Fish In a Barrel Time

This first week in November finds us taking exception with one of our oldest journalistic rules. Since the beginning of “ruminations on things that matter for thinking investors”, I have assiduously avoided “naming names”, i.e., writing about the specific investment merits of a particular stock. One does not want to degenerate into a “tout sheet”, and on among the safeguards against degeneracy, as with many other of life’s hazards, is remember that there are not only lines one does not want to cross, there are lines one does well to not even go near. This exception is being made because it is the best way to illustrate something that has become almost too obvious too see: stocks are ridiculous, stinkin’ cheap right now, the kind of bet against the end of the world one only gets once or twice in a lifetime (if it happens twice in your life, you were probably too young and didn’t have the proverbial two-nickels- to-rub-together the first time, or too old and world weary the second time.) So I am going to include a few thoughts about some (but not all) of my favorite (most beat up?) stocks.

This past week shook my conviction, but just a bit. No one should have been surprised that the Market needed to pull back after ripping about 18% in just six or so days. The first -5% day (Wednesday) had the feel of a normal pullback, with a concentration on the stuff in the indices. It had a nice orderly feel to it. Thursday was another matter, likewise down about 5%, but had all the gentility of Hutus meeting Tutsis on a moonlit road. That day’s carnage brought the indices down to within about 6% of their 10/10 lows, and sent us home wondering if Friday might not end up being the day “the center did not hold”. Friday brought wretched news (GM running out of money, unemployment up more than expected, hedge funds still have lots to liquidate, President-elect Obama appointing some memorably loutish alumni of the Clinton Administration). The Market popped up like a prairie dog with a tail full of fire ants anyway. This is a healthy sign. The urge to purge is still there, but not nearly as urgent. The hedge funds are still there, but their ranks are thinning. The unwinding of the 2 and 20 business model has been painful even for those of us who got nowhere near it, but it is most decidedly a finite process. The bad news will keep coming, but Big Dump I wrote about on 10/19 is likely getting down to the late innings. It matters much less to investors that GM might go through a reorganization (unless of course they are owners of GM securities) than that of a class of investors, apparently bereft of the humility that was considered virtuous before the self-esteem movement ran amok in the education system, thought they were immune to the ill effects of leverage gone bad and now are reaping the consequences. This liquidation will probably keep the Market moving sideways for a few more weeks or even months, but it will run its course.

We are at a point much like late 1987 or 1990 or 2002, only more so. I can’t speak for 1974 or 1932, but you would think it was 1932 to listen to some people. Heck, if you are working in “the business” and living in a money center, where most the people you know are contemplating big time life style changes, it is 1932, in the same way it was in Seattle in 1972 when Boeing was said to be down for the count. The Street is a scary and depressed place right now. That does not mean that the challenges are not real. What it does mean is that the messengers are traumatized, a herd a scalded cats ready to bolt up a tree any time anyone reaches for anything resembling a pasta pot. The events of the past year have been unsettling to a degree that nothing we went through in 1987 or 1990 prepared us for them. However, I do believe we have reached the point where one has to make the same bet I did back then, the Bet Against the End of the World. Valuations are such that for a bet on the stocks of reasonably secure enterprises to not work out much better than money market rates, we would have to be at something akin to the end of the world. It would be an outcome so bad that however much money you have would be the least of your worries. I would not recommend that anyone put all their money into stocks. Some kind of rainy day (or year) cash reserve is still in order, but there will not likely be another opportunity like the one that is at hand for another couple of decades at least.

I would encourage readers to look at that dismal time that was the 1970s, the (as my Company Commander at the time put it) “peanut poppin’ redneck” in the White House, the Ayatollah, the gas lines, disco, Whitewater, double-knit pant suits and double digit inflation. The Market had a swoon of similar magnitude to what we just endured in 1973 and for most of 1974. It, too, was the worst downturn since the Depression. Then a funny thing happened. From its nadir in late 1974, the S&P rose 54% in a year. If you look at the records of value investors, as lousy as the second half of the 1970s were for the rest of us, well-situated investors had a splendid four years. You can look it up! But they had to be there, and not wait for a theme (like energy, which worked great until about 1980 and then gave it all back and then some) to appear to them on the pages of USA Today.

The bargains are everywhere, even among the some of the most stellar of “blue chips”, stocks that haven’t been cheap in decades, if ever. A good example would be Intel. (INTC - $14.63 ) At less than 12 times current year EPS, with a couple of dollars per share more cash than debt and a franchise (leadership in the advance of microprocessor power & functionality) that will never be matched, it has been the sort of a “no-brainer” that I don’t mind recommending to strangers I meet at parties who want to talk about the Market (another rule being bent for the first time). I have spent the last couple of years studying Intel and its place in the world and have concluded that “the end of the line” for Moore’s Law is well beyond the far edge of my three to five year investment horizon. I reckon the appreciation potential to be something on the order 20 times EPS of $2+, well within that timeframe. Earnings might flatten out or even decline a bit in the year ahead if the global economy slows enough, but it would little more than a speed bump considering all of the life changing innovation that Intel’s own innovation is still unleashing around the world.

That said, if you forced me to make a short list of “best ideas”, INTC would not be on it. As compelling as two points of downside and 20+ points of upside, with a decent dividend yield (Yes, INTC has a well covered 3.5% yield!) no less, there are plenty of situations offering significantly more appreciation potential without significantly more risk. While I presently own more INTC than I ever would have imagined owning even a few years ago, I would be more focused on other stocks with much more upside that are arguably riskier (based on comparison of attributes) but as practical matter the downside is not all that different (they’ve all been crushed to valuations that could not have been imagined a year ago). So without further ado, here are five stocks that I am particularly pleased to suggest and to go “on the record” with”:


Seagate Technology (STX: 485MM shares @$6.60) As the world’s leading and low-cost producer of hard disk drives (HDD), STX has both facilitated and benefited from the burgeoning (40%+) growth in demand for data storage. It has also played a hand in the consolidation of what for most of its three decade history had been a frightfully competitive market. Seagate will probably earn about $1 this (June) FY. In a more normal period, FY 04 to FY 08, grew EPS from $1.41 to $2.63). Based on $1 EPS, gross CF will be just under $3: Free Cash Flow will be $1.45. The company has net debt of a little under $1B, or less than two (trough) years of FCF. With $0.48/year in dividends, the stock has an attractive yield. Unless the “growth in data storage” thesis has run its course, STX has earnings power well above $3 per share. I still expect the Market to accord a low teen multiple once this downturn proves that the HDD business is less cyclical (doesn’t give it all back in the downturn) than in the past. $40 within three to five years would not surprise me.

USEC (USU:110MM @ $4.05) is one of four companies in the world that enrich uranium for electric power production and the only one that is US based. As a provider, under long term contracts, of the fuel that provides 20% of what keeps the lights on, it is in a stable and low risk business. They will likely earn something like 30c this year and 70c next year while spending close to $1 per share developing a next generation technology. The reason the stock trades at a huge discount to a $12 book value, which consists largely of very fungible inventory, is lingering uncertainties about the funding and construction of a new plant, the American Centrifuge Project. The funding issue was signed into law earlier this year in the form of a loan guarantee by the Department of Energy (which used to own USEC and has a royalty interest in the production of ACP). Once the DOE loan guarantee is finalized sometime before the present Administration departs, the only remaining “issue” will be their ability to construct the American Centrifuge Program on time and on budget. This is not without risk (it is similar to the risk in a new aircraft engine program, but my estimation more contained, as if the new engine had millions of hours on it already, which the ACP does), but it is out there in time, as in two or so years from now. Once the financing question that goes away (they will be borrowing on an as needed basis through the Federal Finance Bank) there will be no good reason for the stock to trade at a discount to book value. I believe the earnings power from the ACP is such that USU could be $30+ in the next five years.

Hutchinson Technology (HTCH: 22MM @ $5.08) the world’s leading (of three) producer of suspension assemblies for hard disk drives. The stock traded off the map because they have been losing money on a GAAP (but not cash) basis. Earnings will recover as volume builds in the “additive” plant they started up last summer (to support the next step-change in suspension design; having this plant makes HTCH the only fully integrated provider to a customer base that needs rapid design, prototype and delivery) and they rebuild their share in the biggest the Seagate desktop. This is by far the largest SKU in the industry, went to zero for HTCH last year and is programmed to grow over the next several quarters. They have also been generating an operating loss on their BioMeasurement startup, to the tune of $5MM+/Q, or nearly $1 per share pre tax. This start-up has developed InSpectra, a device that non-invasively measures tissue oxygenation (StO2), a drop in which is a precursor to “going into shock” (is there an ancillary market putting these in brokerage offices?). It was approved by the FDA last year and continues to progress well ahead of expectations in terms of getting into hospitals, protocols and additional indications. Given what they have going for them, worst case I see the stock narrowing the discount with tangible book value (about $19). Alternatively, with a moderately profitable BioMeasurement division and the suspension business reaping the benefits of that investment in “additive” technology, it is no stretch at all to get to $5/share and, considering the potential of the StO2, which is already being regarded in some quarters as a standard vital sign, a P/E of 20+.


Mohawk Industries (MHK 68MM @ $39) is a leading producer of floor coverings, including carpet, tile, wood and laminate. The company earned $6+ per share in both 2006 and 2007, a period of declining housing activity and rising energy and raw material costs. These pressures got even worse in 2008, especially in H2. MHK will only earn about $3.60 this year and will probably see weak demand in the few months of next year. However, raw material and energy costs will be lower, and the company has been working very hard to otherwise reduce cost and emerge from the downturn an even stronger company. They should be able to continue to generate free cash flow and reduce the borrowings that funded their acquisition of Unilin in late 2005. (They paid down $128MM in Q3, and $1.4B since the acquisition.) This has been a splendidly well run company, a low cost provider of a basic need (predominately replacement). It is presently selling for less than eight times trough free cash flow and five times a more normal year’s free cash flow. I anticipate EPS of $10+ within the next five years and decent, mid-teen multiple on that.

The Dixie Group (DXYN 12.2MM @ $4.15) is another, albeit much smaller producer of floor coverings. In 2003, DXYN transformed itself by selling its commodity operations and using the proceeds to pay down debt, focus of it high-end brands (Masland and Fabrica) and develop Dixie Home, a new better-priced brand. Reaping the fruits of this transformation has been postponed by the housing downturn, but the company has remained profitable and continues to develop new product. This recent extension of its lending agreement to May 2013 put to rest any concerns about financial flexibility. The stock is trading well below its tangible book value of roughly $12. I believe DXYN has earnings power a couple of years into a recovery of something closer to $2 than to $1 per share.

Obviously there are many other bargains to be had, some of which are no doubt even more compelling. Only time will tell. These are but a few of the stocks that I expect future investors to say “Dang! Did it really get that cheap?” when they pick up a Value Line. The important thing is not to pick “the best of the best of the best”, but to heed the maxim, attributed to Woody Allen, that 90% of success is just showing up. It’s been hard enough just to show up lately, especially if showing up means stepping up and buying. So show up, and try not to throw up. We’ve lived through worse.