Cover Your Shorts on These 2 Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Every now and then there comes a stock the bears just love to talk about. We have all heard about a stock that is overly beaten down from accusations that, ironically, bear no relation to the fundamentals and momentum. While there are times when negative events are hard to detect from financial statements, in general, a stock can only be beaten down so much by this speculation. It is at these occasions where investors may be able to find their way to the greatest profit.
Herbalife (NYSE: HLF): Not a Ponzi Scheme
While Herbalife continues to exceed expectations, it trades substantially under intrinsic value. The stock receives one of the most bullish ratings on the Street with a consensus of 1.2 on a 1 to 5 scale (where 1 is a "strong buy"). In fact, Caris & Company released a "buy" report on Oct. 31 while upping its price target from $90 to $101. The stock is currently worth $48.92.
And for good reason. Over the past five years, EPS has gone up by 28% annually. Yet the MLM seller is forecasted a 15.5% rate over the next five years. Assuming it meets expectations, 2016 EPS will come out to $6.96. At a multiple of 14x, this translates to a future stock value of $97.44. Discounting backwards by 10% yields a present value of $60.50, which implies a nearly 25% margin of safety--more than enough to justify an investment. As evidenced by the PEG ratio of 0.85x, future growth has not been fully factored into the stock price.
Fortunately, the fundamentals are also performing excellently. In the third quarter, EPS of $1.04 came out $0.03 ahead of consensus while revenue was $60 million ahead of consensus. Guidance reflects a positive outlook on volume and net sales momentum, and the increase in planned 2013 capital expenditures is a testament to Herbalife not being a Ponzi scheme, as its critics contend. Management is increasing its capex budget because it wants to hike up manufacturing of real products that real consumers buy. Why do investors continue to assume the worst for Herbalife?
To say nothing about the company's geographical exposure in a diversity of regulatory regimes, Lieberman Research just recently reported that 5% of domestic households have purchased a Herbalife product in the last three months--more than 5.5 million households. And of those who purchased Herbalife, 90% came outside of the distribution network. Similar results were experienced in Korea. And finally, if the company were operating a Ponzi scheme, why would it begin operating successfully in China where direct selling is illegal?
Avon Products (NYSE: AVP): A Prime Activist Target
Another direct seller, Avon Products is similar to Herbalife in several respects. It has also been widely criticized by the market, but for a different reason: Its performance has been lousy. And, moreover, its performance has been lousy due to generally weak leadership on the part of management.
Unfortunately, matters have gone from bad to worse. Since rejecting the $10.7 billion takeover bid from Coty, shareholder value has plummeted to $6.6 billion. And the company shouldn't expect such a nice premium next time. Third quarter EPS of $0.17, which was supposed to demonstrate turnaround potential, fell $0.05 short of expectations. Revenue also fell 8% y-o-y and missed forecasts by $30 million. In fact, results were so terrible that management had to admit that its performance was "disappointing.. But the worst event that investors feared would happened just happened: Management cut the dividend distribution by 73%. The forward yield is now 1.5% versus an original yield of 6.1%--that's a pretty big "buying" point, if not the only "buying point," and it is now irrelevant.
The good news is that Avon is now a prime activist target for an investor like Carl Icahn. Although the Andrea Jung was recently, and rightfully, booted, the entire board can easily be replaced to unlock value. The dividend cut has just ticked off an already agitated shareholder base, and, if a major shareholder comes in and lobbies for a takeover, it would drive up the stock price. Though multiples are very expensive, it is still capable of being elevated from greater growth expectations, which are now basically estimated to be flat.
Moreover, if you compare the company to Estee Lauder (NYSE: EL), it's not too expensive. Estee Lauder trades at a respective 27.9x and 20.3x past and forward earnings but is forecasted for 15.2% annual EPS growth over the next five years. Sure, the company was able to produce double-digit gains over the last few years, but its projected growth curve is unreasonably. It is for this reason that I encourage buying Avon shares with the prospect of an activist entry or buyout proposal.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.