A Look at Mohnish Pabrai's Big Investment Themes

by: Investment Underground

Stephen Zhu, Lead Editor

We are always on the lookout for skilled, successful value investors who make headlines. Today, we’re highlighting Mohnish Pabrai, an investor who has carefully learned much of his style from Warren Buffett and earned impressive returns over the years. Let’s take a look at some of his holdings and break them down:

Horsehead Holding Corp (ZINC): As hinted at by its ticker, Horsehead Corp is a producer of zinc. It is in fact the largest zinc producer in the U.S., as well as a manufacturer of other zinc products. It formed in 2003 as a merger between two established zinc firms and produces goods using unique electrothemic smelting facilities. Recently, shares have slid to $10.90, down from a 52-week high of $17.98 a share, for a market cap of $476 million. The stock currently does not yield a dividend and earns $0.74 per share for a P/E ratio of 14.69, close to the market and industry average.

During the company’s earnings call last month, it announced that Q1 2011 revenue and product shipments were up, year-over-year, by 12.6% and 9.1% respectively. Further, Horsehead reported $0.33 EPS during the quarter, beating analyst estimates of $0.16 EPS for Q1. Despite this, the share value has continued to fall to its current price point, 53% above its 52-week low of $7.11 per share. Pabrai has been holding steady with his shares of Horsehead amidst the recent sell-off of some of his other positions. This, in spite of strong estimates for 61.5% earnings growth for the current quarter and 93% growth by the end of the year. Horsehead operates with fairly low profit margins and earnings can be erased by price changes for its raw materials. Therefore, even though Horsehead shows the potential for some growth, its risks in negative market sentiment and earnings volatility cancels this out.

Pinnacle Airlines Corp. (PNCL): Pinnacle Airlines operates a small regional airline flying a fleet of jets in the Midwestern U.S. and a fleet of turboprops under Continental Airlines and US Airways, primarily in the northeastern U.S. The stock is currently down to $4.29, just $0.03 above its 52-week low of $4.26 and 51% below its yearly high of $8.68 a share. This translates to a P/E ratio at 9.68, below the industry average of 13.84, with no dividend attached.

Pinnacle is currently going through a transition period - its former CEO and CFO have both left the company in the past few months and the former CEO of Frontier Airlines, Sean Menke, was only named the new CEO recently. He will have plenty of issues to address as the company goes forward from a loss of $0.16 per share in Q1 2011, compared to profits of $0.09 per share in Q1 2010. Estimates for Pinnacle’s growth are poor, at negative 50% for the current quarter and negative 32.10% earnings growth on the year. Pinnacle is planning to increase revenue by rebranding and expanding its highly capable airport ground handling service, which is already a strong income source. Though shares of PNCL have been steady in Pabrai’s portfolio, the low valuation along with a new, experienced CEO means this stock could have some upside potential.

International Coal Group, Inc. (NYSE:ICO): This mining company produces coal from the large deposits that it controls throughout the northern and central Appalachian regions in the U.S., and sells to industrial electric utilities and steel producers, among others. It’s been stable between $14.56 and $14.59 over the last month as the company processes a takeover bid from competitor Arch Coal Inc. (ACI). Arch Coal is offering $14.60 in cash for shares of ICO, which is about a 32% premium over the pre-announcement price of $11.03 per share. With EPS of $0.16, the P/E ratio spiked from 68.9 to 91.1. However, it seems that, even with the premium, many shareholders aren’t satisfied. Several law firms are flocking to the transaction to investigate the fairness of the deal on behalf of International Coal investors. If you already had a stake in International Coal, as Pabrai did, congratulations to you; the investment is now reaping a fairly nice return. Otherwise, steer clear from this stock for now as the inflated price and risk of the acquisition falling through make for an unpalatable situation.

In the coal space, we prefer shares of Cloud Peak Energy (NYSE:CLD), as the last true pure-play in the Powder River Basin. We think it is the most likely acquisition target.

Wells Fargo & Company (NYSE:WFC): Wells Fargo is one of the big four national banks in the U.S. and offers a broad range of financial products and services for both consumers and businesses. It’s trading at $26.28 a share, only 14% above its low of $23.02, for a P/E ratio of 10.81 which is about industry average. The stock pays a dividend of $0.48 for a healthy 1.9% yield. Despite Wells Fargo maintaining a strong recovery from the financial crisis, the stock is down from a 52-week high of $34.25, like its banking peers, amid concerns about increased federal regulation. John Stumpf, CEO of Wells Fargo, has stated the banks are concerned that increased capital requirements and other new rules could harm their revenues and lending abilities.

With a poor public perception of big banks’ practices, the momentum right now is against firms like Wells Fargo. However, the government has previously shown its willingness to side with the banks in serving a greater public interest, so it’s definitely possible it will happen again. In the last quarter, Pabrai slightly increased his share holdings in Wells Fargo, even though he was undertaking heavy selling in other areas, so he still sees value in the bank’s stock that has not yet been realized. With the deflated price and solid financials of Wells Fargo, investors should buy into this stock as a promising performer from the finance sector. We prefer Wells Fargo to the other large-cap banks with enviable positions, namely JP Morgan (NYSE:JPM), Suntrust (NYSE:STI), and US Bancorp (NYSE:USB).

Terex Corp. (NYSE:TEX): Formerly known as Terex USA, Terex Corporation is a manufacturer of the machines, equipment and replacement parts needed in construction, shipping, power and similar capital-intensive industrials. The company also provides some financial products and services for firms to rent, lease or purchase Terex equipment. The stock is priced at $25.03 per share, near the middle of its 52-week range between $16.79 and $38.50. The company doesn’t pay out a dividend and has a trailing 12-month loss per share of $1.56. So instead we take into consideration its P/S ratio of 0.60, lower than the industry mean 1.04.

Terex is in the middle of trying to acquire German crane manufacturer Demag with a $1.3 billion takeover bid, a bid that is nearly half of Terex's own market cap of $2.74 billion. Demag executives believe the offer undervalues the company and are willing to negotiate for a higher price, but Terex so far has refused to budge. If Demag agrees, then Terex's stock may take a hit. But if no deal is reached, Terex executives may simply let the offer expire on June 30.

Mohnish Pabrai has sold off a portion of his Terex shares in the last quarter, indicating the stock has lost some of its attractiveness due to poor earnings over the last year. However, analyst estimates for Terex’s next few quarters are very positive compared its competitors. With Terex’s acquisition attempt appearing unsuccessful, Terex stock is an addition worth considering. We think the company is an eventual acquisition target for larger players Caterpillar (NYSE:CAT) or Deere (NYSE:DE) at some point, given its niche position and valuable intellectual property.

Cresud Inc. (NASDAQ:CRESY): This agricultural company, based in Argentina, produces staple crops such as wheat, corn and soybean and engages in cattle ranching throughout Latin America. Cresud also leases some of its farms to third parties and provides commodity brokerage services. Its stock ticker has tumbled to $14.68 in recent weeks, 28% above its 52-week low of $11.45 a share. The P/E ratio is a still a bit inflated at 23.68, but the company pays out a dividend of $0.33 per share for an attractive 2.10% yield. Investor interest in South American agriculture companies is growing, seeing such stocks as versatile and stable investments during this period of economic uncertainty.

Firms like Cresud, controlling dozens of farms, represent investment in tangible assets like land and produce a good that is steady in value internationally. For his part, Pabrai slightly decreased his fund’s holdings of Cresud in Q1 2011 when the stock was valued closer to its 52-week peak. Back during the March earnings announcement, Cresud had reported a 23% increase in sales and operating income and, despite the recent drop in stock price, had a positive outlook for demand and yield at the end of the year. With the deflated price, and positive outlook, as well as increasing interest in this sector, Cresud deserves a spot in a portfolio looking for a stable asset.

Investors should take note that guru investor George Soros has been in and out of CRESY shares.

Air Transport Services Group, Inc. (NASDAQ:ATSG): The Air Transport Services Group is an industrial airline primarily operating aircrafts for shipping freight for U.S. military transportation needs. The company also helps with equipment and maintenance for the USPS, and other aircraft logistical needs.

Modest, year-over-year increases in cargo shipments through major airport hubs are rising.
The latest figures out of its key hub, Memphis, show a .98%, 4.54%, and .68% increase in traffic year-over-year for the months April, March, and February, respectively. Volatile international cargo loads rose as much as 24% in April and 10% in March.

This all bodes well for Air Transport, as its bottom line is directly tied to increased cargo traffic. Air Transport, a $400 million market cap operator has no defensible moat, in our opinion. So we suggest that investors interested in the transportation space take a look at Expeditors International of Washington (NASDAQ:EXPD), which is a long-time favorite due to its defensible position and ability to return cash to shareholders.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.