Seeking Alpha
Portfolio strategy, bonds, dividend investing
Profile| Send Message| ()  

By David Baskin

Sometimes bad things happen to good companies. The latest example is the scandal surrounding SNC Lavalin (OTCPK:SNCAF) and its dealings in Libya. With the collapse of the Gaddafi regime news of possible irregularities is emerging, and the stock has paid a heavy price. On Feb. 28th and 29th the shares dropped by over 22% on news of about $50 million in spending which was inappropriately charged against a project to which the spending did not relate. At the same time, the company adjusted its projected earnings downward by about 18%. The market reaction knocked about $1.6 billion off the market capitalization of the company.

SNC has about $20 per share of “concession” interests – things like its 17% interest in Highway 407. Prior to February 28th, the engineering and construction business was valued at about $28 per share. Today it is valued at $17.40 per share, a drop of 38%. Is it possible that the core business is worth 38% less today than it was three days ago? Of course not. When markets react they react emotionally, not rationally, and few stop to do the math. Stock market history is replete with examples of stock holders who shoot first and ask questions later.

Sometimes, of course, full blown panic is justified. This is in cases where the company is an outright fraud – cases like Bre-X, YBM Magnex, Livent and most recently, Sino Forest. But where the companies are large, well established entities with a long track record of successful, profitable operations, a review of recent history shows us that selling is usually the worst course of action. Here are some recent examples of bad things happening to good companies.

In April, 2010, the Ontario Government announced that it would change its pricing regulations for generic drugs. The change would reduce profits for pharmacies. Between their high point in March, prior to the announcement, to their low point in June, Shoppers Drug Mart shares fell 27.7%. Today, less than two years later, Shoppers shares are trading $1.00 or 2.3% lower than they were worth the day before the announcement, and investors have collected $2.00 of dividends in the meantime. What appeared to be a disaster turned out to be a temporary setback, except of course for those who sold their shares at the bottom.

Also in April, 2010, an oil rig owned by BP exploded in the Gulf of Mexico, causing one of the largest oil spills in history. BP shares fell by 50% over the next two months, from $53.50 to $26.75. There was much talk that the company would be forced into bankruptcy. Today BP shares have recovered to $47.40, up by 77% from the bargain basement prices after the disaster. Including the $2.00 in dividends received in the period, investors are down less than 10% from the value before the event, provided that they did not sell out.

Maple Leaf Foods (OTCPK:MLFNF), one of Canada’s largest manufacturers of processed meats, announced a recall of products in August, 2008, due to listeria contamination. Within a few days it was discovered that at least five deaths and dozens of illnesses were connected to company products. The shares dropped by 41% in a two month period. Today, they trade at exactly the same price as they did the day before the recall. The same thing happened with the shares of drug manufacturer Merck (MRK) when it launched the recall of its drug Vioxx, the largest drug recall in history. After falling 33% on the day of the recall, the stock was at record highs thirty months later.

One of the most dramatic recent examples involves Canadian mining giant Teck Resources (TCK). In July, 2008, Teck agreed to acquire Fording Coal for $14 billion, and funded the purchase by taking on $9.8 billion of debt. Teck, and the market, did not know that the deal would close amidst the market crash two months later. With coal prices dropping sharply, there were fears that Teck would collapse under the weight of the new debt. The shares plunged from $47 prior to the acquisition to a low of $3.35 in March, 2009, a drop of 93%. However, the company managed to keep its debt current, and when coal and other resource prices rose, so did the stock price. Teck hit an all time high of $64.62 in January, 2011, up by 37% from its price before the Fording deal, and up by a stunning 1,829% in less than two years.

We await the results of SNC’s internal investigation with interest, but we are fairly certain about one thing. Whatever is revealed, it will not cost the company anything close to the $1.6 billion hit that the stock market inflicted this week. As a result, and as always, the true value of the company will be recognized, and share prices will adjust to reflect this. Those who sold in haste will be able to regret at leisure.

Disclosure: The author and clients of Baskin Financial own shares in Shoppers Drug Mart, SNC Lavalin and Teck Resources.

Source: When Bad Things Happen To A Good Company