaround plan to cleanse the company of unprofitable segments, reduce SG&A costs, streamline the business, and refocus on the company's core business. By doing this, they were hopeful to increase margins, grow sales, and return value to shareholders.
So far, the plan has gone decently. With such a significant overhaul in the works, the company still has a lot of work to do, but the company hired an excellent CEO in Andrew Mooney to run the plan. The company does not expect to see the first fruits of their labor until 2014, but we are hopeful and like the plan a lot. As for the stock's valuation, the company is a tough valuation since they have negative EPS. Yet, they are only priced at 0.8x sales, 2.7x book, and an enterprise value/revenue of just over 1.0. So, the stock is in no means even fair valued let alone overvalued, which makes it an attractive name.
What to like in 2014?
2014 is the year when a lot of the company's plans will start to really come into fruition. ZQK's most important plan has been to rededicate their core brands (Quiksilver, Roxy, DC), strip them down, and get back to the basics. Since Mooney came into office, the company still has not seen a dramatic benefit to their brand. The problem for the company is that designs for the brands were already out through several seasons, and the company would not be able to see dramatic improvements to the lines until the fall of 2014. The company hopes to create more brand strength by divesting their non-core products, globalizing product design (so that products are similar across all regions), and licensing secondary and peripheral products. By creating brand strength, the company believes that they can create better growth and redefine what Quiksilver stands for.
Next year, a lot of this will start to come into fruition. They have sold off their non-core assets and will have a streamlined business by Fall of 2014. The company is expected to turn their first positive EPS since FY2006 (eight years), and we believe that move could be worth a lot for the company. The company's five-year plan is for EBITDA to reach 13% of revenue. It is only at 3% in the TTM, so we are going to be seeing significant margin expansion through a strong reduction in SG&A as it is very high at almost 50% of revenue.
So, how can Quiksilver possibly grow 100% next year. Well, let's take a look at the numbers. The company is expecting 2-3% growth in revenue as well as expansion of EPS to 0.10 - 0.15. The company's move into profit will give them an inflated P/E since the EPS is minor, but we think the key is the momentum that these types of turnarounds can create - a la Priceline.com (NASDAQ:PCLN) or Apple (NASDAQ:AAPL). If the company can get to a net margin at 4% in 2015, we are looking at an EPS of around 0.50. The company's future PE is currently near 30. 30 x 0.50 is $15, which is closing in on potentially 100% give or take.
Is this possible? Two things have to occur. The company has to start to prove margins will expand and they can control SG&A early on in the year. If they are struggling, the plan will lose credibility. If they do show it, then valuations will continue to remain at high levels. A future PE of 30 is misleading, but it is easily likely given that the company could see operating margins move to around 10% by 2018 and net margins at 7-8%. The turnaround has to work.
We have been high on Facebook all year. We believe it is a service with staying power, ad potential, and has done well at realizing mobile is the future and focusing their attention there. The stock, though, is also quite expensive at 137 P/E and 47 future P/E, and they are the quintessential "momentum" name. What we have to understand about growth is that companies with these valuations only lose them if they stop growing, people question their growth, or the company speculates they may slow down. Until that time, these stocks tend to remain quite rich in valuation, and there is no reason at this time to expect FB to lose that valuation unless one believes that Facebook is going to be in one of those three situations.
We see no reason to believe that at this time. Mobile is doing quite well. In the latest quarter, the company saw their mobile ads become 49% of their business from 14% one year prior as they made $880M in the quarter from mobile ads, and they look well on their way to make it to $1B. Before the quarterly report, many analysts had noted the company had the ability to have a much higher impression rate for ads on mobile than they were currently showing, but the company sort of nipped that in the butt when they noted they did not want to increase advertising frequency on the homepage. Yet, the company was rolling out Instagram ads as well as potential for video on Facebook are going to continue to help. Right now, all is right for FB. Actually, though, shares have been held in check since mid-October, staying flat. The main reason for this is Twitter's IPO, but we see this as a short-term issue. There is more than enough room for both to dominate in social media, and TWTR is yet to show any profits.
What's coming in 2014?
There is so much to like here. The company's biggest selling point may be as simple as more ads is more money. For one, Instagram is going to potentially add 15% in ad revenue in 2014 alone. The photo sharing service is really starting to take on its own form with Instagram Direct where photos can be sent directly to another person, building off success of Facebook Chat and Snapchat. Further, the company will see mobile revenue grow to around $8B in 2015 as the company is underselling its business significantly right now. The ad-per-newsfeed is at 1-to-20 right now, but Deutsche Bank suggests this could go to 1-to-5 next year. Despite the recent notation that they will not increase that ad rate in Q4, the company will likely rethink that in 2014.
With $8B in core ad revenue, the company is easily going to hit $10-$11B in revenue in 2014. The company, though, has other potential opportunities that we believe are enticing. The challenge is to stay on top and add users. The company has suffered from being less "cool" as new older users have adopted that, but that is okay with the company as they seem to want to become more of a utility for connecting people over just being the cool thing to do. Being a lifelong utility has more staying power than today's cool thing. Some potential additions in 2014 that will add more value include adding Snapchat or Foursquare, introducing artificial intelligence things a la Siri, add video ads that will cost more, and continue to expand internationally. The sheer volume of potential people to come online and add smart mobile is enticing in itself.
With revenue looking to come in around $10.5B in 2014, the company will likely see EPS around 1.10 - 1.15. At that rate multipled by current P/E of 115, shares are worth $132. Obviously the calculation is skewed as the company is already pricing in some of their future growth in the current P/E, but we only need to get to $110 for it grow 100%, which would but the current P/E at 100. We believe this valuation is definitely very, very high, but the fact is that this is a stock that people want to own. And if TWTR struggles at all, we will see a massive push once again for FB out of TWTR as well. The key to us is that they continue to see revenue growth of 30% in each quarter, they increase the ad rate, and they add Snapchat or a messaging service. If they hit all three of those, 2014 could be another great year for FB.
You might not have heard of small-cap Reed's, but you will want to take note of this company. One of the most exciting aspects of REED is that the company is part of a growing industry - natural foods. Within natural foods, REED is in an even more exciting portion - kombucha. We are looking at a company that is in one of the most exciting growth portions of the food industry. The kombucha industry grew 40% in 2013, and it may grow 50%+ in 2015. The industry is now a $500M industry now, and we like the industry to continue to expand in the coming year. The company is the #2 in the industry, and the #1 company is private.
The stock is very cheap and quite unknown, which is part of the reason for it making this exclusive list. The stock is priced at 2.5x sales, but with only 12M shares outstanding, if they start to attract attention we can expect a Chipotle (NYSE:CMG) style small share float explosion. The company is another that is still struggling to turn consistent profits, but given the potential in kombucha, this could easily be a thing of the past. In the company's latest quarter, they saw 75% increase in volumes for kombucha sales year/year, and the company is really just getting started a little over one year into the industry. In fact, the company is having so much success with the product that their current production appears unable to meet demand, and they are starting to look for some third party companies to help production. According to Nelson data, kombucha will grow 70% in 2013, and the main reason is that kombucha is making the move from the natural foods market to the mainstream market.
What's coming in 2014?
More growth! The company is expected to see 30% revenue growth in 2014, and that will help push profits a lot. One of the biggest problems for the company has been productin capabilities. The company spoke many times in their latest quarterly report of production issues causing them to not reach their maximum potential. They also mentioned that they are spending a lot of money to improve efficiencies. The kombucha is only produced in REED's West Coast facility currently, but they are looking to expand it to their East Coast facility and move some simpler products out to allow for larger kombucha production. As the production issues become less intrusive, margins should grow as well as volumes.
Expanding distribution will be a big part of the success of 2014. If the company can continue to add more locations, they will really start to see success. They added quite a few companies in 2013 - Kroger (NYSE:KR), Wegmans, Jewel-Osco, owned by Supervalu (NYSE:SVU), and other natural grocers. The movement into larger, standard grocers will have a two-fold benefit. First off, it will expand volumes organically. Additionally, it will introduce the drink into more homes and more tasters that will also increase the amount of people that drink the beverage, compounding growth further. Many natural foods consumers already like the drink, and so they need a more mainstream consumer to get into it to have more success.
This one is tough to value given its lack of profitability and a lot of questions about how much they can grow in the coming year in margins. What we can see is that 25-30% revenue growth is not at all out of the question. Revenue is expect to move to around $49-$50M in 2014. Price/sales at 2.5x puts the company's market capitalization at $125M, a 50% growth in market capitalization. That would push share value to $10 alone. Yet, the effect that growth will have is that when the growth starts to become more mainstream, this stock will get a long squeeze because so few shares trade, and we can see the price/sales growing year/year. The most similar company is Chipotle, which took off in valuations when it started to attract attention because share float is so small for their scale.
For REED to blow up in 2014, the company will need to see 30% revenue growth in each quarter, will have to solve production problems and add more key big chain distribution networks, as well as attract a new class of consumers of their product and stock. A tall task but one we believe has a lot of potential.
Blackberry is a stock left for dead, and that is why upside potential is significant. Just take a look at Hewlett-Packard (NYSE:HPQ) stock this year. Despite not a lot of success, the turnaround story and potential steps from here are attracting a lot of attention that led to 100% gains this year. We see a similar type of potential for Blackberry this coming year as the company has priced for death, but it is about to undergo a major cosmetic shift. Currently, shares are priced at 0.3x sales, 0.4x book, and under 5x FCF. All three show significant upside potential from here if the stars align.
The company's new CEO John Chen has laid out some solid plans for the coming year. Chen has iterated that the company is no longer for sale, and that the company is looking to enterprise over consumer products moving forward. The company will have four target areas: hardware, enterprise, cross-platform messaging, and software. The company could definitely go places with messaging if they advance their technology and make it more widely available. The company also was once the enterprise leader, and they hope to get back to that place.
What's to come in 2014?
This is the make-or-break for BBRY. The company has to start to show that they can transform their business, shed the consumer-based market for other markets, and have success in the four key areas for the company. Execution is the key here, and the company will be skewered (and maybe bankrupt) if they cannot properly execute the four-prong plan. Yet, if they can start to see some pickup and reformation of the business, this story will move up, quick, fast, and largely. This is a stock that can grow 100% and potentially more…not that they will or are likely to. Yet, the upside potential is huge given that literally everyone appears to be against them.
Citigroup's Ehud Gelblum noted some worries:
Overall, and putting the new C-suite of executive changes aside, we have seen very little different or revolutionary in Chen's approach and believe the company remains spread thin between various market segments such as high-end enterprise devices, mobile device management and other enterprise services, BBM, and low-end / consumer. We also fail to understand why Foxconn will be more successful in designing low end BB10 devices that can compete against low-end Android than Blackberry has been itself, while in the high end and enterprise, the strategy appears to be pretty much business as usual, an approach that so far has proven to have little traction. Note that to the extent the new Foxconn low end BB10 devices are successful in converting existing BB7 users over to BB10, Blackberry would lose service revenue at an even faster pace in exchange for a device sale that likely is break-even at best.
Yet, we see a bit differently. We see that the company has a leader that is skilled talking restructuring like Meg Whitman, and the Street appreciates that. Further, he has a plan. Something that Blackberry has not had in years. They don't want to wallow in the consumer hardware market, shifting to security, consumer-end products, and enterprise devices. We believe the risk to the downside is only bankrupt or just putzing around, while the upside is tremendous if the company can start to see some synergy.
Right now, BBRY is extremely cheap, and valuation here is almost pointless. Earnings are not what we need to watch. Revenue even is probably irrelevant. Its execution, confidence, and a return to some sense of potential to make it out of this mess is really what matters. If they can continue to show these three signs, this stock will make extreme gains in 2014.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: I have no business relationship with any company whose stock is mentioned in this article. The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.