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$KMG And $PEIX: Potential Diamonds In The Rough

|Includes: KMG Chemicals, Inc. (KMG), PEIX

The exercise of quantifying a company's major attributes in numbers - known as valuation - can be misleading sometimes as numbers don't always capture industry dynamics. As a result, Pacific Ethanol Inc. (NASDAQ: PEIX) may look like nothing more than a frivolous buy to an untrained eye. Similarly, specialty chemicals player KMG Chemicals Inc. (NYSE: KMG) may not look a great buy at the first glance, but there is clearly more than meets the eye.

Houston, Texas based KMG Chemicals sells electronic chemicals and industrial wood treating chemicals to industrial clients in the semiconductor, utility, and railroad industries. Although the stock has moved up 10 percent over the last month, it is still way below the highs of $24 per share seen in October. At current market price of $17.3 per share, the stock trades at a price earnings ratio of 345. That's enough for some people to stop reading this right away, but for those who want to know more, it is a turnaround play.

The company announced a global restructuring of its electronic chemicals operations in October last year that also involved a plant closure. The move, coupled with accelerated depreciation, has put pressure on the company's earnings, although the top line growth has remained intact. For the nine months ended April 30, its revenues grew 44.1 percent to $262.1 million. Although a large part of this growth is due to an acquisition, the fact that it still has a low debt equity ratio of 0.7 speaks volumes about its operations. The company will emerge as an even more solid player once the restructuring is completed. Thinking on these lines, analysts at Gabelli & Co recently upgraded the stock to 'buy'.

Pacific Ethanol is in no financial distress, but its dependence on government subsidies has earned it a lot of naysayers. Its losses over the last couple of years are often highlighted as proofs that the business model is unsustainable. To an extent, this criticism is fair as the excessive reliance impedes and clouds the earnings growth. However, equally true is that the government is highly unlikely to dislodge from its position that biofuels must continue to be a strong part of the nation's energy solution. In the Obama administration's FY 2015 budget proposal, the sector has got more subsidies. Pacific Ethanol will be one of the biggest beneficiaries of this move. Meanwhile, the company is recovering well from the November 2013 shock and its financial distresses by repaying debt; a trait visible in the stock's forward earnings ratio of 8.8. Another positive for the sector is the nationwide shortage and resulting firmness in ethanol prices due to recovering demand from overseas markets.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.