3 Safe-Cheap Post Bankruptcy Stocks For 2012

Includes: COSHW, CPS, CY, LYB
by: Oozing Alpha

U.S. markets have been very unkind to stocks lately. S&P 500 index is off 7.6% for the month of November and down 7.9% year-to-date 2011. Small caps have been beaten up worse - the Russell 2000 index has fallen 10.1% so far this month and is down 15% YTD 2011!

If you watch and listen to the talking heads on CNBC and on other financial channels, you will hear consistent warnings - - tread carefully in equities, keep a lot of dry powder handy and wait until things become clear.

While there might be some wisdom in these messages, I think we can agree on one thing - - the opportunity to generate extraordinary and outsized returns, is scarcely available when things "become clear."

Given this backdrop of extreme caution, I decided to take a look at one of my favorite investing areas, post-bankruptcy stocks. Here is the gist of what I discovered in looking at 30 companies from the most recent bankruptcy cycle (2008-2009):

  • A barbell-shaped distribution of returns - the top half has generated an average return of 86% and the bottom half lost 49% on average, since emergence from bankruptcy.
  • Zero correlation between market capitalization and returns (counter-intuitive because one would think/guess that in this type of a market, investors would gravitate toward the perceived safety of large-cap, liquid names).
  • A negative correlation between returns and financial leverage (intuitive since one would expect investors to avoid stocks of companies with a lot of debt in times of uncertainty).

Are there low-risk, attractively priced stocks in this mix? That is what I wanted to know and I did indeed find some. I used a method similar to Joel Greenblatt's Magic Formula, except that instead to ranking cheap alongside high ROIC stocks, I ranked cheap next to financial leverage.

The three best situated stocks in terms of valuation and leverage were:

I. Spansion (CODE): Semiconductor company which serves diverse end markets such as mobile phones, gaming, telecom and automotive; the stock is trading at 2.3x LTM EBITDA and has a low net debt / EBITDA ratio of 0.5x. As of 9/30/11, Spansion had $301 mm in cash/investments versus $450 mm in total debt. The sector is out of favor which helps explain the deep discount.

II. LyondellBasell (NYSE:LYB): Commodity chemical company trading at 3x EBITDA and has almost no net debt. It recently announced a special dividend of $4.50 per share and trades with a dividend yield of 3%.

III. Cooper-Standard (COSH.OB) (OTC:COSHW): Auto-parts company trading at 3.3x EBITDA and a net debt / EBITDA ratio of 1.1x. Management recently announced that it had discontinued a sale process which likely disappointed investors and has pressured the stock.

This limited analysis is by no means sufficient to make investment decisions but provides a good starting point to do further research.

And remember, good things happen to cheap stocks!

Disclosure: I am long CODE, LYB.