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The Best Rebound Stocks in the S&P
Monday, December 20, 2010 - 10:30 AM
arring a year-end shocker, 2010 will go down as a good year for stocks. The S&P 500 is up more than 10% this year, and roughly 75% of stocks in the
index are in the black in 2010. Of course, the other 25% would like to get past 2010, especially those that have been hit hard. I went rummaging through the dustbin of S&P 500 losers and have found a few intriguing rebound candidates for 2011.
A few of these names will be familiar to our readers. I
recently suggested that grocery chain
SUPERVALU (NYSE: SVU) looked far too cheap, especially when compared to other industry players.
I also continue to think that
Office Depot (NYSE: ODP) is once again
finding its footing, and should close some of the valuation gap with rivals
Staples (Nasdaq: SPLS) in 2011.
H&R Block (NYSE: HRB)
The price-to-earnings (
P/E) ratio on this tax prep firm really gets your attention. But few would argue for a higher
earnings multiple at the moment. With unemployment at high levels, demand for the company's software and services are at a multi-year low.
Well, it may be a no-growth business right now, but
free cash flow remains quite impressive. H&R Block has generated a cumulative $1.0 billion in free cash flow during the past two years. While business slumps and
shares trade at levels last seen in 2002, management has decided to use some of that
cash flow for ongoing stock buybacks. The company's share count has fallen by 10% in the past year, and management expects to take another chunk of the share count out of the public's hands in 2011. And while investors wait, they can also focus on the company's 4.6%
dividend yield.
Will results rebound in 2011? Perhaps, but it will likely be a few years before improving employment trends enable H&R Block to post meaningful growth again. In the interim, the shrinking share count should set the stage for eventually higher per share profits. And it's unlikely that business will slump further, so that miniscule P/E ratio likely provides solid downside to the stock. If you're looking for long-term
appreciation and a healthy
dividend, H&R Block is emerging as a solid discounted play.
Diamond Offshore (NYSE: DO)
One notable event stood out as the black-eye of 2010: the Gulf oil spill, which along with
BP (NYSE: BP), took down
shares of Diamond Offshore, an operator of 46 offshore rigs for clients on several continents. Diamond is the country's second-largest provider of offshore drilling services, by
market value. The company's
shares plunged from $100 at the beginning of the year to around $60 by June, and they've been stuck there ever since.
The Gulf oil spill surely hurt. Sales are on track to fall -8% in 2010, while profits are off by a third. And few expect a sharp snapback in 2011, as drilling in the Gulf remains below previous levels while the industry settles on new safety standards. This business is all about supply and demand. With weak rental demand for these ultra-expensive rigs, asking prices are off sharply. The industry must now wait for demand to catch up with the supply of rigs, at which time daily lease rates should rebound.
More than likely, gulf drilling activity will only slowly rebound during the course of 2011, setting the stage for much improved results in 2012. As investors look ahead and anticipate that rebound, and a jump back in
earnings per share (EPS) toward the $10 mark in 2012,
shares should make up some of the lost ground from 2010.
Action to Take --> All the companies on this list sold off for good reason. But SUPERVALU, Office Depot, Diamond Offshore and Office depot sill look poised for better days ahead. Near-term results could still be uninspiring, but incremental improvements should bring some of these deep value names back onto investors' radars in 2011.
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David Sterman===============================================
Stock Analysts Agree: Supervalu Is no 'Buy'
By Ben Steverman
Of 14 Wall Street analysts who follow the supermarket company, none recommend the shares, spurring some contrarian investors to seek opportunity as Supervalu pays down debt
Supervalu (SVU) may be the least-loved large-cap stock on Wall Street: Not one of the 14 analysts who cover the supermarket company recommends that investors buy shares. Among the seven stocks in the Standard & Poor's 500-stock index without a buy rating, Supervalu is followed by the largest number of analysts, according to Bloomberg data.
Ordinarily diplomatic—and cautious when criticizing companies they cover—analysts are blunt about Supervalu, a 150,000-employee grocery chain that sells under various brands, including Albertsons on the West Coast, Acme in Philadelphia, Jewel in Chicago, and Shaws in New England.
"I don't think they're going to be able to recover from their current challenges," says Karen Short, an analyst at BMO Capital Markets, who rates the shares "market perform."
"Their base business is in a very poor position," says Jefferies & Co. analyst Scott Mushkin, who says shareholders would probably be better off if the company were broken up and sold to competitors. He has a "hold" rating on the shares.
In second-quarter results reported on Oct. 19, Supervalu's same-store sales fell 6.4 percent and total sales dropped 8.5 percent, to $8.66 billion, vs. year-earlier results. As consumers defected to other retailers, the chain's customer count was down 3.9 percent from a year ago, a decline that Janney Capital Markets analyst Jonathan Feeney called "awful." Feeney gives the shares a "neutral" rating.
Minuscule Price-to-Earnings Ratio
In the counterintuitive world of stock investing, unanimous negativity can attract buyers looking for a deal. "Overpessimism is what attracts us to the stock," says Thomas Villalta, lead portfolio manager of the Jones Villalta Opportunity Fund (JVOFX), a Supervalu shareholder. He says the stock is "significantly undervalued."
Supervalu shares are down 14 percent in 2010, compared to supermarket chains Kroger (KR) and Safeway (SWY), which are up 7.2 percent and 7.6 percent, respectively. For Supervalu, the price-to-earnings ratio, a common measure of valuation, is 6. For mass-market retail peers, the average p-e is 15, according to a Bloomberg data measure that includes Wal-Mart Stores (WMT), Kroger, Safeway, Whole Foods Market (WFMI), CVS Caremark (CVS), and Walgreen (WAG).
Craig Herkert, a former Wal-Mart executive, took over as Supervalu's chief executive officer in May 2009 and is trying to turn the company around by cutting costs, lowering prices, and paying down debt. "It may be too little, too late," says Ajay Jain, an analyst at Hapoalim Securities, who has a "neutral" rating on shares.
Analysts' list of concerns about Supervalu start with its debt load. At the end of the last quarter, the chain had $7.1 billion in total debt, most stemming from the acquisition of the Albertsons grocery chain in 2006, which more than doubled its sales while increasing its debt load sixfold.
Few worry that Supervalu could default on this debt soon. In fact, the company is paying debts down faster than it had previously indicated, including a $650 million reduction forecast by the company for this fiscal year, which ends in February.
Paying Debt Leaves Little Flexibility
"The debt is manageable for now," says Evan Mann, an analyst at credit research firm Gimme Credit.
The problem is that debt payments leave less money for other needs. "It doesn't give them a lot of business flexibility," Jefferies' Mushkin says.
And Supervalu has many urgent priorities. From marketing to technology, the company's systems are behind those of competitors in many areas, analysts say. "They're just so far behind, I don't know that there is any way to catch up," BMO's Short says. She adds that the chain also hasn't effectively responded to the latest retail trends, from discounters' new food offerings to the growth of specialty chains such as Trader Joe's. "They have not kept pace," she says.
Herkert, Supervalu's CEO, has acknowledged the problems and is trying to catch up. He has brought in a new management team, is centralizing such functions as marketing, and is changing the assortment of items on shelves to a more efficient mix. He is also positioning Supervalu as "America's neighborhood grocer" by adding more local merchandise to each store.
Analysts say many Supervalu stores need to be renovated, particularly those acquired in the Albertsons deal. "The Albertsons store fleet was kind of caught up in a time warp," Jain says. "You have to put a lot of capital in those stores, to wow customers [and] get them to come back," Short says.
Supervalu Can't Afford Pricing Wars
Kenneth Levy, Supervalu's vice-president of investor relations, says stores are being renovated and replaced at the correct pace. In fact, the condition of stores isn't the main reason for recent sales declines, he says: "Now, more than any other factor, customers are shopping based on price."
While Supervalu prices vary from one area of the country to another, analysts and executives agree that they are too high, compared to those of nearby competitors. In some geographic markets, Mushkin says, Supervalu's reputation for higher prices is so bad that it may need to price significantly below competitors in order to bring back customers—which would provoke rival supermarkets to respond. Given the chain's debt level, he says, "they just don't have the financial wherewithal to get in a pricing war."
Supervalu has started adjusting prices, although it's not trying to undercut discount stores such Wal-Mart. "We need to be fair on price," Levy says. "We don't need to be the low-cost provider." He notes that with its wide assortment and convenient locations, "there are clearly some advantages to being convenient to shop."
This is the dilemma that caused Don Wordell, portfolio manager of the RidgeWorth Mid-Cap Value Equity Fund, to sell his Supervalu shares in the late spring: Cutting prices makes it harder to pay back debt, but high prices are scaring away consumers. "I just don't see the light at the end of the tunnel," he says.
Wordell had been pinning some hopes on the possibility that Supervalu could raise cash by selling off stores, but most such sales have been small. On Oct. 29, Supervalu announced the sale of its 14-store Bristol Farms division. Sale terms were not disclosed. Supervalu has also been making acquisitions, including the purchase of a six-store pharmacy chain in Missouri and Illinois, announced on Oct. 18.
Could Save-a-Lot Save the Day?
As of July 20, Supervalu owned 1,161 supermarkets in the U.S., while also operating the 1,200-store Save-a-Lot discount chain and a food distribution business that serves 1,910 independent grocery stores.
The Save-a-Lot chain, which features small grocery stores selling only Save-a-Lot brand merchandise, is one source of investor hopes for Supervalu's future. "That's a real growth vehicle for the company," Levy says, noting plans to double the number of Save-a-Lot stores in the next five years.
There is also evidence that the sales slide at Supervalu's supermarkets could be stopping. The company projects same-store sales to improve from the first to second halves of its 2011 fiscal year. In the first five weeks of the current third quarter, same-store sales improved by one percentage point from the second quarter, senior vice-president of finance Sherry Smith told analysts on Oct. 19.
Whatever the reasons for hope, equity analysts see few catalysts to improve Supervalu's earnings in the near future, says Gimme Credit's Mann. Supervalu is "doing the right things but it takes time to change people's shopping behavior," he says, noting that any improvement could take two or three years.
Alan Lancz, president of investment firm Alan B. Lancz & Associates, has been buying Supervalu shares, betting they will rise along with other grocery chains when the economy improves and food inflation boosts the value of inventories. But he freely admits the company's serious problems. "With Supervalu, it's going to take a little patience," he says.
Steverman is a reporter for Bloomberg News .
I haven't been able to figure out how exactly they arrive at the magnitudes of the haircuts, but I suspect their methodologies are qualitative in nature (i.e., SWAGs). They may be right in their approaches, but I don't think so. Furthermore, from a technical perspective, the slide from $12.40 at close of trading on October 18th to an intra-day $8.20 on December 7th appears to have run a capitulation course I've observed in the past (e.g., BP from early May to late July 2010). Absent incremental downside catalysts, the market has fully priced in the company's long road to deleveraging, stabilizing gross profits and optimizing the cost structure.
