Behind Every True Turnaround, Lies a Hidden Bull

Adem is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Are you the next penny stock legend? Just destined to find that “needle in a haystack” stock and strike it rich?

If you’re like many "deep value" or "turnaround" investors you spend your days looking for consumer stocks that are rapidly losing customers, all in the name of a cheap price.

That's a fool's errand, but don't fret we can find beaten down stocks with long-term bullish trends and get on the right side of them today.

Bulls the market misses

What is the right trend that Mr. Market can’t see today? Believe it or not, it’s the biggest dog in the energy sector: coal. Coal stocks have been hammered, yet it plays a tremendous role in our future--there lies our opportunity.

As Charlie Munger has said, "Go to where there are market inefficiencies. You need an edge. To succeed, you need to go where the competition is low.”

Here are three turnaround coal plays--sure to make “Poor Charlie” proud.

Coal: down but not out

For turnarounds, a beaten down consumer play (say BlackBerry or Radio Shack) isn't ideal because they need "too many miracles"--ones you can't control. Not only do those companies need to innovate with less cash and execute flawlessly, they also are at the whim of very fickle consumer tastes.

There is simply no way to predict what consumers will do. Yes, every turnaround story is speculative in nature but we're more likely to succeed on a beaten down need.

That's certainly the case for coal, the sector and once top performer Arch Coal (NYSE: ACI) have been at the mercy of a ruthless one two punch: plummeting natural gas prices and increased regulations. The result? Arch Coal, the real bellwether of the industry, has reported four quarters of consecutive losses. Even worse, Arch had missed analysts’ expectations for three quarters prior to its current slump (fy. 2011).

But dig a bit deeper, and you'll find a story that can find its spark again. According to recent reports by the U.S. department of energy, coal still has a fairly bright future. By 2035, coal output is expected to exceed 2008 numbers (which todays output lags), led largely by a spike in demand of over 20% in emerging markets.

The best part for potential value investors? This isn't a sunny projection, it's actually rather conservative. In just 2011 these projections were far ahead of todays. It's fairly obvious to see that the recent slump has affected these conservative estimates, as they point to increased stiffening of U.S. coal regulations combined with renewable energy demand skyrocketing.

But what would happen if a Republican President is elected before 2035? Or, what if renewable technology doesn't advance so quickly? Neither scenario is a longshot; the variables all lean to an upside for coal, and the downside is already aggressively priced in.

The competitive landscape

Since coal is a commodity, picking the absolute right stock matters less than it would in other industries--like, tech for instance. Walter Energy (NYSE: WLT) could be a great pick for investors seeking a well-diversified producer. The company’s client portfolio is vast, as it produces metallurgical coal for clients worldwide with needs in areas like steel, steam and coal bed gas (natural gas).

Walter has certainly felt the brunt of the coal downturn, as its earnings have slid almost as fast as its stock price. It went from EPS of $7.46/share in 2010 to just .066/share in 2012, all while its stock price lost nearly $40 in 12 short months! Mercy!

But let’s say that you feel the current projections for coal to rebound, or at least to stabilize, are correct. Well, in that case, you may be inclined to agree with analysts who feel the company will earn $3.12 again in 2014. If the company comes anywhere close to that estimate, given today’s short interest (14%) the stock could double--quickly.

And what about CSX (NYSE: CSX) which has been hammered by "coal association." Sure, the railroad does generate about 30% of its business through coal shipments but did Mr. Market forget that all of its other business lines (housing, auto, agriculture) are either surging or rebounding--with excellent long-term growth projections?

CSX is seen its stock price stalled near $20 for over a year, not because it stopped growing (2012 EPS beat 2011), but simply because its growth has slowed. The company has met or exceeded analysts’ expectations for four straight years and growth is projected to continue.

While I won’t pretend that CSX doesn't face some coal related challenges in the short-term; I feel that the 2.5% dividend yield gives the patient investor more than enough reason to stick around for the time when coal can hold its own among its other business units. When that happens--watch out.  

Revisiting Arch Coal

Even if the current conservative coal forecast is correct, demand will still rise due to drastic population growth and emerging middle class economies in China and India. To be sure there are risks. Arch Coal, will need to return to profitability by cutting costs in the short-term if it hopes to stay solvent and enjoy the long-term rewards.

But at a current price hovering just over $5/share, if it were to just return to the profitability it enjoyed in 2011 (forget 08') it would earn 1.07 a share. If you feel that it can and will survive and you can wait a couple of years, a P/E of 15x gives you a triple.

Like any true turnaround play, the risk matches the reward.

Diamonds are not for Fools

The Foolish investor shouldn’t waste time contemplating how quickly Amazon can kill RadioShack. Rather than look for the diamond in the rough, you should hunt for corn in the corn fields. Find common sense trends, the ones the world can’t avert,  the ones that are misunderstood; once you do, you’ll finally invest with the  wind at your back.


Adem Tahiri has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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