2 Perfect Stocks Down 40% Each?

By Chad Henage - October 16, 2012 | Tickers: HUN, KRO, RSG, VE, WM | 0 Comments

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If it seems like an oxymoron that a “perfect stock” could be down 40%, that's exactly why I think investors should pay attention. I'm always on the lookout for companies that are off their 52 week high by enough that just a recovery in the stock could give investors a nice return. I recently used the Fool.com CAPS Screener for large cap stocks that both rated a perfect 5 stars by the CAPS community, and were down 50% from their 52 week high. The problem was there were no companies that met this test. When I lowered the percentage to 40% only two companies popped up. The two companies this screen turned up were Veolia Environnement S.A. (NYSE: VE) and Kronos Worldwide (NYSE: KRO). In theory, these are two “perfect” stocks selling at a 40% discount, what I want to know is why? 

Veolia Environnement S.A.:

Veolia is in the boring businesses of waste management, recycling, and energy management. This company sounds like the type of stock Peter Lynch would have loved. Veolia has been in business for 150 years helping people with things they don't want. You couldn't ask for a more stable business, and the company is set to capitalize on this opportunity. If you know about Waste Management (NYSE: WM) or Republic Services (NYSE: RSG) you know a bit about Veolia. There are two huge differences between Veolia and these two state-side competitors. Veolia is expected to grow much faster and investors get a much better dividend. While Waste Management and Republic are expected to grow earnings by about 6%, analysts expect Veolia to grow earnings by over 14% in the next few years. When it comes to the company's dividend, take a look at the comparison between the three companies:

It's ironic because as you move up in yield, the payout ratio at each company rises. You could make the argument that Republic Services could pay a similar dividend yield if they pushed their payout ratio up to where Veolia is currently. This is probably the biggest risk when it comes to Veolia, if the company allows its payout ratio to climb much higher investors will question if it's sustainable. That being said, it's hard to ignore a company with an over 7% yield that is also expected to grow by over 14%.

Kronos Worldwide:

Kronos is another company that would probably make a list of stocks Peter Lynch would like. The company is in the exciting industry of making titanium dioxide pigment. The company won't win an award for the most exciting business of the year, but that's not a bad thing. Kronos describes their business as making paint, plastics, paper, and clothing fiber, “all look better because of titanium dioxide pigment." The company has turned itself into a global leader in the paints and plastics industry because of this focus. They count companies such as Huntsman Corp (NYSE: HUN) as one of their chemical competitors.

Trying to understand what investors are thinking in marking down Kronos is a bit difficult. The company sells for a forward P/E ratio of just 6.41 and though analysts expect just 5.5% growth going forward, I think the company could do better. Kronos has nearly doubled its revenue over the last three years, and operating cash flow is up 242% over that same timeframe. It's understandable that analysts don't see that type of torrid growth continuing, but I think 5.5% is too conservative. I believe the economy will continue to recover, and as it does so industries that Kronos participates in like paints and plastics will see higher demand from better economic activity. As one of the backbones of the industry, Kronos should benefit.

In addition, the company pays a 4.12% yield while investors await positive results. By comparison, their competitor Huntsman pays a yield of 2.64%. The even bigger difference between the two companies is, Kronos has a 55% free cash flow payout ratio, whereas Huntsman pays out 300% of its free cash flow. With both companies selling for similar P/E ratios, I can't see why Kronos should be knocked down this far.

Conclusion:

I can certainly see the risks associated with each company. In Veolia's case, the company's high payout ratio might cause the dividend to be in jeopardy at some point. Investors are probably also looking at the fact that Veolia is based in Europe, which as everyone knows is having its share of financial challenges. However, with a 7% yield and a 14% expected growth rate, Veolia looks like a steal at these prices.

Kronos biggest challenge is getting investors to believe that their torrid growth phase isn't completely over. The company may not double revenue in the next three years, but if it can beat analysts estimates (which it has done over the last 3 quarters) investors should be happy with the results. With the company paying a 4% yield that is well covered, investors have a chance at some dividend growth as well.

This is a case where I'm willing to bet the CAPS community is right in assigning these two companies the coveted 5 star rating. The 40% decline from their 52 week high seems like an ideal opportunity to pick up these shares at a significant discount.

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