These Fallen Stocks Have Rapid Rebound Potential

David Sterman's picture

Monday, May 11, 2015 - 1:30am

by David Sterman

There is one simple rule about earnings season: have plenty of cash on hand.

That's because a few dozen stocks will fall sharply on tepid results or cautious forward outlooks and real bargains can emerge.

Of course, many stocks that have been punished deserve to stay in the penalty box for quite some time. Their near-term problems are unlikely to dissipate any time soon. So you need to dig deep to find the rare diamonds in the rough that have been unfairly punished. When the dust settles on earnings season, these are precisely the kinds of stocks that value investors will seek out.

I've looked at a few dozen earnings season casualties and have found two of them that appear poised to claw back recent losses.

SUPERVALU, Inc. (NYSE: SVU)
This operator of several grocery chains was in deep distress just a few years ago. Yet a series of asset sales managed to trim the company's debt load from around $7.6 billion in fiscal (February) 2010 to a recent $2.7 billion. And the company has managed to generate profits in each of the last two fiscal years, after generating losses in the prior three years. Cost cuts and better merchandising strategies get the credit.

Investors that had profited from the turnaround apparently decided to take profits after reviewing recent fiscal fourth quarter results. Shares have fallen more than 25% over the past month.
 

It's unusual to see a stock move lower after a company delivers a generally solid profit report. Yet in SUPERVALU's case, investors may be focusing on the fact that revenues were a bit lower than expected (though still up more than 10% year-over-year). 

Yet if you dig through the company's most recent conference call, you'll hear a lot about many small transformations that should set the stage for better operating margins in coming years. For example, the company is investing heavily in private-label goods, which tend to have even better margins for grocers than branded goods. SUPERVALU is also making a strong push into ethnic goods, which is a savvy move as many of its SAV-A-LOT stores are located in neighborhoods with a strong Hispanic presence. Lastly, the company is closing several dozen underperforming stores each year, and opening a similar number in underserved communities. 

Meanwhile, this is a clear value stock, despite solid gains prior to 2015. SUPERVALU generated around $800 million in earnings before interest, taxes, depreciation and amortization (EBITDA) in fiscal 2015, and with the current business model tweak being made, that figure should approach $1 billion by fiscal (February) 2017. That compares to an enterprise value (EV) of around $5 billion. 

Much of that EBITDA may be earmarked for debt reductions. Assuming that $5 billion enterprise value remains constant, then the value of the equity should rise by a dollar for every dollar of debt that is paid off. Said another way, $500 million in debt drawdowns over the next two years would boost the company's market value by around 22%. And lower debt should allow for a high EV-to-sales multiple of six or seven. That equates to even greater upside. 

United Insurance Holdings Corp. (Nasdaq: UIHC)
Blame it on the weather. It's often considered to be a lame excuse for poor quarterly results, but in this instance, it's true. UIHC, a property and casualty insurer, had an abnormally large number of insurance claims in the frigid U.S. Northeast, which led to a large quarterly profit shortfall. Just a month ago, analysts thought the insurer would earn around $1.70 per share this year, though profits of around $1.15 a share now appear more likely. 

The recent weak results mask an otherwise healthy business. Thanks to an expansion into new states, UIHC saw the amount of insurance contracts in force rise by 20% from a year earlier. The company is entering five new states this year and expects to enter another five states next year. 

Notably, few analysts think the recent profit shortfall will have any longer-term impact. For example, the 2016 profit forecast has remained constant at around $2 a share. The fact that shares have fallen from the 52-week high of $28 to a recent $17 now looks like a clear overreaction. Analysts at Keefe, Bruyette & Woods surely think so, having recently raised their rating to outperform with a $24 price target. 

Risks To Consider: Investor trust takes time to rebuild, so when stocks fall rapidly, as these have, they may stay depressed for several quarters. 

Action To Take --> These are solid, profitable businesses that can now be had for a much better price. The market hands investors only a few gifts every earnings season and SUPERVALU and United Insurance Holdings are among them. 

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David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.