Two stocks in search of a turnaround
The contrarian investing that has paid off for these two Canadians is seen in action with two turnaround stocks, one famous, one less so.
How risky is it to be a contrarian investor?
What are your chances of buying a stock that’s down and seeing it reward you with a thrilling run back up the charts?
In part, that depends on how much time you are willing to take with a stock. It also depends on whether or not you agree with the contrarian philosophy, which in effect says that it’s better to avoid popular stocks that have already been bid up in price.
But let’s hear from some card-carrying contrarians. Specifically, two Canadians who have followed this approach for years, and prospered.
Four times a year, these investors publish Contra the Heard. They pointedly do not offer specific buy, hold or sell advice. They purchase stocks and comment on their progress for their subscribers.
We’ll review their philosophy, check their results, and take a look at two stocks they have earmarked for turnarounds. One is a name you should easily recognize. The other is not likely to have been on the tip of your tongue anytime lately.
Shot in the foot
The philosophy of these investors, who refer to themselves as the Contra Guys, could pass for a conservative one in many ways. It rewards patience, diversification and dividends.
But it also demands that you take a cold, hard look at a company that has shot itself in the foot — sometimes both feet — and decide it can get back up and run.
The philosophy focuses on stocks that have the ability to increase by at least 50 per cent in value. To determine who these firms might be, you have to hit the books.
Thus, the Contra Guys “carefully analyze corporations’ financial statements, concentrating on debt ratios and book values.” And, “analyze management’s ability to reach its stated goals.”
They pick no company that has been around for less than ten years. And they seek out takeover candidates well before takeovers occur.
Once their target for the stock has been achieved, the approach is to sell 50 per cent of their shares, then “market time” the rest.
They do not affiliate themselves with any broker or financial institution. They also keep their distance from the market’s buzz: “Practice patient investing while ignoring the daily pulse of the market.”
How has this worked out? Well, the stock market rally of 2009 brought their return for the year to 47.4 per cent. That makes their ten-year return 14.3 per cent and their 15-year figure 16.6 per cent.
Nice work if you can get it. And if you’re willing to look at an ugly duckling and conclude it will turn into a swan. Here are two such birds.
Things got worse
“Initially, the selection of Jean Coutu Group (TSX-PJC.A) might cause a few people to scratch their heads,” admit the Contra Guys. “Is this in fact a contrarian purchase? Well, yes it is.”
This company has had better days and traded much higher. And it should get back up there, they believe.
“While Coutu’s pharmacies are unknown to those of us who live west of Cornwall, Ontario, the chain is a powerhouse in La Belle Province, where its stores outnumber Shoppers Drug Mart by two to one.”
Coutu’s problems came in the U.S. In 2004, it made a “brash foray” south of the border, snapping up over 1,500 Eckerd drug stores from J.C. Penney. This did not work — and then things got worse.
Coutu flipped the under-performing stores, and 300 others under the Brooks name, to Rite-Aid in exchange for board seats and 250 million shares. This made it Rite-Aid’s largest shareholder.
The deal was closed in 2007, just in time for the recession. Rite-Aid has piled up ten consecutive losing quarters.
In Montreal, CEO Jean-Francois Coutu started leaning on Rite-Aid to sell assets (it has refused so far) and started writing down the value of its own investment in the firm, taking a hit of nearly $400 million.
That sacrifice is starting to pay off. Coutu’s third-quarter results were better than expected (thanks in part to the H1N1 scare — bad news can be good news for a turnaround stock).
“Though not cheap, Coutu’s current share price is quite decent considering its upside,” say the Contra Guys. An aging population also points to higher sales of prescription medication. “In the meantime, the firm maintained a nice habit last April, increasing its quarterly dividend, which is now up to 4.5 cents per quarter.”
The target range for Coutu is $18 to $22. The shares are now trading at $9.65. The yield on the dividend is just under 2 per cent.
Point A to Point B
You just might have run across the name of CSI Wireless Systems, a maker of global positioning systems (GPS). But the name has changed. It’s now Hemisphere GPS (TSX-HEM).
Its chief mission is not to get you from Point A to Point B, but to supply sophisticated positioning systems for commerce and industry.
The Contra Guys bought this stock in December at a low, low price — “just a nickel above the bottom, a level not seen in the past decade,” they tell us.
And the stock went on a nice run, scooting up 42 per cent. That run “appears to have been well coordinated with tax-loss season,” they add.
“However, this swift kick doesn’t mean the company is by any means out of the proverbial woods.”
A number of new products have been introduced, which indicates that R&D spending is paying off. But there is still a lot of old inventory to get off the shelves, still something of a roadblock for this Calgary firm.
Contra the Heard has a target price of $3 to $4.50 for the stock and it is now resting at $1.03 (and we do mean resting, it is not heavily traded). This one does not pay a dividend.
It takes a certain amount of fortitude to dig down in the discard pile for tomorrow’s winners. But for a true contrarian, only those willing to start at the bottom can achieve the greatest rewards.
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