2 New IPOs with Strong Upside

#-ad_banner-#A dozen years ago, Silicon Valley was responsible for one of the most prolific initial public offering (IPO) markets ever seen. Many fortunes were made, as a record 486 companies went public in 1999. The next year was the second-best ever, with 406 additional new issues coming to the market. Of course, many dollars were subsequently lost in that mania and no one wants a return of such frothy days.

But the IPO market is surely getting back on its feet. If the economy obliges, we may get close to 200 IPOs this year, the best showing since 2007. The good news is that the quality of newly-public companies is fairly high, as investors only accept companies that have real businesses and a true path to profits. The one blight on the IPO market: China-based companies. The five worst performers of the past 12 months in the new-issues market all hail from mainland China, according to investment adviser Renaissance Capital. The list is led by China Xiniya Fashion (NYSE: XNY), whose shares have dropped  68%.

But in general, the after-market has been kind to new issues. The eight-largest IPOs of the past three months have nearly all posted strong gains. That’s a testament to their quality — and to investors’ interest in newly-public companies. The strong performance of these stocks is likely to help grease the wheels for the next large crop of new IPOs slated for release this summer. Of the stocks on the table below, two stand out as having continued near-term upside.

1. Arcos Dorados (Nasdaq: ARCO)

This Argentina-based company takes its name from “golden arches,” as it operates McDonald’s Corp. (NYSE: MCD) franchises in 20 emerging markets. The appeal of this IPO isn’t its value relative to 2011 results, but instead the long-term positioning that could virtually guarantee steady growth.

First, Arcos Dorados’ exposure to quickly-growing middle classes throughout South America looks to pay off handsomely. Many countries in the region had been characterized by small elites and large working classes that really couldn’t afford to eat out much. Nowadays, in countries like Brazil (which accounts for roughly one-third of the company’s nearly 1,800 restaurants), rising living standards placed a great portion of the population into the middle class. And this new group of consumers is eager to spend.

The other appeal is the status of the dollar. Some suspect that the dollar will hold its value in coming years, but a growing group of economists claims that any cure for the budget deficit and the trade deficit will have to come at the detriment of the dollar. If the dollar indeed weakens 10% or 20% from current levels as it’s predicted, then investments in firms like Arcos Dorados could provide a solid hedge.

Right now, total sales are growing about 20% annually, led by 10-12% same store-sales growth. Both of those metrics are bound to slow, but this could prove to be a steady 10-15% bottom line grower for the near future, as management reaps continued operating efficiencies over a rising store base and pushes margins up to levels seen by Mickey D’s. Right now, operating margins are only 60% of those seen by McDonald’s.

2. Air Lease (NYSE: AL)

This is an intriguing new IPO. I’m a big fan of the aircraft-leasing market, as it can be a powerfully profitable business when air travel is expanding and demand for aircraft is rising. [I recently profiled Aircastle (NYSE: AYR), a competitor,  which still trades well below book value.]

Air Lease, which completed an IPO in late April, isn’t quite the same bargain. That’s because investors are willing to pay a premium for the services of CEO Steven Udvar-Hazy, who has a strong industry track record during the past 40 years. He’s using the IPO money to order yet more planes, which will help keep the fleet quite young. As it stands, Air Lease’s fleet averages less than four years of age, which means they are the most fuel-efficient and least likely to be pulled from service if the industry turns down.

If history is any guide, then Udvar-Hazy will use every tool in the arsenal to boost the company’s bottom-line, from well-structured contracts to access to low-cost borrowings. This strategy could make Air Lease the most profitable company in the business if the global economy continues to expand.

Action to Take –> These two companies, along with patent risk management provider RPX Corp. (Nasdaq: RXCP) and natural gas storage company Golar LNG Partners (Nasdaq: GMLP), all went public within the past 25 business days. This means new analyst coverage will soon hit the wires, perhaps giving these stocks an added boost.

Back in October, I discussed how to play “quiet period” stocks. The strategy works especially well for stocks that have weakened in after-market trading, but it could still be helpful for these recent IPO gainers.