Analyzing Bargain Stocks

We employ the use of net working capital as a proxy for liquidation value in our analysis – as a minimum valuation to judge whether a stock is selling for considerably less than its worth to a private owner. Sometimes a company goes into self-liquidation. PDL Biopharma (PDL) is one of those companies where management decided that the best course of action for stockholders is to liquidate itself. This stock is what Ben Graham called a ‘Special Situation’. PDL, formerly known as Protein Design Labs, was founded in 1986. Its recent business strategy was to finance commercial stage and late clinical stage pharmaceutical assets via royalty monetizations, debt structures, or a combination of both. Later on, it pivoted to receiving equity in under-commercialized products. Management estimates liquidation of PDL to fetch between $350m to $700m ($2.98 to $5.97/share) for the stockholders. The equity sells for $368m or $3.18/share at the close on May 15 th . Book value as

Ever since Covid-19 wrecked financial markets, the eminent investor Warren Buffett made one prominent move: He sold all his airline stocks. Our job is to evaluate whether the value of the equity is worth far more than the current price. Hawaiian Holdings (HA) is the sole owner of Hawaiian Airlines, which operates flights throughout the Hawaiian Islands, to several cities in mainland USA, South Pacific, Australia, and Asia. Its operations have been fully halted after Covid-19 struck. It generated revenues of $2.8bn and ebitda of $481m in 2019, its last full year of normal operations. Net debt as at March 31st 2020 was $737m before participation in the government loan programs (below). The equity is selling for $527m or $11.47/share. HA availed the US government’s payroll support program (PSP) that provided $292m in loans, with a further option for $364m in secured loans. HA received $146m of the PSP in April 2020 with the balance due between May and July. Management

The steel industry is a prime example of a notoriously cyclical industry. There are, however, examples of quality operations within the industry. Steel Dynamics (SD) is one of the larger and higher quality steel operators in the US. It generates revenues from steel production, metals recycling, and steel fabrication. Steel production is the largest contributor to revenues (75%). It has 13m ton capacity for steel production and metals recycling. 95% of sales are in the US and SD’s products are used primarily for construction, auto, and other manufacturing activities. Its competitive advantages lie in a diversified value-added product offering, control of secure supplies of recycled ferrous metals (65% from own source), and importantly a highly variable cost structure. Management has taken efforts to control the fixed overhead/ton of production over the years. SD is part of the ‘critical infrastructure industry’ designated by the US government, which allows it to operate u

Waddell and Reed Financial (WRF) is a holding company that is one of the oldest mutual fund complexes in the US established in 1940. It earns its fees via Investment Management, Underwriting/Distribution, and Shareholder services. It has assets under management (AUM) of $60bn as at April 30 th 2020 and assets under administration of $52bn, which include advisory and non-advisory accounts held in brokerage or fee-based asset allocation programs. Its revenues are from the Institutional, Unaffiliated, and Wealth Management segments – with investments in equity, fixed income, and money market funds – employing a wide variety of strategies. As an active manager, it has seen relentless redemptions – with AUM falling from $80.5bn three years ago. Performance has been poor with only 37% of its funds and assets in the top half of mutual fund performance over a five-year period. Revenues have declined from $1.52bn five years ago to $1.08bn in the last twelve months. Net in

‘Value’ investing strategies have experienced their longest period of underperformance vs the S&P 500 index since 2006. Gamco Investors Inc (GAM), controlled by the celebrity investor Mario Gabelli, earns fees running several value-oriented funds including 24 mutual funds, 16 closed end funds, and 1,700 institutional and private wealth management accounts. Although the funds have beaten the S&P500 since inception in 1977, 14.7% net of fees vs 11.8% according to management, recent performance has lagged – 21.3% in 2019 vs 31.5% for the index. This, along with the relentless competition on fees from index funds has driven assets under management (AUM) down to $27.5bn on March 31 st 2020 from $43bn just over two years ago. Large declines in AUM in Q1 2020 were due to stock market declines as a result of Covid-19 but client redemptions have been significant over the recent past. GAM earns investment advisory fees (as a % of AUM), performance/conditional fees (on out

Mining is deemed a ‘critical infrastructure’ industry by the US Department of Homeland Security, which confers participants with certain benefits during the Covid-19 pandemic. Warrior Met Coal (WMC) is an NYSE-listed company that mines metallurgical coal in Alabama, which is converted to coking coal that is critical for steel production. WMC ships supplies via rail to the Port of Mobile, Alabama – and sells to Europe (54% of sales), South America (26%), and Asia (20%). It has proven and probable reserves of over 200m tons with production of under 8m tons a year. It also has access to the ‘Blue Creek’ facility that can boost its production by 54% after investing $25m – expected to take place in July 2020. Average selling prices in Q1 2020 fell to $134.47/ton compared to $194.47/ton in Q1 2019, a decline of over 31%. (Selling prices were $194 and $190/ton in the previous two years.) Fortunes are dependent on the notoriously cyclical steel industry. It generated revenu

US tariffs against China - starting with 10% tariffs in September 2018 and followed by 25% tariffs in May 2019 - has several US victims. One of them is Flexsteel Industries, Inc. (FI), a manufacturer of residential, contract upholstered, and wooden furniture products. They import 42% of their sales from China, and were hit badly. FI is a long-established company - and one of a multitude of relatively small furniture manufacturers serving the US and Canada. There are few dominant players in this industry. The dominance of online purchasing trends has also impacted profit margins. FI announced a restructuring exercise in June 2019 expected to last two years. Management budgeted $48-53m in restructuring costs, of which $31.4m have been incurred to March 31st 2020. FI generated $402m in sales and net losses of $21m in the last twelve months. Average net income over the last five years can be pegged at between $12m-$15m. A closer examination of the restructuring costs reve

The tidal flow of money into passive investment strategies tracking index funds, particularly the S&P 500 has dented the active money management business. Hennessy Advisors Inc (HA) operates 16 open-ended mutual funds of which only one tracks an index. HA earns money via investment advisory fees, and shareholder service fees. Investment advisory fees range between 0.75% and 1.25% of the assets under management (AUM) and shareholder service fees (which includes administrative services for redemptions/change of fund options, etc.) amounts to a flat 0.1% of AUM. Management of six of the sixteen funds are outsourced to sub-advisers who charge between 0.27% and 0.42% of AUM. Most of the funds are divided between quantitative strategies and actively managed portfolios. Every fund, except for HA’s Japan fund and Focus fund have lagged their relevant benchmarks and indices over 3, 5, and 10-year terms. These two outperformers contributed 42% and 12% of HA’s revenues. The third hi

We’ve covered several bargain stocks from climate-unfriendly industries such as coal and oil. This stock is from the opposite end of the spectrum. Renewable Energy Group (REG) is the largest manufacturer of biomass-based diesel (biodiesel) in North America. Biodiesel is used primarily as transportation fuel and reduces carbon emissions. It has capacity to manufacture 505mn gallons of product annually. REG is highly dependent on government regulation for its economics. The cost of manufacturing biodiesel is higher than petroleum-based products. The attractiveness of the product lies in regulation requiring petroleum refiners and importers to purchase mandatory quantities of biodiesel, which earns them renewable identification number (RIN) credits. Each gallon of biodiesel generates 1.5-1.7 RINs. However, no purchase obligations have been set for 2023 and beyond when it’ll be under the discretion of the EPA. The company is also dependent on biodiesel excise mixture tax cr

Here’s another stock from the declining coal industry. The share of coal in US electricity production has fallen from 53% in 2000 to 24% today. Natural gas poses the greatest cost-effective threat to coal, without counting the threat from government mandates for using renewable sources. Alliance Resource Partners LP (ARP) is a limited partnership listed on the NASDAQ that mines coal from the Illinois basin and Appalachia totaling seven coal mining complexes in the eastern United States. It is the second largest coal miner in the Eastern US. It supplies 79% of its output to domestic US electric utilities, 18% outside the US, and the balance to brokers and industrial companies. ARP also earns royalties by leasing oil acreage it owns. In 2019, this amounted to only $52m. ARP generated $1.96 billion in sales in 2019 and ‘adjusted’ ebitda of $600m that excludes several one-off items. Operating cash flows amounted to $517m and management indicate maintenance capex of $260m leav

One of the gripes against most stocks is the lack of 100% payouts of earnings. The reinvested profits are left in the hands of management, and this very often fails to materialize in market value. Limited partnerships are a breath of fresh air in that regard. However, there are specific attributes of limited partnerships, which foreign investors should beware – though distributions are generous, ALL partnership income is taxable – and withheld by the partnership at the highest effective tax rate, currently 37%. Further, partnerships can dilute existing partners by issuing additional units. Ciner Resources LP (Ciner) is one of those limited partnerships listed on the NYSE. It is the world’s largest natural soda ash manufacturer (as opposed to synthetic). Its primary competitive advantage is the low cost of production from the Green river basin in Wyoming. The company’s ultimate parent is based in the UK and owned by Turkish interests. It owns 51% of Ciner Wyoming, which co