As efficiently as 401k plans can grow retirement savings, they frequently limit investment strategies. Many employer plans do not allow some common investment vehicles: options, futures, short selling or micro-cap stocks. IRA investing in some low-priced micro-cap stocks is the subject of this article.
I was recently challenged by an individual who had a tax credit expiring in 2011. His strategy was to move money from his company 401K to a self-directed ROTH IRA, using the tax credit to balance the 401k withdrawal tax. He was frustrated because all the mutual funds offered by his company plan were invested in "institutional-grade" stocks. He wanted to have some under-the-radar low-priced stocks in his retirement stable that he could watch grow until he retires in five years.
I advised him that he should at least diversify his holdings if he was going to limit that ROTH IRA to small cappers, which was a challenge given the portfolio size. We decided to include about 30 stocks, selling under $5 per share. Part of the diversification strategy was to invest 10% of the IRA in three stocks of enterprises with predominately global operations. We also wanted some sector diversification and a minimum 2% dividend return on the portfolio.
While I cannot recommend sinking an entire nest egg into these stocks, I do think that some have compelling fundamentals and growth prospects which might justify a long-term IRA investment. We decided to dip our toes into three highly-speculative stocks:
Trans World Corporation (OTCQB:TWOC) - $2.65.
Trans World Corporation is a New York company that acquires, develops and manages casinos in Europe. Given the economic crisis in Europe, anything in that part of the world deserves some scrutiny. It helps that their 5 full-service casinos draw players from the prosperous Czech/German/Austria region. They operate under the brand name of American Chance Casinos with US themes such as Chicago Roaring '20's, New Orleans Bourbon Street, 1950's Miami Beach and the South Pacific. They also operate a modern-style casino in a non-owned luxury hotel.
A hotel division was launched in 2009 with the opening of their own four-star Hotel Savannah and Spa, 45 minutes from Vienna, Austria. While the hotel operation contributes less than 5% of the total revenue, the last quarter's room revenue was 28.7% over the 2010 third quarter. Part of the TWOC growth strategy is to develop such boutique hotels at their popular casinos sites.
During the third quarter ending September 30, the revenues for the company improved by 23.6% year-over-year and net income was up 55.6% to $.08 per share, $.22 per share for the nine months of 2011.
I am frequently faced with choosing between solid value or market momentum. For momentum investors, TWOC shares closed Friday at the 52-week high of $3.00, but by most metrics this qualifies as a value stock. The current price is a deep discount to its book value of $4.45 per share. Trailing 12-month revenues of $37.7MM per year exceed the market cap of $26.6MM for a P/S ratio of .71. If the fourth quarter earnings matched the third it will lift the trailing annual earnings to $.30, yielding a PE of 9. More telling is an annual operating cash flow of $.56 per share.
On the downside, it appeared to me that compensation was a little high, totaling $1.2MM per year for the top three execs. I checked into similar public casino companies with less than $100MM in revs such as Century Casinos (CNTY - $2.57) and Nevada Gold and Casinos (UWN - $1.68), and the TWOC compensation compares OK. It should be noted that CNTY also operates in Europe and Canada and a case can be made for that stock in this portfolio.
One important advantage of CNTY over TWOC is that it is more liquid and is on the NASDAQ. The TWOC average volume of less than 1000 shares per day is usually a deal killer with me. However, we finally decided on this one since my friend has a five-year investment plan, is not buying an enormous number of shares and does not plan to trade this portfolio. CNTY did not qualify for the global exposure we required as its operations are primarily in North America.
Whenever investing globally, currency fluctuations are unavoidable; however, it apparently has not been significant enough to justify segregating that on the TWOC financial statements. Although the Euro/Dollar relationship could create a drag or a boost to earnings from quarter to quarter, I think a globally-diversified portfolio should include some European exposure. Once again, with long-term holdings, the "lumpy" quarters are not such a concern.
I am aware that Las Vegas Sands (LVS) and Melco Crown (MPEL) also have growing international casino operations, so I decided to compare their fundamentals to CNTY and TWOC. Although they are "institutional grade" stocks, their value metrics do not approach TWOC in P/E, P/S or P/B.
Regarding competition, it appears that Trans World has staked claims with right-sized casinos in their territories, and increased demand can be managed with economic expansion to existing properties. A new entrant would only fragment the market to its own detriment.
If you decide you want to invest in TWOC, you might take a cue from CEO Rami Ramadan. The CEO bought 3500 shares in December by picking up a few hundred shares every few days.
We will now take our quest for low cost global diversification to South America:
Transportadora de Gas del Sur (TGS) - $2.85
TGS is the largest transporter of natural gas in Argentina with about 5000 miles of pipelines. It also produces and sells natural gas liquids and has a small telecommunications division. One big attraction of this stock for this portfolio is that it could pay a 10% dividend or higher.
In addition to my big crush on the smart and elegant president of Argentina, Cristina Fernandez de Kirchner, that country is intriguing from an investment perspective. During the past two years, economic growth has exceeded 9% annually. Even with the phenomenal growth, the MERVAL stock exchange in Buenos Aires lost 30% of its value in 2011. Probably skyrocketing inflation is the biggest cause for the drop. Additionally, the government manipulates the currency to keep the Argentine peso devalued to the US dollar as much as 1.0% per month.
TGS is regulated by the Argentine government which is a two-edged sword. While it is subject to the changing policies, it transports 62% of the natural gas in Argentina and is relatively free of competition in its territories. Despite their dominance in gas transportation, actually more than 60% of the company's revenue now comes from the liquids business, which is not regulated by the government.
For the 6 months ending June 30 revenues were basically flat and reported net income was $.17 per share after taxes, etc. according to the company filing. It should be noted that the company had filed for a rate increase and tax reconsideration, but it has been legally delayed during 2011.
Like our first selection, TGS is selling below its book value of $3.55. It also has a respectable Price to Sales ratio of 1.22 and a PE of 9., assuming a second half 2011 income of $.13 to add to the first half net earnings of $.17, or $.30 for the full year. We have seen others predict more than $1 per share using GAAP calculations, but we prefer to incorporate the most conservative numbers in our investment decisions.
Technically unlike our first selection, TGS is selling close to its 52-week low of $2.75.
The bottom line is that even though the stock is a beaten down value proposition, the company is solidly-profitable in a relatively tough year. There are several potential drivers for growth and capital appreciation: a rebound in the Argentine stock market, slowing of inflation and reversal of exchange rate hits, approval of rate increases (with a reduced tax bite), new large gas sources within Argentina and continued growth in the liquids market. TGS is the leader in its business, and the exposure to the fast developing economic growth of South America is a plus in my opinion.
Although their telecom business probably has value, I am totally discounting that in my investment decision. Telefonica (TEF) and Telecom Argentina (TEO) are high-yielding telecommunications giants in South America that would probably not allow TGS to develop a substantial niche in their territory.
An important reason we chose TGS instead of other alternatives is that in the universe of $3 stocks there are not many that pay a substantial dividend. Unfortunately, the dividend history of this stock is an enigma. Last year they paid $1.50 (about a 50% yield based on current share price!), but years 2008 to 2010 saw dinky divvys between $.05 and $.064. Before 2008, they went 7 years with no dividend after years of double-digit payouts in the 90s.
The company has given no hint about their next dividend which should be paid in April or May. TGS had a history of occasionally paying gigantic dividends in the 90s like last year, and the next year they paid dividends of between 10 and 12%. TGS should have 2011 net income of $.30 and levered free cash flow of $.32, as well as cash of $.50 per share in the bank. We expect a dividend between $.20 and $.30, but that is only a guess at this point...a 6.7 to 10% yield. We expect the yield to normalize over the next five years.
No portfolio can claim to be globally diversified without some exposure to China. There is no shortage of low-priced Chinese micro-caps with seemingly great fundamentals and growth so the choice was not easy. The winner is...
Winner Medical Group (WWIN) - $3.04
Winner Medical is a leading China-based manufacturer, exporter and retailer of high-quality medical dressings and consumer products made from 100% cotton. They own 54 domestic and international patents on their products.
The Chinese micro cap market has been devastated by vicious short-selling and scams, both real and imagined. When we decided to sift through the Chinese micro-cap wreckage, our goal was to look for a company that had been the proverbial "baby thrown out with the bath water." In 2011, WWIN had many of the symptoms of the typical Chinese micro-cap implosion. Despite glistening revenue growth, there were unforeseen disappointments in income, reductions in margin and the independent auditor resigned. The stock steadily fell from its $6 price in January for a 50% annual loss for its investors.
I normally keep my distance from a "falling knife" but WWIN has begun to shown signs of rebounding. Once we uncovered the real story behind the 2011 problems, the growth and solid fundamentals became more clear.
The biggest issues for WWIN began with the spike in cotton prices that started in September 2010, which coincidentally was the month they closed out their fiscal year 2010 with a stunning 40%+ net income growth. Cotton is their primary raw material and its spot price had been range-bound for some time under $1 dollar a pound. In the next six months the price of cotton spiked to $2.30 a pound. Management decided that they needed to start hedging their cotton cost with futures and promptly invested in futures just at the peak in prices, resulting in a $1.5MM trading loss. To his credit, the CEO fell on his sword and reimbursed the company for this foible. They also hired a seasoned commodity trading group to manage their cotton hedging going forward. Now the price of cotton is back below a dollar, but for fiscal year 2011, the cotton spot averaged $1.68. The cost of goods sold increased 35% as a result, and the profit margins dropped accordingly...as did net income.
Also, during the 2011 fiscal year the company aggressively expanded, opening 19 retail stores and increasing marketing staff, incurring expansion costs. It should be noted that WWIN only gets 24% of revenue from China and the rest is from international exports. More than half comes from the US and Europe, where they only have been marketing for 6 and 11 years, respectively.
Oh...the auditor resignation...actually BDO Hong Kong resigned so BDO China could take over as Auditor. This was due to the new auditor's ability to provide services not available with their sister firm.
We do not expect another nightmare year for WWIN and, in fact, we expect the year over year comps to be exceptional as a result in 2012. The company reports their first quarter results on February 9, and there should be some hangover from the over-priced inventory absorption from the cotton spike, but we expect the following quarters to benefit as much as 35% from the more normal cotton costs. Couple this with the company guidance of 20 - 30% revenue growth and WWIN may blow away current analyst estimates of $.58 per share net income for 2012.
The Winner Medical fundamentals are attractive. At analyst estimates, the PE is still less than 6. Like our other selections, they sell below their book value of $5.20. Price to sales ratio of .48 indicates good value.
More important, Winner Medical is different from many flash-in-the-pan Chinese micro-caps. It has been in business for 20 years and has mature and seasoned management that is invested in the company. It counts among its customers some of the largest disposable medical product distributors. Its existence depends on reliability and quality.
As a check into the global growth prospects for their products, we looked at New York exchange-traded distributors of WWIN products, Covidien (COV) and Cardinal Health (CAH). Single-digit sales growth is projected for those customers. For what it is worth, there are 42 analyst opinions for those two stocks and 36 of those rank them a "buy" or a "strong buy."
In summary, we see Winner Medical Group as a value play in a growing market sector with the added dynamic of being under-the-radar and possibly misunderstood. Over the long term the real fundamentals and growth have a way of coming to the surface, and in the case of WWIN, we think this will help the stock price.
As a cautionary note, we must reiterate that these three stocks are at the risky end of the investment spectrum for many reasons: thin trading, unreliable government policy, exchange rate risks to name a few.