Everyone likes a stock with a good story. And there’s no story more inspiring than the turnaround story: failure (or at least some trouble) is followed by rock bottom, and then redemption. Of course, as an investor, you have to get in at some point before redemption. With that in mind, today’s Investment of the Week features three turnarounds in progress. The first comes from the expert in the area, George Putnam, editor of The Turnaround Letter. Here’s one of his most recent recommendations, from the August 8 Investment Digest.
“One of the pioneers in the web-based stock brokerage business, E*Trade Financial Corp. (ETFC) went public in 1996 just in time to participate in the last phase of the tech/Internet bubble. After recovering from the bursting of that bubble, E*Trade made the mistake of going into the sub-prime mortgage business, which almost destroyed the company.
“Citadel, the huge Chicago-based hedge fund group, rescued the company in November 2007 by purchasing its troubled sub-prime mortgage portfolio and making an investment in the firm. While this took the worst problems off of E*Trade’s books, the company has suffered from delinquencies in other loans that it made before the 2008 financial meltdown. It brought in a new CEO and effected a 1-for-10 reverse stock split in 2010, but the stock price has continued to slide.
“E*Trade is making progress on a number of fronts. It has improved the balance sheet and continues to build on its strong brand presence in the retail brokerage world. However, the gains have been overshadowed by margin pressures from low interest rates and weak trading volumes. The company’s delinquent loans are steadily shrinking as its legacy loans roll off the books. The legacy loans are down by more than 60% from their peak in late 2007, and total delinquencies have dropped by 28% over the last year alone. If the housing market continues to strengthen, as we expect, the pace of improvement should accelerate. As a result of better financial performance—including a net profit last year for the first time since 2006—E*Trade’s capital ratios have improved to some of the strongest levels in the company’s history.
“On the brokerage side, E*Trade has strong brand recognition—think talking baby ads—and a valuable franchise. Customer accounts and assets are both growing at a decent pace, and management is adding trading features to keep that pace going. Moreover, the company is making progress at selling more retirement services and other high margin products to its customers. At the same time, management is cutting costs through operating efficiencies, with an additional $40 million in cuts targeted for the coming quarters. … As E*Trade continues to reduce legacy liabilities, it is well positioned to profit if either rates move up or trading volumes increase (or, better still, both). We recommend buying E*Trade up to 12.”—-George Putnam, III, The Turnaround Letter, August 2012
Our second recommendation was the Spotlight Stock in the July 25 Investment Digest. This stock’s chart hasn’t broken its medium-term downtrend yet (although the last month has been slightly better than level), so there is potential for more downside before the company’s turnaround is reflected in the stock. But Top Stock Insights Editor Ian Wyatt thinks that will happen sooner than later. Here’s part of his recommendation:
“Unlike most truckers, Quality Distribution (QLTY) doesn’t own trucks. The approach helps keep debt levels and operating costs low. … By managing through an affiliate network, Quality Distribution avoids high costs such as tractor purchases, maintenance, terminals and fuel. It’s able to focus more resources on driving new sales and lowering back-office costs.
“Though the strategy sounds great, management was unable to implement it correctly—initially. They wanted to manage a network and operate their own fleet of trucks. Management also took a ‘quantity was greater than quality’ approach to finding affiliates, which ballooned out of control. The revenues continuously grew, but Quality Distribution remained unprofitable until 2005. After two more bumpy years, trucking industry veteran Gary Enzor took the helm as CEO in 2007. …
“Enzor quickly divested Quality Distribution of non-core operations. He also cut down the affiliate network. By decreasing the number of affiliates, Quality Distribution was living up to its namesake—favoring quality over quantity. This adjustment allowed the company to focus on high-growth business segments and work only with the strongest partners. The result was higher margins and more favorable contract terms.
“The company quickly profited from the appointment of Enzor as CEO and commitment to an asset-light strategy. Enzor’s solid management skills and revamped affiliates should help drive record business growth at the company. By operating through an affiliate network, Quality Distribution is able to diversify its customer base, geography and end market. This scale allows Quality Distribution to provide safer and more reliable service to its customers. In turn, it’s easier to earn long-term contracts with those businesses. Long- term customers are important in the trucking industry. An established long-term client base acts both as a barrier to entry and growth driver.”—-Ian Wyatt, Top Stock Insights, July 2012
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Our third turnaround situation today is a tiny ($9.7 million market cap), thinly-traded government services provider. It was originally recommended in this year’s Top Picks issue by Benj Gallander, editor of Contra the Heard. The company had already begun its turnaround, and Gallander wrote:
“This outfit that provides staffing services to the government is in the midst of a strong recovery after being in dire straits. That helped the company do better than a stock price triple in 2011 and it looks like there is lots more ahead.”
As part of its turnaround the company changed its name a few months later. And so the stock was going by its new moniker when Gallander wrote in our Top Picks Mid-Year Update issue in July:
“TeamStaff, Inc.’s (TSTF) comprehensive turnaround continues with a name change to DLH Holdings Corp. (DLHC). It recently went through some difficult times, but in 2010 CEO Zach Parker arrived and embarked on a clear transformation plan. In order to expand operations, this healthcare solutions provider did a rights offering that raised better than $4 million, with insiders picking up a major stake. Still, the share count remains below 10 million.
“Though not yet signed on the dotted line, it appears that a deal with the Presidential Financial Corporation will double the company’s borrowing potential to $6 million. Both revenue and the backlog remain in growth mode and the recent quarterly loss was pared to less than $1 million. The balance sheet has negligible debt and revenues are north of $40 million. A suitor could pay a 100% premium in this consolidating sector and only fork out around $25 million. That is certainly not out of the question. This company traded above $5 for years and if the turnaround is successful, that would register a triple from this level.”—-Benj Gallander, Contra the Heard, July 2012
As Gallander mentions, in addition to gradually reflecting the company’s turnaround, this stock also has the potential to reward investors by being acquired. Just be sure, since it’s so thinly traded, not to pay more than you want. Also note that DLHC reports earnings tomorrow, August 15.
Wishing you success in your investing and beyond,
Chloe Lutts
Editor of Dick Davis Investment of the Week
