Bullet-Proof Portfolio - Top 10 Ideas; Trough Value, Big Dividends, And Weathering Coronavirus And Oil Tanking

Summary

• The interest rate cut timing was arguably early as it won't modify behavior relative to the coronavirus. With OPEC faltering and fear peaking that we are head-on towards recession, opportunities abound.
• The aggressive selling caused by the Fed cut and oil plunging produced some amazing opportunities for quality dividend materials, chemical and retail stocks already hammered by investors gravitating to perceived safety stocks.
• With oil prices collapsing and panicked liquidation in many quality names that were already cheap, it's a great time to rotate into quality names trading at unsustainable valuations while collecting outsized dividend yields.
• Chemical stocks – TSE, OLN, DOW, HUN, and Lanxess are all very compelling at the cheapest values they have ever garnered. Likewise, WRK is part of a corrugated packaging group that stands to benefit from the current turmoil.
• Retailers CPRI, PVH, and GES are all at unheard of valuations with underlying support and huge upside, while RACE provides a great short opportunity with a great risk/reward to the downside.

As has been said, the market mechanism appears broken, and there is no rational price discovery being conducted. Machines, algos, bots, high-frequency trading and ETFs may seem great at times, but the resulting price dislocation is gut-wrenching. Just when fundamental analysis suggests that a stock price must be close to the bottom and that historically "this is it," we then get another leg down. In most of the names listed in our TOP 10 Picks, they are trading at about 50% of trough during the 2008 banking downturn. Nothing compels investors more, to buy or sell positions very quickly than greed and fear. The lack of understanding surrounding the full consequences of the coronavirus has prompted fear and volatility reminiscent of the banking crisis. Add to that the Fed slashing rates by 50 basis points in an emergency move in between meetings, and investors understandably conclude things must be serious. The last two times the Fed made similar emergency cuts were in 2008 during the banking crisis and, before that, in 2001 following the tech bubble. The market is already factoring in an additional 50 bps cut two weeks from now. The question at this point becomes, should an investor step in and buy deeply discounted stocks, or wait until they are certain not to be catching a falling knife. Prudence might suggest it depends upon one's risk profile. However, while the broader indexes and many large-cap companies perceived to be "safety stocks" have only corrected minimally, there are many small and mid-cap names which have been decimated and appear to present a very compelling risk/reward profile.

This is a transitory event vs. 2008, which was a systemic event. Until the coronavirus fears subside, we likely have an overhang.

Investors know monetary policy cannot fix a global pandemic. However, our Fed felt the need to make a move anyway demonstrating their accommodative stance. After a brief rally, markets sold off and have remained choppy in the wake of the coronavirus. The companies most obviously experiencing an immediate impact (e.g. airlines, hotels, travel-related, etc.) have been slammed. And the beneficiaries (e.g. those helping with a vaccine, video-conferencing companies such as Zoom Video Communications (ZM)) are doing well, while the large-cap "defensive plays" have corrected from record highs, but to a lesser degree than the market in general and small and mid-cap value in particular. There are a group of completely neglected stocks that have been sold off aggressively potentially standing to benefit from either supply-chain issues, capacity shutdowns, and the fact that inventories were already very low in some cases, and some of the companies on this list are already trading at all-time low valuations with abysmal sentiment. What follows is our list of very compelling BUY ideas and our structural sell idea.

What are the best names to buy here?

Arguably, our Top 3 picks are all close for "best ideas" and depending upon the day, and the news flow, one or another could slightly be favored. Regardless, we believe all three provide a very safe high dividend yield in a low rate environment with little downside risk at current levels. The pendulum has simply swung so far that we are seeing valuation extremes surpassing levels of the banking crisis and even the Great Depression. My favorite chemical names at this point are Trinseo (TSE) and Olin (OLN), with a slight edge to TSE. Trinseo was already ridiculously cheap a month ago just above $30 per share. It is down 45% since then, and it was already a great buy then. What is it at $17? Insanity...I have never in my career seen a stock trade for around 1.6x cash EPS. As this is too small to get on Warren Buffett's radar, some deep value players need to do a deep dive on this company and appreciate that it is inevitable that TSE will either be bought out at a much higher price, or the price appreciation should be around 6x from here to around $100 per share over the next 18 months or so. Olin is likewise, ridiculously priced. Either there is no sell-side coverage, and they are completely asleep at the wheel, or too afraid of being fired for stepping in prior to the absolute bottom that they are frozen with fear.

Both small-cap deep value and neither make any sense to be priced at current levels. Both are at trough valuation, have a huge dividend yield (8% and 6.2% respectively), structurally sound, and a large dedicated investor base. Both TSE and OLN have activist investors; TSE with M&G at 20% (or more possibly now) and a huge steady-hand holder in BlackRock at nearly 15% ownership. Olin has a strong activist with Sachem Head at just under 10% ownership. OLN also has some steady-hand investors in Fidelity, BlackRock, and Vanguard with around 14%, 11%, and 10% ownership, respectively. One key takeaway here is that regardless of the number of shares outstanding, the actual float is smaller as we can point out that roughly 35% to 50% of the shares in both of these small chemical companies are held in very steady long-term hands, much more likely to acquire than to sell shares at current levels. And we believe WestRock (WRK) at current levels is ridiculous given their steady earnings, quality business, and positioning as perhaps the best of a small oligopoly of players in this space. They also have a huge dividend yield (6%) and likely have seen their stock tank due to ETF selling, and bots, as opposed to any active manager making a decision that it makes sense to sell WRK at these levels.

To categorize our TOP 10 ideas by industry, we will start with WRK in paper/packaging, then chemicals, retail, and auto.

Paper and Corrugated Packaging

(1.) WestRock Co. (WRK) - $26.61 per share with a 7% dividend yield. A producer of corrugated and specialty consumer packaging, WRK is well-positioned to benefit from the continued expansion of e-commerce and an attractive (oligopolistic) industry structure. While an initiative at Amazon (AMZN) to consolidate and right-size shipping boxes and the disruption of the short-lived tariff trade war created demand headwinds in 2019, the impact of the Amazon initiative has passed, the trade war is de-escalating, and a new initiative for Amazon vendors to use packaging that is ready-to-ship from the warehouse shelf should become a tailwind for corrugated packaging as it gets adopted. WRK still pays a historically hefty ~7% dividend yield and generates meaningful free cash flow, trading at <6x forward EBITDA.

WRK operates in an oligopoly where the top three suppliers control 80% of the market. They have a clear history of operating as an oligopoly, thereby cutting capacity if demand gets weak. Perhaps one player may lose a small percentage of volume for a period, but pricing is protected. After two years of destocking in containerboard because of the trade war, there is little inventory, which means even if demand slows further from currently low levels, volumes won't decelerate much going forward as the industry no longer has the drag of falling inventories. The Chinese are starting to import containerboard now after completely reducing inventories to nearly zero. Given their new import restrictions on quality for recycled paper, they are starting to import containerboard from the US. Their import gap is 8 million tons, which is 20% of the US market. It would be hard for pricing and volume to go down when this amounts to 20% of US containerboard capacity. Containerboard pricing is likely to go up from here NOT DOWN, with industry participants now taking about a pricing hike in the late summer. While WRK does not have a century-long history, they have ample room to pay the dividend even if earnings were to fall. Their dividend is covered more than 3x currently, so earnings could decline from here and WRK would have plenty of room to pay their dividend.

Chemicals

(2.) Trinseo (TSE) - $16.41 per share with a nearly 10% dividend yield.

Trading a full point below its IPO price of $19 from June 2014, it is amazing in light of the fact that the company nearly six years ago was levered 4.5 to 1 and paid no dividend. Since then, the company has bought back a substantial portion of its shares, de-levered, increased FCF dramatically and grown its position within their respective markets. Here at the bottom of the cycle even at very depressed levels of profitability, the company pays a dividend of 8% while continuing to buy back stock. On a normalized basis, TSE is trading at a 45% FCF yield with the stock trading at 2.2x normalized free cash flow per share. Keep in mind the management team spent over $1mm on buying stock in the open market last August in the high $20s, and M&G (activist investor) acquired and filed a 20% stake closer to $30 per share. At price levels close to the IPO, we believe this is a huge over-reaction and is likely a 5-bagger (it was a 6-bagger last time) from current levels over the next 18 months. We never thought we would see TSE back in the $20s, let alone at $20.

We published up a detailed analysis for Seeking Alpha about two weeks ago. For a deeper dive, this is worth reading to understand Trinseo's business units, and walking through the valuation, and changes that have happened over the past 5+ years. (Trinseo Analysis)

TSE has generated an EBITDA of $590 million on average from 2015 - 2018 before the sharp contraction in 2019 ($355 million). The consensus has EBITDA falling to $331 million in 2020, which is $6 million above what we estimate the absolute trough is assuming all divisions trough at the same time. In addition to investing heavily to improve the growth profile and the profitability of the portfolio (which has meant CAPEX above $100 million due to a number of specific projects, which are now ending), the company has been a good allocator of capital paying a healthy dividend while reducing the shares outstanding by close to 5% per year (despite much higher prices). We expect the free cash flow to accelerate significantly over the next few years as businesses recover from the cyclical trough, while CAPEX declines and the share count continues to shrink. On a normalized basis (2021/2022), we expect the FCF per share to be $9.94 per share (assumes $523 million of EBITDA, 36 million shares outstanding and $75 million of CAPEX).

Spreads showing some improvement in Asia - we believe this is due to styrene operating rates being super low still as of Feb., not much yet in Europe.

Source: Bloomberg

(3.) Olin Corporation (OLN) - $10.98 per share with a 7.3% dividend yield. A chemical company that has been around for about a century with a history of consistently paying dividends without fail since 1926, Olin has been completely tossed out by investors. The FCF yield is more than 25%. Olin's two chemicals divisions (Chlor-Alkali Products & Vinyls and Epoxy) manufacture and distribute chlorine, caustic soda, and epoxy materials, while its ammunition division (Winchester) manufactures small-caliber ammunition. OLN is the largest Chlor-Alkali player in the world as well as the low-cost operator. It is also the most compelling stock we can find in this space. With a $2.1 billion market cap and a 6.2% dividend yield, OLN has paid its $0.80 annual dividend for more than 90 years. It is a cheap business that is not well understood, dismissed by many as a low-quality commodity business, subject to both the housing cycle and low caustic soda prices. This simplistic view misses the hidden qualities and competitive positioning of Olin, and the long-term trends in supply and demand that OLN and its shareholders are poised to benefit from.

The industry is performing at depressed levels, competitor capacity has been shuttered and at current prices, there is no risk of significant additional capacity entering the market for years to come. New capacity, if announced today, would take at least 3-4 years before it hits the market, and at current pricing, would not earn its cost of capital.

One repeated refrain from analysts is that if we enter a recession, OLN's financials would likely deteriorate, and it might be a bankruptcy candidate. This is ridiculous for anyone who has thoroughly analyzed Olin. OLN's earnings will not fall further in a recession. How can I be sure of this? EBITDA is already at trough (cost curve support - higher-cost players losing money now). In fact, OLN's EBITDA, different from most chemicals is actually countercyclical because they make two products out of the same process - chlorine and caustic soda. Chlorine is more cyclical and very hard to store. So, when demand slows down for chlorine with a slower economy, the caustic market gets tight as demand goes down less than chlorine. This is why peak profitability per unit was actually achieved in the 2008 financial crisis. They have been paying the dividend for 94 years straight (including the Great Depression of 1929, the Great Recession of 2008 and every other crisis in between). We believe chances are close to zero, that the coronavirus is going to cause OLN to reduce the dividend, as the bear case believes. OLN's liquidity profile is strong, and they generate so much cash that they will be at 2x net debt to EBITDA by the end of 2021. Investors have asked - "Why do you prefer OLN to WLK?" OLN is a better company and has a much better risk/reward profile than WLK. Simplistically, one can view WLK as just OLN + DOW. However, it is much better from an investor perspective to simply buy OLN and DOW separately. For investors seeking a basket of the most compelling chemical companies, we strongly encourage them to buy TSE and OLN, and then HUN and DOW.

US export prices have clearly improved over the last two weeks - both for caustic and EDC. EDC is up ~2c/lb which is equivalent to ~$40m of annual EBITDA for OLN; will be important to watch to see if prices hold.

Source: Bloomberg

Source: Bloomberg

(4.) Huntsman (HUN) - $15.85 per share with a 4.1% dividend yield. Huntsman is a manufacturer of differentiated organic chemical products and of inorganic chemical products. HUN operates through four segments: Polyurethanes, Performance Products, Advanced Materials and Textile Effects. Its Polyurethanes, Performance Products, Advanced Materials and Textile Effects segments produce differentiated organic chemical products and its Pigments and Additives segment produces inorganic chemical products. The Company's products are used in a range of applications, including adhesives, aerospace, automotive, construction products, personal care and hygiene, durable and non-durable consumer products, digital inks, electronics, medical, packaging, paints and coatings, power generation, refining, synthetic fiber, textile chemicals and dye industries. The four business segments provide good exposure to a wide range of end-market customers, including Bayerische Motoren Werke AG (OTCPK:BMWYY), Electrolux, Chevron (CVX), Bayer, Procter & Gamble, etc. Two months ago, Huntsman closed the $2bn divestiture of its intermediate chemistry franchise to Indorama which helped improve their business mix focusing the company on areas with better market growth and less dependent upon production costs.

HUN Insider Buying - Three HUN executives made significant purchases in the open market in their own stock showing confidence in their company's prospects for upside at these levels. Senior-level executives including the CEO, CFO and a VP, purchased 16,200 shares in aggregate at approximately ~$19 per share.

While I normally would not give much weight to a sell-side recommendation, BofA put out a very solid and detailed analysis of HUN when they launched in mid-January with a $27 price target. With a 30% price decline over the next 7 weeks after launching, the thesis is still intact, and with 70% upside to the BofA price target (which we view as conservative), we believe HUN should have a place in value portfolios and has a very nice dividend yield.

(5.) Dow, Inc. (DOW) - $30.53 per share with a 9.2% dividend yield. Dow is a free cash flow machine. The company is a supplier of high-volume commodity chemical products like silicone and polyethylene. Most of Dow's chemical products are tied to basic feedstocks, most notably crude oil. The cyclical nature of Dow, and its tethering to feedstocks and global trade obviously makes the company vulnerable to volatile commodity prices and trade tensions that have plagued the market, and add to that the coronavirus and OPEC's falling out that caused oil to plunge around 26% today.

While some investors last year held fears that Dow's business would be threatened if crude oil increased, that really is not so much of a problem for Dow. The majority of Dow's petrochemical facilities use natural gas liquids (NGLs) as their primary feedstocks. While DOW does use oil as a feedstock for some of its international facilities, higher oil prices generally make Dow more competitive in the global market. Today's oil plunge crushed Dow nearly 22% in a single day. The stock was already pricing in lower oil. From a mark to market perspective, you get about a 10% cut in earnings (which again - has already been more than priced in). Had Dow been down 5-7%, it still would be compelling. With the stock now hitting an all-time low with over a 9% dividend yield and sub-$30BB market cap, it is getting silly. This is a quality large-cap company that should not be trading at these levels.

Prior to today, the trade war with China and the market starting to fear an economic slowdown and lower oil pricing explained much of the decline. Another issue is that many investors are simply not familiar with the new Dow Chemical since last year's spinoff of the former DowDuPont into Dow, DuPont de Nemours (DD) and Corteva (CTVA) and need to see it operating on a standalone basis for a bit longer in hopefully a less chaotic environment.

Chemical stocks in general, and specifically, our list of favorite names including TSE, OLN, HUN and Lanxess and finally Dow have seen stock prices excessively hammered beyond reason, and with machine selling and ETFs, we believe there are not enough active money managers today that recognize the values we are seeing as a result of a widespread industry slide done to the extreme. Average operating margins in the chemical industry fell over 20% among 50+ chemical companies between the Q1 2018 and Q1 2019. Likewise, spot prices for N. American high-density polyethylene have fallen by about 30% since March 2018. But we believe all of the bad news for chemical companies (and then some) has now been factored-in. Dow has a highly diverse portfolio ranging from consumer care to infrastructure, and packing markets worldwide. Also assisting Dow from competitors is cost-reductions resulting from the DowDuPont separation. Fast forward one year after the deal was done and Dow's business is less capital-intensive, allowing Dow from needing to shell out a lot on CAPEX to maintain its business. Dow can now use the cash for share buy-backs and paying that huge 9%+ dividend.

It was only last November that DOW was at $54 per share, and Jim Cramer was super-bullish on DOW calling it a "juggernaut" with a lot of room for upside. With a 44% decline since then, we believe DOW has a lot of bad news priced-in, and the risk/reward is very compelling at these levels.

(6.) Lanxess - EUR €39.77 per share with a 2.3% dividend yield. Lanxess is a top-notch specialty chemical company based in Germany. With 58 production sites and around 15,500 employees in 33 countries, Lanxess is a dominant company on the global market. They are the best player in their respective areas, including producing, developing and marketing chemical intermediates, additives, specialty chemicals and plastics, with annual sales of around EUR 7.2 billion. I have yet to write-up Lanxess in detail, but there are some good write-ups on Seeking Alpha that explain the story. (Lanxess Remains Cheap Despite A 40% Rally). Despite the name of that article from last November, the stock is now at a multi-year low. Investors have to go all the way back to 2016 to find a better entry point. Back in May of 2017, Warren Buffett purchased a 3% stake in Lanxess which put him in the top 6 holders of the company. (Buffett announces stake in Lanxess). Lanxess was certainly compelling then, and Buffett paid about 60% above where the stock is currently residing. There are a lot of exciting aspects to the Lanxess story. It is sufficiently intriguing and likely to generate enough upside for investors that it is worth buying either the local shares or an ADR to obtain a position. This is the best management in the industry and they are setting up a global marketplace that will likely be worth the entire value of the company alone. They have the technology, high barriers to entry and the expertise such that their business model coupled with their performance makes this entry-level a "must buy."

Retail Names - Great Brands, Historic Low Valuations, and Excellent Online Exposure

(7.) Capri Holdings Limited (CPRI) - $20.21 per share. Formerly known as Michael Kors Holdings. CPRI was renamed following acquisitions of two marquee luxury houses, Jimmy Choo and Versace. We have followed the core Michael Kors business for close to a decade as the highly successful entrepreneur, whose business bears his name, grew the affordable luxury brand into a global multi-billion franchise. As the growth of the company matured, cash generation increased, but the valuation multiple fell considerably as growth investors transitioned out of the stock. While the lower valuation alone could have made the situation potentially interesting given the quality of the franchise, the experienced management team and an investor-friendly approach to capital allocation; the transformational nature of the recent acquisitions made CPRI particularly compelling.

The company traded at a P/E multiple of 12.5x in 2016-2017, in line with U.S. peers, but the valuation compressed significantly after CPRI acquired the two European fashion houses. This seemed strange to us given that the market had already validated the valuations (Jimmy Choo was publicly traded in the UK and Versace was acquired through a competitive auction). Following the recent political turmoil in Hong Kong, the stock traded down to less than 6x P/E, despite the company repurchasing an equivalent of 14% of the current market capitalization annually over the last 5 years while maintaining leverage < 2x.

Because CPRI is investing significantly in the acquisitions, the margins of the new subsidiaries are depressed and will not materially contribute to earnings this year. This means investors through CPRI are effectively buying the core Michael Kors business for half the valuation it carried a few years ago and a similar discount to peers today while getting the acquisitions for free. Adjusting for the near-term impact of the Coronavirus, we estimate the core business generates just under $5 / share in cash EPS. A normalization of the P/E multiple to 12.5x would drive 100% upside to the stock. In addition, the capital the company spent on the acquisitions was $22.80 / share. As the investment cycle is completed and the earnings power of the acquisitions emerges, we expect the market to give the company credit for at least a portion of that value. If investors gave full credit, that would generate an incremental 73% upside.

Management's business plan calls for just under $6.50 in consolidated cash EPS by 2022. At our price target of $85 / share (vs. $24 today), this would imply a P/E multiple of 13x, a slight premium to the company's valuation before the acquisitions, despite the fact that 30% of the earnings would come from luxury goods businesses where direct peers are valued at much higher multiples.

(8.) Guess Inc., (GES - $12.40) like many retailers has reached new lows on a combination of coronavirus and economic recession fears. It seems insane that GES has hit a new 52-week high and a 52-week low in less than two months to start a wild 2020. Last year, GES crushed investor expectations the last two quarters of the year and run up to nearly $24 per share by mid-January before nearly getting cut in half by the end of the day today. GES had been weak into the last two-quarters last year due to the same negative chatter about weak US department stores (see Macy's (M), Nordstrom (JWN), etc.). The reason investors turned out to be wrong is likely why the stock is oversold, and even if they are very conservative with guidance, will likely see a nice bounce out of their report next week. (1.) There is a real turnaround going on at GES. In the last 2 quarters, US department stores were weaker than expected, and GES blew out their numbers. (2.) GES has less than 30% of sales in the US, with over 70% of sales in Europe and Asia. Thus, they did not have such big US exposure that created any issues. And (3.) The European outlook is improving - one can see the European market has been outperforming US market recently. Obviously, China retail sales reported are weighing on the stock, and an overall global slowdown as well, but at current levels, the bar is incredibly low, and GES is a quality player to the up-and-coming emerging middle class wanting "luxury at a reasonable price." The value appeal of the GES brand, and the execution of a solid management team, makes GES a solid company to own at current levels. If the turnaround plan works, the stock is likely going north of $50 (the convert they did is struck at $46). Thus at $12 and change, we believe there is not a lot of risk to the downside, as a tremendous amount of bad news is already reflected.

GES is leveraged to a stronger EUR. As a reminder, GES lost over 1/3 of their earnings over the last 5 years as the EUR went from ~1.35 to ~1.05. Europe has been in the scrap-heap for the past year and US growth has been better due to fiscal stimulus. This is largely in the past now, so the EUR is likely to strengthen from here which is very positive for companies such as GES and our next quality retail pick, PVH.

(9.) PVH Corp. (PVH - $61.50) is the cheapest it has ever been by a wide margin. At these levels, the stock is down about 55% from its 52-week high hit last April at around $135. Two of the best affordable and well-known luxury brands out there (Calvin Klein and Tommy Hilfiger) are trading at about 6.5x EPS for this year. The average historical multiple is 17x. No other brands have more leverage to the growing middle class in emerging markets over the next decade. Basically, a lot of capital has been allocated to consumer PMs because of fear of industrials/materials on the back of trade war - and they were blown-up huge in names such as JWN, KSS, and ANF. PVH reports in two weeks, and with the stock already at $60, we believe expectations are so low that PVH will crawl over the bar, and the stock will lift. Last quarter, PVH had already dropped 30% going into the print but was still down another 14% after reporting their quarter even though they only cut numbers by 1% for the full year. Below $70 it was cheap. At $60, this is a gift.

Autos - Internal Combustion Engines (ICE) in Decline; Electric Vehicles = Future

(10.) Ferrari (RACE) - $137.73 - Short the stock. We have written extensively about the challenges facing Ferrari, and why we believe the stock should still see 70-80% downside from these levels. Since we first wrote our "SELL FERRARI" note (How to Destroy a Great Global Brand...), RACE has dropped about 16%. We think this is just getting started and would encourage investors and short-sellers to sell into any rally or strength in RACE. We followed up our initial piece with a more detailed look at exclusivity and examining numbers for Ferrari relative to manufacturers Bugatti and Bentley, as well as why China will not be the big growth vehicle for Ferrari that bulls argue (Short Ferrari Part 2). We believe the perfect storm of catalysts is hitting Ferrari, and the stock will see a valuation more in-line with auto manufacturers such as Volkswagen (OTCPK:VLKAF), which trades around ~5x P/E. While Ferrari might deserve closer to a 10-15x multiple for its exceptional brand creation, we believe a premium beyond that level is unwarranted and unlikely for investors to ascribe such a lofty valuation for long as the problems become evident in the numbers. By our calculations, that still places RACE stock closer to the $30-$40 range from the current price of $137 per share.

For the Ferrari bulls out there. Let me share another reason you should sell your stock, and others should short this highly-challenged and over-valued company. For RACE stock dynamics, the Euro is rallying very hard which is a big negative for RACE since all of their production costs are in Euros while their sales are in all kinds of currencies around the world. Part of the reason for the rally in RACE in the fall of 2019 was the sharp fall in the Euro. This has now more than reversed and the Euro will rally harder as the US is cutting rates more than Europe. RACE stock is going to fall much further as it has so many headwinds now working against it. Moreover, the Coronavirus is projected by many to crush overall car sales in 2020. (Coronavirus Expected to Slam 2020 Car Sales) on a global basis. In China, where the coronavirus originated and has created the most cases, deaths and challenges, the fallout is worse. Coronavirus Piles More Pressure on the Struggling Car Industry.

"This year is shaping up to be the toughest for manufacturers since 2009 as the epidemic hits auto sales while they're down."

Analyst’s Disclosure: I am/we are long TSE, OLN, WRK, DOW, HUN, CPRI, PVH, GES. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[kualla83]

Hats off. Not sure why I didnt look at DOW. 100% right on that analysis. Well done.

[Prati Management]

@kualla83 - thanks for the acknowledgment and kind words. I still think DOW has some nice upside from here. If you are looking 3-6 months out or more, I think you can buy TSE, CPRI, PVH, WRK, OLN, DOW and if you can buy international stocks, I think Lanxess (LXS) and HeidelbergCement (HEI) are very cheap with good stories and nice dividends. Best wishes and good luck for a prosperous year.

[kamendc]

Very timely calls, well done sir (with 20/20 hindsight) - except the Ferrari short.
Had I been more prudent and kept dry powder during last March's crash, could have loaded up on all these names and they are now 2-3-4x. Unfortunately, I had margin calls right then, and no free cash.
But I've been dipping in TSE, OLN lately, still good value. And opened up a small position (100 shares) in DOW at today's drop. I guess it was due to "buy the rumor sell the news" mentality.

[Prati Management]

@kamendc - I think it was de-risking due to COVID concerns. I think DOW bounces back quickly. They had a great report. The selling was quick and aggressive, and then it has been easing back up. I think DOW continues to substantially higher levels.

[Prati Management]

APRIL 21, 2021.
CPRI update. Look up CPRI on Seeking Alpha. All of the "analysis" articles are negative, cautious, and urging investors to avoid the name. CPRI has been a monster, and is about to rip another big leg up. Kering (owns Gucci) reported a huge beat. LVMH did the same a few days back. I expect CPRI will demolish the quarter (additionally, expectations for CPRI are a lot lower). There are so many skeptics on CPRI. It is among my biggest positions, and I encourage investors to buy it aggressively.

[Breaker12]

@Prati Management what's your PT for CPRI and GES now?

[Prati Management]

TRINSEO UPDATE for June 04, 2020

The UBS Chemical Team Wrapped up an Investor Call this Morning (6/4/2020)
Primary Points from the call:

1.) UBS just finished hosting a conference call for their institutional investors saying real-time data for chemicals is better than expected.

2.) The main theme in chemicals that UBS recommends investors to play is the fact that due to COVID-19, more people want to avoid public transportation/ Uber, etc. and drive more in individual cars.

3.) What is the best play on higher miles driven? Trinseo. Since Lanxess sold its rubber business to Saudi Aramco, Trinseo is best-levered rubber play for exposure to increasing individual miles driven. There was another rubber company, “Synthos” but it was taken private. This makes Trinseo the only game in town for investors looking to play this trend. Their synthetic rubber business did $137mm when the market was healthy. Expectations are for $25mm. One can see there is a disconnect here.

Remember, investors move into large-cap stocks first. For example, quality large-cap such as DOW move first despite their being less overall upside. For investors seeking liquidity, it is the quickest way for exposure to the sector. As the market has now bounced a lot and most people have missed it, they need high beta to catch up. TSE is still down around 40% YTD while the market is back close to flat. TSE is still down nearly 80% from in 2018 high. Trinseo's end markets are already looking better than what analysts and investors were expecting. TSE will provide the high-octane for investor portfolios from this point.

[busterbrown]

Thanks Prati, I loaded up around 800 shares at an average price of 19.88, so I'm a happy camper. Furthermore, knowing that the runway is quite long, this will be a good long term hold for awhile.

[Prati Management]

@busterbrown - delighted to hear! I think you will be selling at $100 per share in 18-24 months. Enjoy the ride. Nice dividend on the way, and you are making serious money!

[Prati Management]

TRINSEO UPDATE - - MY ASSESSMENT OF THE MORGAN STANLEY DOWNGRADE OF TSE FROM MAY 28, 2020

As I have received a ton of questions on TSE, and how a big firm like Morgan Stanley could downgrade to a SELL, I am posting this on my TSE-related articles so that those following the name can view my analysis and better understand the issues. I reiterate that TSE is my TOP PICK and very high conviction. Bottom line – I think the Morgan Stanley research report is weak, agenda-driven, poorly researched, uses specious reasoning, flawed logic, and simply gets the math wrong. I think it is an embarrassment to their firm, and as the stock performs, it will become obvious to those following TSE what the agenda was.

I went through the 65-page MS report, written by Angel Castillo, last night in detail for the second time. His argument is really all about the styrene market being oversupplied, everything else is kind of backfill. His call on styrene is that all this capacity is coming on in China (which we knew about and discussed), but that this time the high-cost producers won’t shut down to offset it. He has no data or argument for why (he cites 13% import tariffs from the US, but this is irrelevant as the US doesn’t export much styrene to China anyway, and even if they did, all these tariffs do is change trade flows (US export to Europe and Europe exports to China without a tariff). So basically he is saying, despite the evidence we have to the contrary, (high-cost plants shutting now) this will be different in the future.

Economically, this makes little sense...be that as it may. Mr. Castillo actually shows how utilization for polystyrene is going up (which is true) but he assumes the polystyrene earnings are flat (so styrene profits down because of lower utilization but polystyrene profits don’t get the benefits of higher utilization). For all the other divisions, he basically assumes very little recovery in earnings to justify his sell case (even though we have plenty of data to support the opposite). To me what is most interesting is that his entire case is based on something that has already happened – styrene profitability is already at marginal cost. This is because a lot of the supply has already come on while demand has been weak due to COVID. He has this long report on why oversupply is such a problem but then he shows that in fact, styrene earnings are ALREADY negative and he has them very slowly recovering from losses to break even. He assumes ZERO shutdowns of capacity outside of the TSE plant in Europe. He ignores the boost to profitability for TSE from closing the plant (even though we know it lost a lot of money last year and more in Q1 2020).

Mr. Castillo also ignores the fact that the hit to EBITDA in 2020 from the oil crash will not happen again in 2021. In 2020 there is a $65 million hit to EBITDA from revaluation of raw materials because of the oil crash. Unless you assume oil will go back to the lows and then have a similar crash next year, which would basically take it to zero, in 2021 you will have a tailwind by the absence of this $65 million hit even if crude prices had stayed where they were at the end of Q1 (Brent crude was 22 dollars per barrel on March 31). Since crude has actually already recovered to $35 as of today, not only will you not have this hit, but you will in fact have the opposite effect in the income statement. This is very high level but if crude going from $60 to $22 caused a $65 million headwind, crude just going from $22 to $35 should give TSE a $22 million tailwind (65/38 * 13). This means that if oil stays where it is, 2021 EBITDA will be helped by the absence of the $65 million hit plus the $22 million positive, for a total tailwind of $87 million. The Morgan Stanley analysis just ignores this.

In addition, he ignores the fact that as styrene profitability stays at break-even, CAPEX will go down, boosting free cash flow. I think what will happen is that the rest of the business will recover, and the styrene business will recover somewhat as there are some shutdowns as we are currently seeing. As oil pricing continues to recover, not only will you not get the hit to EBITDA from raw materials timing, but you will actually get a boost to EBITDA (double-positive as the negative impact goes away and then you get a positive impact on top). This means that EBITDA will recover to about $450 million over the next 18 months and then gradually get the lost $100 million from styrenics over the following 2 years. While many investors were spooked by this MS report, I think the company will start exceeding numbers significantly starting this quarter, and people will forget about the Morgan Stanley SELL report, and TSE will head much higher, and inflict a great deal of pain on those are short the stock.

[Barribas]

Hi Prati,
Not convinced about Capri.

As you say Versace (cost $2b) and Jimmy Choo (cost $1.5b) are generating zero profit in latest quarterly. In the March 2019 AFS when they bought these businesses pro forma's for these business they had profits of $579m and $623m making them theoretically good investments on paper, but no business fails on paper.If you add up the "lost " profits of $1.2b each year that's an incredible amount of "investment" in the business. Not sure it is possible to ever recover from that.

Also in 2016, speaking loosely MK carved out the Asian Pacific regions and gave it to CEO and friends to have monopoly over and to sell into. Then in 2019 bought back MK HK from him for $500m.Arguement "Better control if held within company" At least thats my understanding. Not sure if Capri is investable with a BoD that allows that to happen and a CEO who is prepared to trade trade with a public company that he is in charge of. I dislike the word governance but I am not sure how this can fly in USA markets as in Africa this would be called theft. To me speaks volumes about the company and makes it off limits, at any price.

[Prati Management]

@Barribas - I wanted to give some thought to your post. Your comment on the related party transaction is not a fair characterization of what happened. When the company went public in 2011, some of the founders decided to separate some of the HK business and keep it in a separate partnership becoming a licensee for the public company. There is simply nothing wrong or inappropriate about this. The founders decided what they wanted to include in the public company and what they didn’t and this was properly disclosed in the IPO document in 2011. In 2016, the company bought these licenses back from the private vehicle. If you look at what has been going in the consumer space, RL and PVH among others have all been doing the same, i.e. bringing licenses in-house to control the brand value. It seems your issue with this in the case of CPRI is because the seller of the licenses were the original owners of the company before it went public. I can only say again, there is nothing wrong with this as long as it was properly disclosed and investors could evaluate their investment decision with full disclosure. However, based on your comment, it appears you have a tainted view regarding ANY related party transactions. If this were not disclosed, I would understand your issue. But why would you (or anyone) consider this be “theft” when the assets belonged to the original owners in the first place (they just decided to exclude them from the assets taken public in 2011)?

Basically, they decided they wanted to keep it among the original founders and sell it to the public market later. So again, they didn’t steal anything. It was simply the way they decided to structure the deal, and it was fully disclosed. If this means you conclude the stock is uninvestable, then that is certainly your prerogative. In terms of the “investment” cost of the lost profits for a year while you improve the longer term profit profile of these assets, I disagree with that. If you can improve profits by even 20% it is well worth it to lose one year of profits because the normal multiple on this profit is well over 5x, so it definitely makes economic sense. Excluding the acquisitions, the stock was on track to do $5 dollars in EPS. At a fair multiple that is worth 75 bucks. When you add the acquisitions – they paid 23 bucks (I think they are worth $40), you get to $115 bucks. If you can buy the stock at $8 per share, that is plenty of upside even if you have these questions or issues. I would encourage you not to let the original deal structure with the owners and bankers give you angst.

[TerminatorZ]

Prati, thank you for this work you've done. I bought most of these picks around when this article came out and continually added, even on the 18th which was the bottom for most of these names. They have returned well so far and I'm looking to hold them for a while. I'll be looking out for your next coverage!

[Prati Management]

@TerminatorZ - thanks for your kinds words, and happy to help. I think it is a solid list. I am weighted heavier in TSE and OLN and don't plan to lighten up on either of them until they are at least double current levels.

[Jabler79]

What's your latest view on Capri (CPRI)? The stock has halved since this article and is now priced to go out of business. Is this just Mr Market's irrationality?

[Prati Management]

@Jabler79 - as you can see, on different days, we get crazy reactions. CPRI is easily worth 5-10x what it is currently trading for. I have been nibbling on the way down (sadly). Today, I loaded the boat. If it goes lower, I will ride it out. I also bought a bunch of 2021 January $10 strike call options. I figure that stock will be at least back in the $20s by then, and I will make some serious money. I paid around $1.70 average for mine. The stock is starting to recover (with the market) and so the options are going up, but there is a wide spread, and you can usually get somewhere in between. And buying the stock outright here is a great value. I have never seen such robotic senseless selling. People are panicked over retail sales. These brands at Kapri are quality, and they will be around for decades (or longer). This is one of those once in a lifetime chances. I hope that helps. I am not fully-loaded in TSE, OLN, WRK, CPRI, HUN, and nibbling on GES and PVH. Wish I could short more RACE, but I will buy some puts at an opportune time.

[Prati Management]

On Olin (OLN) - it is noteworthy to mention - OLN will benefit from what is going on with the slowdown and coronavirus because chlorine demand will fall in the US, driving production cuts and much higher caustic prices. This is what happened in 2008. They have plenty of liquidity with no pressure until 2025

[Silver Saving]

Bought yesterday, I'll double down on it today. Like you said, they have gone 96 years paying out...I doubt it stops now.

[busterbrown]

Any thoughts on S&P downgrading OLN to BB? Or, no big deal? I'm looking forward to buying more tomorrow. Thanks for your article and your responses.

[Prati Management]

@busterbrown - Thanks for the question. I can totally understand the question. Sadly, rating agencies are always the last guys to show up, downgrading when the bad stuff has already played out. The employees working there are typically the same quality you expect to find at the DMV. They enjoy closing the barn door after the horse has already left. It is the equivalent of the sell-side "downgrading" names like this when they are already down 60%-80% from the peak. Many analysts love to upgrade at the top and downgrade at the bottom. The rating agencies are barely taken seriously. Bankers trying to do debt deals play them off of each other.

OLN's debt is in good shape, and I remind you, this is a cash-generating machine.

Recall the embarrassing downgrade back in 2011 of US Govt debt. Everyone was already aware of the accelerating debt of the govt. The 2011 S&P downgrade was the first time the US federal government was given a rating below AAA.

While it was shocking at the time, it was so late and already anticipated that it had the opposite effect when S&P downgraded as one would have thought. S&P had announced a negative outlook on the AAA rating in April 2011. The downgrade to AA+ occurred FOUR days AFTER the 112th United States Congress voted to raise the debt ceiling of the federal government by means of the Budget Control Act of 2011 on August 2, 2011. The market actually went up. This was very memorable, and professionals both in the debt and equity sectors simply shook their heads at the stupidity and timing of this downgrade. Where are these guys when they should be looking forward? Not backward?

This is directly from Wikipedia:

The US Government commenced an investigation into S&P's role in the rating of several mortgage-backed securities which played a role in the 2008 financial crisis. In order to mend its relationship with the US government, S&P asked its then-CEO to step down, a mere 18 days after the US was downgraded. S&P announced on August 23, 2011, that Deven Sharma would step down as a Chief of Standard & Poor's effective September 12, 2011, and would leave the company by end of the year.

Just embarrassing.

[Prati Management]

on TSE - more insider buying yesterday. Also, TSE has no debt maturities until 2024. This stock action is so overdone.

[The Private Island Saver]

Fine article, bought half a position in TSE, WRK and OLN. Hopefully they will all avoid bankruptcy.

[Prati Management]

@The Private Island Saver - Thanks for your comments. I put bankruptcy for any of these companies at less than 1% in the next decade. OLN has survived for over 100 years, and paid its $0.80 annual dividend for 96 consecutive years (which includes the Great Recession of 1929). This seems bad, but in 1929, people were jumping out of windows. Suicides were commonplace daily back then. WRK and TSE are rock-solid. I could go into more detail, but these companies are well-situated to weather an economic storm, and will lead out of the recession.

[Leisure Enthusiast]

Well, so far the market doesn't agree. Are you sure you haven't overlooked something?

[Kajoobies88]

Would you consider $CC as well along the same lines as $OLN and $TSE?
@Prati Management

[Prati Management]

@Kajoobies88 - Great question. We do not like CC. In fairness, it could be a home run. High profile and very smart investors such as David Einhorn at Greenlight Capital like the name and have big positions. To us, there is too much legal risk. We view CC as binary. Either they prevail, and the stock is a moonshot, or they don't and it is a train wreck. TSE and OLN are both home runs without legal risk. Hope that helps.

[The Private Island Saver]

What is your opinion on the titanium dioxide market outlook?

[Illuminati Investments]

Love WRK and OLN at these prices, so guess I should check out TSE so I can have all of the top 3.

[Prati Management]

@Illuminati Investments - I would strongly encourage it. I lean slightly to TSE as #1. They are all solid, but TSE is arguably the silliest at this level.

[stocktrader22]

TSE looks interesting, but why are you so high on OLN? It appears they are losing quite a bit of money and demand is way down.

[Prati Management]

@stocktrader22 - Things are not always as they appear. OLN is a cash flow generating machine. We are at trough both on demand and valuation. It is common to try to calculate "normalized" earnings or free cash flow for cyclicals. OLN is the low-cost and largest producer of Chlor-Alkali. Names like this frequently look expensive (or average) at the bottom and cheap at the top (peak earnings). We estimate the costs to replace OLN's assets would be $16bb. Management would likely tell you $14-15BB. New capacity would take 3-4 years to bring online if a big player started today. It is not happening. OLN is well below $2bb market cap now (about $1.7bb). As the cycle turns, OLN's free cash flow will go vertical, and in addition to easily being able to cover their $0.80 annual dividend, they will be able to do a very meaningful share buyback. With a ~7.5% dividend yield, and a nearly 100 year history, I am comfortable. As they say "buy low, sell high." This is the cheapest OLN (and TSE) have ever been. We have been in a chemical cyclical downturn for the better part of two years. We can go over this in more detail if you want to go over specifics, but the company is in great shape.

[Prati Management]

@stocktrader22 - Also, I will publish another article soon to go over a few of these names in greater detail. For example, for OLN, the underperformance of OLN equity compared to OLN bonds and the High Yield index is shocking. HY yield index is more leveraged and has direct oil exposure which OLN does not. It is simply insane, but markets are not efficient these days, which provides amazing opportunities for investors who are prepared to step in.

[emailog]

About some big 5G stocks? I would love to buy some but I just don’t know which ones!

[jnove]

"Since we first wrote our "SELL FERRARI" note (How to Destroy a Great Global Brand...), RACE has dropped about 16%. "

Sure, you should be the creator of Coronavirus and OPEC's last decision.

Even a damaged clock is right twice a day.

Short Ferrari and Long Capri?!?

Rolls Royce sales fall in China and you see a relationship with Ferrari but Capri has bought Versace (lot of weight in China) and you are long.

Jeezz, I will definitely follow you in the coming years in the articles here, because I think you deserve the penny. Maybe I am changing your name to "Oracle", because the first sentence is really humble.

By the way, if you want to make a bet (real bet with real money), I have lots of funds to afford one that says Ferrari will not decrease by 70-80% like you believe it will. When I believe in something I am willing to bet. If you are, great, will get in touch.

Should take your profits and run, that's my advice because for anyone that knows (in depth) these two companies this is a joke.

[Prati Management]

@jnove - I am happy to take some "luck" at times, but RACE is toast, and I have already made my bet. I have a very large short bet on the stock at $180 per share. I have it in print. You can cry about coronavirus and oil, and argue it has outperformed. Fine. The HSBC upgrade of RACE today is shameless and not helping Ferrari much. You and the sell-side will continue defending Ferrari all the way down to double-digits, and then perhaps you will get nervous. As for your continual petty barbs, I honestly don't have time to continue replying to your nonsense. If you cannot understand that there are no good comparisons for Ferrari, I cannot help you.

Capri's two PUBLIC acquisitions were at $23 per share. It is trading at $19. It is an excellent retailer and very cheap. And yes, China will hurt it's sales, but I believe that is reflected in the stock. I hope you buy a lot of RACE. Just remember to acknowledge when RACE hits double-digits again, and my list of Buy ideas are much higher.

You can change my name to "Oracle." I have lots of names for you...
But I will be polite, and ask you to quit wasting my time, and stop posting if you don't have some facts, and something intelligent to say. Valid points and criticisms based upon analysis and ideas are great. You arrogant pontifications about your not liking the RACE short or the CPRI long without any coherent logic or arguments are simply annoying. Make your bet. And let me know when you capitulate and sell your RACE. I will let you know when I cover. However, I can assure you it will remain in place for a while, and I will cover at much lower price points.

[VladPutin]

Making money shorting RACE!!! I want to bet you some real money. I know the company. Joke? Jnove a good joke? Da! Comrade, you are missing things. Ti koosok kakashka. Proshchay.

[Prati Management]

@VladPutin - Are you commenting to @jnove? I want to make sure I am reading your comment correctly. I hope you are making money shorting RACE.

[awisecpa]

I like your approach and I thank you. These are beaten down, not sexy, very good divvy payers and they have more upside than down. OLN was on my radar two weeks ago and I bought at $16, but today I had lots of fun adding to that below 11! Scooped up TSE at 17 and sold Apr 15 puts for 1.50 too.

Last night I went on the EPA website and looked at all approved antimicrobials to combat COVID-19 and then looked up every public company on the list. Some great companies! Do you know SCL? Would like to know your thoughts. Not a great divvy, but a great company with a long history.

[Prati Management]

@awisecpa - great to hear and you are very welcome. Nice buy on TSE, and good to hear you are adding to OLN. I do know SCL. It is a lot more expensive and pays a much lower dividend yield. They are a fine company, but to me, the out-sized return opportunity just isn't there. I would bet you could buy it, and it would be OK. But, I would tell you to buy more TSE and OLN. And if you want to have a bigger basket, add HUN and DOW. WRK is absurdly cheap here as well. I do not think this dislocation will last long. The coronavirus is already contained in China, S. Korea, and Italy has shut down, and the virus will be contained. We should just shut everything down for a few weeks, and we would have it contained here too. Regardless, it will pass. The stocks are already discounting the worst recession ever. Consequently, when things start to improve, these stocks will fly.

[awisecpa]

Thanks - looking at everything but taking time buying. In 5-10 years, we’ll be thankful we bought at these prices.

[Prati Management]

@awisecpa - You are most welcome. I hope sooner than 5-10 years, but I get your point. Much as we would all like to be able to do so, it is impossible to pick the top or bottom (other than rare occasions of great luck) I think with most of the names on the list, we are close enough to the bottom that I am willing to wait and accept a little bit more pain if needed. With some of these names already down close to 80%, I think there is not much downside, and collecting 8-10% dividend yields waiting for things to turn up is OK by me. With interest rates so low, we have to be willing to take some risk. At these valuations, I would be at a loss to understand why investors would not take some risk, and buy these names. With so much stimulation and liquidity in the system, once people are no longer afraid of the coronavirus or at least can see an end in sight, I would think we will see a vertical move in the most beaten-down names. We shall see!

[frogmaier]

EMN starting to look very enticing here as well.

[Prati Management]

@frogmaier - yes, chemicals have simply been slammed, and I believe the group is way overdone. However, I was very discriminating when putting my list together. I certainly looked at names such as WLK, EMN, LYB, and so on. But the list I put forth, I believe is cheaper, more compelling, better dividend yield etc. Just like the reader who asked about PKG. I looked at PKG and IP, but WRK is the best. And for chemicals, TSE, OLN, DOW, HUN and Lanxess are all top-notch. You may have a portfolio that requires more names, but I figured 10 stocks in a few industry groups that are misunderstood, and ridiculously priced, provides that ONCE IN A DECADE opportunity to load up.

[MMM82]

Excellent article, thanks. Initiated WRK last year b/k I thought it was value play then, recently added more. Query: does LYB operate in same space as DOW, OLN, etc. If so, what’s your assessment?

[Prati Management]

LYB in same space as DOW, but business mix is not as good as DOW. DOW is down more, but LYB is more impacted by oil, etc., than DOW. LYB is not in the same space as OLN. Hope that helps. Load up on TSE and OLN.

[frogmaier]

thanks for a GREAT article PM.
love your picks.
need a bigger shopping cart!!!

[omninoob]

Excellent writing and sound logic. However I am digging a bit further, how do you view WRK vs PKG? Just by looking at the overall comparison it seems PKG delivers in form of equity rather than dividends? Your perspective would be appreciated.

[Prati Management]

@omninoob - I like the space in general, and PKG and even IP, are OK. But WRK is by far the best and most attractive. To sum it up - 1/3 of the valuation, better exposure to consumer packaging which benefits from the transition to more paper-based packaging and the Dividend is twice as high. I am sure you are aware that there is a big move away from plastic packaging and towards consumer-friendly and recyclable paper-based packaging. WRK is the best-positioned. I encourage you to LOAD UP. This valuation is seriously unheard of. The market is in panic mode, and investors are being given gifts.

An ideal situation for people who have been on the sidelines or who have a lot of cash on the sidelines. You can build an amazing portfolio of companies TODAY that will generate a huge yield, and will likely provide a massive capital return. I have described what we are seeing here as ONCE IN A DECADE OPPORTUNITY. No ambiguity - LOAD UP.

[omninoob]

Thank you for the reply. It does seem very attractive; I will also look into the chinese counterparts in the industry :)