With limited opportunities for investing in distressed companies right now, the size and phase of a bankruptcy are key factors for possible investments as part of a credit portfolio, says Nancy Havens, Founder of Havens Advisors, and Richard Goldstein, Managing Director at the firm.
“We try and do full-out bankruptcies. And on the bankruptcy side, there are not that many bankruptcies to do right now. We’re interested right now in the size of the bankruptcies,” Ms. Havens said. “In credit, we are in a bunch of bankruptcies and strict event situations as well as high-yield situations that are also event related.”
Ms. Havens gives AMR Corporation (AAMRQ.PK), parent company of American Airlines, as an example of an investment opportunity for her firm. She said her firm has been known to short securities of companies that it believes will go into bankruptcy and/or are going to have a fairly substantial hill to climb in the future.
“We were blessed with a new one, recently American Airlines, which was a very nice big one,” she said. “We expect the bankruptcy business to continue, and do prefer, generally, and have larger positions in these specific situations in general.”
Large contractors and firms in the construction space have reported revenue growth rates despite the weakened market for construction in the U.S. as their cost structure variabilization increases toward more rental and leasing of heavy equipment, says David Wells, a Senior Equity Analyst at Thompson Research Group.
“There’s going to be a lot of business that’s going to go to the rental channel because they’ve seen the services they can provide, the reliability and the fact that you don’t have to pay interest, you don’t have to pay taxes, you don’t have to maintain the asset,” he said.
Wells has a “buy” rating on United Rentals (URI) due to the company’s ability to buy heavy equipment, and rent it out to clients quickly. He says this activity by URI is another example of the level of demand in the marketplace right now.
“The interesting thing is if you look at the capex that they’ve done, United is expecting a gross capex figure of $775 million in 2011, pretty high level of capex. They’ve actually grown their overall fleet size, but they’re still able to rent out that equipment at very high rates of utilization,” Wells said. “In the last quarter, they reported utilization of 73.5% and low to mid 70s is kind of the theoretical max there.”
The increase in data demand and the limited spectrum availability are shifting competitive dynamics in the wireless communications space, leading carriers to engage in a mix of capex, partnerships and M&A activity to satisfy the seemingly unquenchable thirst for faster data transfers by smartphone users, says Jonathan Chaplin, Senior Analyst at Credit Suisse.
“You’ve basically got a land grab for spectrum going on right now, and there is very limited supply, and it has interesting implications for a couple of companies,” he said. “There are two options, either moderate usage or demand or increase prices. Right now, we don’t see a big demand moderation. Either the quality of service on wireless networks is going to go down or pricing is going to go up.”
Chaplin likes Clearwire Corporation (CLWR) in the near term although the company had a difficult time in 2011 from a stock performance perspective. He says Clearwire is the one company in the wireless communications space with massive amounts of unused spectrum, and he believes the company’s spectrum is going to increase in value significantly as data demand increases.
“In the case of Clearwire, we think with the breakdown of the AT&T/T-Mobile merger, there’s going to be a big increase in demand for their spectrum. AT&T is going to need more spectrum. T-Mobile is going to need more spectrum. Leap and MetroPCS, who had planned to buy spectrum, need more spectrum,” Chaplin said.
The primary growth prospects in the energy infrastructure space are in the logistics related to the handling of crude oil and natural gas liquids and are providing opportunities for most entities, says Brian Watson, Director of Research at SteelPath Fund Advisors, a money manager with a focus on energy infrastructure primarily through master limited partnerships.
“We’ve had declining crude oil, declining natural gas, declining natural gas liquids production in the U.S. for a generation practically, and now it’s actually reversed,” Watson said. “I think that seismic shift, which maybe hasn’t totally been recognized by most of the market, creates a really interesting opportunity set for these infrastructure providers.”
Watson says Buckeye Partners L.P. (BPL), a refined products transporter primarily moving gasoline, diesel and jet fuel from refining centers to consuming centers, is the firm’s largest holding across its funds.
“It’s a very attractive base business that benefits from annual tariff escalators and things like that. It’s a very secure low-risk business with some growth to it,” he said. “It trades attractively on a valuation basis, and we think it’s got an opportunity to have some multiples expansion as we go forward.”
The staffing sector is trending up as the market is not properly valuing the fundamental as well as the secular growth opportunities, and the near-term cross currents in Europe around the sovereign debt issues are masking growth in the U.S., says Kevin D. McVeigh, CPA, Senior Business Services Analyst at Macquarie Group Limited.
“When you layer in how quickly temporary help is growing as a percentage of total nonfarm payrolls, I think it bodes well for a much greater market opportunity,” he said. “If you look at that overall, it is trending at about 1.8%, in a period that I would characterize as early to midcycle, versus the prior two peaks of about 2%.”
McVeigh has chosen Robert Half International Inc. (RHI) as a top pick in the staffing sector due to how healthy the demand has been on the IT side in the near term and the well-capitalized balance sheets of staffing firms overall as a group.
“One area in particular that has really, even through the downturn, exhibited resilient characteristics and has participated in and enjoyed nice strength in the upturn has been IT staffing, which bodes well for companies such as Kforce and Robert Half,” McVeigh said.
Increased capital expenditures guidance in 2012 may mean higher earnings for truck-leasing companies as they use capex to refresh their commercial rental fleets in response to increased demand for full-term lease contracts, says Kevin W. Sterling, CFA, Senior Vice President and Senior Equity Research Analyst at BB&T Capital Markets.
“Now we are beginning to see the commercial rental demand translate to more leasing activity,” he said. “I find it encouraging that we are seeing an uptick in leasing because that tells me that the business community feels a little bit better about the environment and their long-term demand picture.”
Sterling has a “buy” rating on Ryder System, Inc. (R). He believes 2011 is going to be a record capex year for Ryder with the company spending about $1.8 billion, and he says he expects 2012′s capex spend to surpass 2011′s level. Sterling also notes Ryder only buys a truck in its leasing division when it knows it has a lease agreement in hand.
“Last cycle, Ryder was at $75 stock, and today, it’s in the low $50s, but yet the company is spending a record level of capex, which could imply record earnings,” Sterling said. “In my opinion, there is a disconnect between the fundamentals and the stock price, which I believe is being driven by economic uncertainty. History tells us that as Ryder’s capex increases their earnings increase.”
Wireless equipment companies, who have end-market licensing agreements across multiple vendors, will benefit from the continued growth of the smartphone industry in the wireless space, says Kulbinder Garcha, Managing Director at Credit Suisse.
“Smartphone volumes last year were 450 million units; they grew 55%, but we don’t think they have maxed out yet. We think that industry will continue to grow from these levels over the next two to three years and that it will will more or less double by 2015, reaching 1 billion units,” he said.
Garcha favors Qualcomm Inc. (QCOM) because the company gets paid by end licensing and through its chipset business, which is 40% 3G WCDMA chipset share. He says on the licensing side, QCOM collects royalties for nearly every 3G device, smartphone and tablet sold in the world, so the growth in the end market drives Qualcomm’s licensing business.
“What that basically means, we think, is that no matter who is gaining share, whether it’s an Apple or whether it’s a RIM, whether it’s an Android vendor or someone else, Qualcomm will collect their royalty because they own the core I.P. along with two or three other companies in the world around which is designed as to how wireless standards operate,” Garcha said.
The small- and mid-cap banks in the northeastern and mid-Atlantic region that are favored as longer-term investment opportunities are the ones redesigning the operational overhead of the industry by focusing on their expense base, overall branch structure and cutting costs, says Collyn Gilbert, Managing Director at Stifel, Nicolaus & Co., Inc.
“For the healthier banks, the pain seems to be more from an administrative and an operational perspective. The weaker banks, I think, we will see it become more of an intense cost burden. They’re really going to have to raise capital or increase staffing, and the overall cost component is going to be too prohibitive for them to make meaningful profits,” she said.
Gilbert says Webster Financial Corporation (WBS) has introduced a banking branch that is a fraction of the size of the traditional branch, and it makes sense because the overhead costs are considerably lower than a traditional branch.
“We would argue that these banks don’t need so much of that real estate or traditional bricks and mortar, and all that staffing, in an industry that’s in a massive deleveraging mode and probably will be for a while,” she said.
The resource values of onshore shale gas plays are expected to firm up dramatically in the next three years, and there is 50% to 75% upside on several stocks for investors taking a three-year view without any move in the commodity, says Amir Arif, an Analyst at Stifel, Nicolaus & Co., Inc.
“There is definitely a long-term upward bias that I think investors should be buying the bids, again, on the quality companies that don’t have any funding issues. Those are the names that you know will survive the next two or three years, and those are low on the cost curve,” he said.
Arif likes Cabot Oil & Gas Corporation (COG) because it is low on the cost curve and has the ability to grow organically 20% to 30% without having any funding gaps. He says Cabot, which is developing the Marcellus shale, will perform well over the next two to three years.
“The names that we are less interested in are those that are higher on the cost curve in terms of gas production, and just because gas prices stay low, they can grow production, but they are not doing it economically. So they are not going to create any value, and that means the balance sheets will only erode further,” Arif said.
The full truckload market is facing pressures from higher operating costs this cycle in terms of new equipment, however there should be some offset as maintenance costs on older equipment declines, and depreciation will be spread out over the useful life of the equipment, says Todd C. Fowler, a Vice President and Equity Research Analyst with KeyBanc Capital Markets Inc.
“So as carriers are replacing equipment, not necessarily growing their fleets, but trading for new vehicles and replacing old equipment to bring down the fleet age, we know they are going to have higher operating costs and depreciation as they bring new trucks into their fleets,” he said.
Fowler names Knight Transportation, Inc. (KNX) as a favorite trucking choice, although it is out of favor with the Street and an underperformer this year. KNX has been affected by some company-specific issues, including investments related to growth initiatives impacting margins, while the installation of electronic on-board recorders negatively impacted their utilization, he said.
“Also, they have more exposure to the western United States, which wasn’t the strongest market this year. We think if investors understand these issues going into 2012, it’s not anything structural with the company, they have easy comparisons as they anniversary some of these issues, we would expect to see the stock perform better especially as fundamentals improve,” Fowler said.
