Marketplace Roundtable – Part 2 – Value Stocks

~ by Tim Murphy, Marketplace Success Manager

We continue our 2022 Mid Year Marketplace Roundtable series with Part 2: Value Stock coverage. Here’s the link to Part 1 (Macro and Tech and Quant Analysis). Once again, our contributors were given the following questions:

1. What are your major takeaways of your area of coverage so far this year? What are you looking for and expecting for the rest of 2022?

2. What’s one favorite idea for the rest of 2022, and what’s the story?

The series will continue with coverage on Commodities, Dividends/Income/REITs, Tech/Crypto, and Biotech/Healthcare.

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*Note for non-Premium readers: If the author provides a link to an article we have included a dollar symbol ‘($)’ to indicate it is behind the paywall. Articles from this account, SA Marketplace, are not paywalled.

Value Digger of Value Investor’s Stock Club: Our loyal subscribers know that we have forecasted since the second half of 2021 that the growth names will continue to drop in 2022, so the growth investors have a lot to worry about in 2022. As such, we have encouraged them to buy select value names and most of our value picks have performed very well so far, despite the ongoing bloodbath.

Moreover, we have noted in our posts for our subscribers that i) investors must not “buy the dip” this year and ii) the day-traders or momentum traders will lose a lot of money in 2022. On top of this we believe the high volatility will persist for the remainder of 2022 and the first half of 2023.

After all, strong fundamentals, sector diversification and technical analysis are key success factors in this stock market. Investors can still make money in 2022, if they are picky while also diversifying their portfolios properly.

IDEA: My favorite idea is DAVIDsTEA (DTEA). First, DTEA has quality specialty teas, a debt-free cash-rich balance sheet while also being very cheap at the current price of about $2 per share, because its current Enterprise Value is about 0.3 times the annual revenue. Based on the latest deal in the tea industry, Unilever recently sold its tea business for about $5 billion or about 2.5 times the annual revenue.

Second, insiders own a big stake (about 51%), so their interests are aligned with shareholders’. Third, DTEA is expected to announce significant growth-related news in the next few months. Fourth, DTEA is a takeover target.

Fifth, the sector tailwinds are unquestionable thanks to: (i) the increasing number of health-conscious wellness-oriented consumers including Millennials and Gen X, who add tea to their daily diets (ii) people will continue to drink tea, even if we have a recession in 2023 or 2024, because this super healthy beverage is a low ticket product too. “

Disclosure: I own DTEA

KCI Research Ltd. of The Contrarian: 2022 has been a fascinating year. For most traditional stock and bond investors, simply avoiding the market, and sitting in cash, as I opined earlier in January of 2022 with this article ($), would have been a win.

There have been some areas of the market, however, that have excelled, and generally these have been value-oriented stocks in the commodity sector, and more specifically in the energy sector. On this note, if an investor has had a significant overweight to the energy sector, this has made a significant, positive difference to their overall portfolio in 2022, thus far (2021 too).

Building on this narrative, remember the energy sector is still only roughly 4.5% of the SPDR S&P 500 ETF (SPY), which is up from an approximate 3.7% weight at the end of March of 2022, as measured by the Energy Select Sector SPDR Fund (XLE).

IDEA: My top idea for Seeking Alpha’s 2021 stock picking contest was Peabody Energy (BTU). This stock had an excellent 2021, and this outperformance has continued in 2022, with Peabody shares higher by 122.2% YTD vs. a decline of 20.6% in the SPDR S&P 500 ETF (SPY). The potential for a further 2022 breakout is something I flagged with a Jan. 28, 2022, public Seeking Alpha article titled, “Peabody Energy: A Breakout Stock For 2022.”

Even with Peabody’s significant outperformance year-to-date in 2022, shares of BTU have pulled back substantially from their year-to-date highs as a combination of a broader market pullback, alongside some company specific concerns have weighed on BTU shares.

These concerns should fade with time, as the remaining three quarters of 2022 should highlight Peabody Energy’s tremendous free cash flow generation potential at today’s elevated coal prices. In fact, look for Peabody Energy to have zero net debt in short order, changing the narrative.

Disclosure: Long BTU, short SPY

Chris DeMuth Jr. of Sifting the World: Litigations such as Renren (RENN) – see my article here ($) – has been a good place to hide out on the long side. It’s by far our biggest litigation, but we’re looking at a number of similar opportunities to put money to work and then to present on StW. On the short side, there has been a reversion to making sense, with value crushing growth and never profitable tech getting annihilated as exemplified best by ARK Innovation (ARKK).

We’re in the golden age of merger arbitrage in which deleveraging and liquidating funds puke shares of deal targets at dramatic discounts to definitive merger agreements and there is an all-time spread between superficial arb tourism and substantive understanding of deal risks. Spreads are wide enough to offer bonanza opportunities if deals close, OK outcomes if they’re recut, and even prices proximate to their standalone downsides. A selective basket of such stocks will perform quite well.

IDEA: My favorite long idea for 2022 remains Renren. It’s up over 243% since my firm first rated it a strong buy on Seeking Alpha while the S&P 500 (SPY) declined over 9%. Its outcome is utterly uncorrelated with the market. This year they’re likely to distribute to shareholders more cash than its current stock price.

Whatever you invest, I’m confident that you’ll get back whatever money you invest and then some. It’s a one decision stock. You pay under $29 and get $33.50 in cash, most of which will be distributed in 2022, you get a third of Kaixin Auto Holdings (KXIN), worth another $1-1.50 per share, and a free lottery ticket of a SaaS business. It’s conservative to say this is worth somewhere in the mid-$30s and it could be worth as much as $40; it is a crazy opportunity under $30. It was even better under $10, but we have more information since it has been substantially de-risked since then. It is still my best long idea for 2022.

Disclosure: RENN is a long position for Rangeley Capital and a long idea for Sifting the World.

Asif Suria of Inside Arbitrage: In our 2022 outlook article ($), we indicated that the Fed would be the key driver of market action in 2022 and we expect this to continue in the second half of 2022. If we see another 75 basis point hike in the July meeting, the risk of recession goes up and markets will continue to remain weak.

Multiple bubbles are currently unwinding simultaneously and this process takes time both in terms of the duration of the downturn and the peak-to-trough decline. The average peak-to-trough decline for the S&P 500 during the last four bear markets going back to 1987 was 43%.

The news is not all bleak. There are several companies that have been correcting for well over a year and have already declined more than 80% from their highs. High growth companies with strong balance sheets and that are free cash flow positive will present generational opportunities to patient investors.

IDEA: Merger arbitrage spreads have widened significantly in recent weeks on account of what appears to be forced selling and heightened risk aversion in the overall market. Most of these deals will likely close, generating excellent annualized returns for arbitrageurs.

Among active deals, we’re tracking over 15 deals with spreads of over 15% and more than 30 deals with potential annualized returns of 20%. One special situation that looks very interesting at the moment is the bid by the Founder and Executive Chairman of Continental Resources (CLR) to take the company private for $70 per share in cash. The stock currently trades at $65.05. Mr. Hamm and his family already own 83% of the stock and it’s unlikely that another bidder will emerge but it is possible that Mr. Hamm could sweeten the deal a little to convince the board. If the deal goes through, it provides a return of 7.6% in a short period of time. The annualized return works out to more than 22% if the deal closes in 4 months.

Disclosure: NA

Dhierin Bechai of The Aerospace Forum: 2022 has been very bumpy for aerospace and defense. Air travel is subjected to the COVID-19 waves as well as the fear of recession and inflation sparked by the situation in Ukraine and supply chain challenges. That’s affecting supply as well as the demand side. On the defense side, we’re seeing those same challenges but we see an improving defense budget environment as NATO countries are committing to the 2% defense budget guide. 2022 likely will remain bumpy due to the cost environment for airlines and the demand side concerns while equipment manufacturers face supply chain challenges.

IDEA: I believe Boeing (BA) has some potential despite fuel price headwinds for airlines and recession fears. Supply chain issues are keeping production rates for commercial aircraft as well as defense equipment below targeted levels. While Boeing is not the most attractive in terms of risk-reward, it has an advantage with an inventory of Boeing 737 MAX and Boeing 787 aircraft.

The 115 Boeing 787s worth $15 billion on revenue level are currently held in inventory pending delivery resumption and could boost cash flow later this year providing a tangible upside to Boeing’s share prices as investors can see cash flow improve and debt being reduced. While the full effect of the resumption in Boeing 787 deliveries might not materialize in 2022, a notable boost in cash flow unlocks significant upside that layers on top of Boeing 737 MAX deliveries.

Disclosure: Long BA

Valkyrie Trading Society of The Value Lab: Certainly value, skewed toward all sorts of commodity and manufacturing issues that have benefited from the goods boom, has fared better than decimated growth, but things are becoming complicated with rising rates. While it’s possible to find businesses that are fundamentally quite safe from the current market environment, including companies with high proportions of fixed rate debt and resilient end-markets due to perhaps strategic importance in the case of government customers or necessities for consumer and business markets, the reversal of the TINA conditioning is an issue for equity markets broadly.

While even in cash there’s no hiding from inflation, equities are looking like a difficult asset class for the short-term horizon (perhaps a couple of months), despite well-positioned businesses being the only security against the storm of negative market forces. Value is less bifurcated and with more viable options than growth, and we remain somewhat long, but cash creates options.

IDEA: We propose to investors Aker BioMarine. It’s a company with very specialized ships designed for fishing krill. It literally slurps them out of the water to avoid crushing and putrefying them. Aker BioMarine accounts for the vast majority of the world’s Krill catch, and among other things they sell their meal to the agricultural industry as a substitute to recently much more expensive grain-based meal due to grain inflation from the Ukraine invasion.

They have fuel exposure (20% of OPEX) hedged at $50 per barrel for the next three years, and most of their debt is fixed. The stock is cheap because of a market collapse in the South Korea Krill oil market a couple of years ago due to some fraudulent advertising by competitors, but the market is recovering, their margins are substantially improving with scale, no competitor has any ships coming online for the next four years, and the Krill catch annually is still half the quota as it’s an emerging market which means we’re far from overfishing risk.

Disclosure: Long AkerBiomarine

Grant Gigliotti of Good Stocks@Bargain Prices: Value is back! But it never went anywhere. Over the past several years, many investors have shied away from the proven principles of value investing and fundamental analysis. They got caught up in the ongoing, overpriced bull market and have finally realized that Warren Buffett’s famous quote continues to be valid in today’s market: “Only when the tide goes out do you discover who’s been swimming naked.”

IDEA: Berkshire Hathaway Inc. Class B (BRK-B) is one of my favorite ideas for the rest of 2022. I’ve personally been trying to buy this company stock for years and it’s finally selling at a bargain price. Investors are currently scrambling to find a well-diversified investment that can keep up with an 8.6% inflation rate that is eating away at their money.

The S&P 500 and most US index funds and mutual funds have been falling and are still overpriced. However, BRK-B offers a sampling of the market with its diversification in holdings of technology, oil, consumer staples, finance, healthcare, manufacturing, insurance, and even candy companies!

The thing that distinguishes BRK-B from the S&P 500 or typical passive investment vehicle is that BRK-B has easily outperformed just about all of them over the long term. Look at any 10-year or 15-year chart comparison and you’ll see that Berkshire has outperformed most passive investments the majority of the timeline. Now is the time for BRK-B.

Disclosure: Long BRK-B

Ranjit Thomas, CFA of Stock Scanner: Value has done relatively well this year. As the froth comes out of the market, fundamentals are in focus once again. There are no buyers for growth for growth’s sake with no profits. Meanwhile, profitable companies returning capital to shareholders are doing OK, particularly as they buy back their stock.

IDEA: Last year I recommended chemical company LyondellBasell (LYB) and the stock has done well. It has a positive return this year with dividends considered (including a $5 special dividend paid recently). With the recent pullback, I like it and believe there’s 30% upside to fair value. It’s benefiting from the current inflationary environment. You can see my article on it here ($).

Disclosure: Long LYB

David J. Waldron of Quality + Value Strategies: With inflation and interest rates rising and markets falling, this is a time to take a step back and witness the scramble of the market timers: “Buy this and sell that. Go to cash. Get bonds. Fossil fuel energy is the future (again). Build an underground fortress of canned goods in your backyard before it’s too late!”

Such reactionary advice borders on cheap entertainment. But remember, it’s not about timing the market; it’s about time in the market. Thus, the ideal time to add inflation hedges, build cash for dry powder, buy energy stocks on the cheap, or get significant price reductions on the construction costs and canned goods for the backyard bunker was five years ago when growth stocks were flying high, and anything out of favor was available at a discount. Instead, whether a bull, bear, or range-bound market, seek quality, enduring enterprises temporarily available at reasonable, if not bargain, prices for buying, holding, and profiting through all market cycles.

IDEA: N/A

The Investment Doctor of European Small-Cap Ideas: This clearly is a stock picker’s market and I have the impression value stocks that were not already outrageously overpriced are performing better than the general market. I use three benchmarks, the Euro Stoxx 600, the Stoxx Europe Small 200 and a capitalizing ETF investing in European small caps. While the ESCI portfolio is down “just” 7% (every loss is still painful) the capitalizing ETF lost over 20% of its value on a YTD basis, while ESCI is down just 6%. The Euro Stoxx 600 and Stoxx Small 200 are down respectively 17.3% and 24.7%.

This seems to confirm it really is a stock picker’s market. Additionally, having cash readily available is important. At ESCI, the cash position has now increased to 13% simply by hoarding the incoming cash from dividend payments. I’m not sure the markets will stabilize soon so it’s important to stick to companies you know and understand with balance sheets that should be strong enough to weather any storm.

IDEA: I am increasing my exposure to Verallia, a Paris-listed producer of glass containers (i.e. wine bottles, jars). The main issue right now is the natural gas price as that’s the main input cost to produce glass these days but Verallia also has a lot of pricing power. On the Q1 conference call, the management indicated it had already hiked prices by a double-digit percentage and would hike again by a double digit percentage in the next few months in an attempt to generate a positive (!) margin evolution by the end of this year. There’s zero customer churn despite the price hikes and Verallia is building new plants to meet the increased demand.

The company is aiming for a minimum EBITDA of 700M EUR resulting in an EV/EBITDA of just over 5. The company also has a firm plan to increase earnings to 3 EUR/share by 2024 which means the stock can now be picked up at just 8 times forward earnings. Not bad for a growing business following the trend of an increased demand with zero customer churn.

Disclosure: I have a long position in Verallia.