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Jelly Roll Capital Equity Research |
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Market Analysis, Education, and Wall Street-Quality Stock Reports |
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The Week in Review, and the New Game Plan |
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Last week we saw a nice bounce across the indices as a follow-through relief rally following the Fed discount rate announcement the previous Friday. This coincided with the CBOE Volatility Index (VIX) dropping 30% and making this synthetic short trade look very good. While I think we are far from out of the woods on this credit mess, I’m not at all surprised by what transpired on either the Fed or market fronts. Simply put, the Fed-must-come-to-the-rescue mentality is deeply engrained in the markets, and any sign of that is sure to spur buying for the time being. The Fed can’t rescue people from this overlevered mess of junk credit and illiquid derivatives though, and thinking they can follow the same rate cut formula as in 1998 - or even hoping they do - is insane. So what to do? Here is what I’m thinking… Right now, I’m working with all 30 of the Dow Jones Industrial components in the hope of coming out with maybe one or two solid buys. I hope to break the companies down into smaller groups and roll out my analysis a few at a time over the next week. As I prepped the quant data on the stocks to begin, a couple numbers jumped out at me that suggest AIG is cheap, Merck (MRK) is expensive, but that regardless of price, I would never bet against Proctor & Gamble (PG) or Coca-Cola (KO). If someone asked me to name on stock off the top of my head to buy and hold until I was 50, it would be either PG, KO, or Johnson & Johnson (JNJ). Ideally, I’ll find one new safe pick in the Dow 30 that will crush the market, as well as one growth-themed stock that should benefit from what I see as being a secular market shift toward growth. I’m also looking at companies that I am well-acquainted with that have been significantly re-priced as the market fell. On the short side, Heely’s (HLYS) has been crushed following guidance that didn’t quite meet expectations, to say the least. The stock fell 44% on that day and now sits at $9.53, down 67% since I wrote about it. Heely’s CFO Mike Hessong said (unsold) inventories were too high and the result would be markdowns and/or curtailment of further shipments, which will negatively impact financial results going forward. Brean Murray analyst David Meyer wrote in a note to clients, “We are downgrading our rating to Hold and would point out that this is a very dangerous situation for the brand and, at best, will take several quarters to be fully rectified.” By “several quarters to be fully rectified” he probably means that it will be several more quarters before the company is taken private again for a song, or is delisted. Continuing with the shorts, tax preparer H&R Block (HRB) is down 17.7%, having closed half the gap between its former price and my fair value target. Some of that selling pressure was likely the result of Warren Buffett liquidating his remaining shares in the company, which I believe is on the decline. Back to the long side, and specifically to housing. I haven’t talked about Builders FirstSource (BLDR) in a long time, and I’ve been disappointed by the performance of the stock. Still, I think this is a great business run by extremely competent people who continue to take market share in a tough environment. By staying profitable and wringing cash from the business through careful handling of working capital, and even making acquisitions (as they did of an Alabama roof truss company at the start of August) when things look terrible, I believe BLDR is positioning itself to emerge as a huge force when housing rebounds. Another housing-related stock I like - possibly even more than BLDR - is USG, the wallboard maker that also has a healthy business in remodeling, which isn’t sensitive to the housing cycle. With the stock at $38.50 and the recent $120k purchase by the company’s president and COO, I would be very optimistic because many good signs are falling into place. The proverbial icing on the cake for me is the Banc of America downgrade, upon which the stock rose. Another case of an analyst closing the barn door after the animals ran out? I’d wager so. Putting a “Sell” on housing right now makes you look so much better, because nobody was aware that things are dangerous out there. Speaking of which, Primus (PRS) is up nicely now, as is American Eagle (AEO), and I believe both have much more room to go before they become fairly valued. In review, I think it is prudent to keep an eye out for good short plays (perhaps start with the latest Short 25) or consider unconventional market plays if volatility picks up again - a synthetic short certainly qualifies, but that is only one of many things you could do. The immediate goal I have is to add one or two large/mega-cap names to the buy list and then search for more non-correlated plays, perhaps in emerging markets or in a stock like PDL Biopharma (PDLI) that will bring in a new CEO following a win by activist investor Dan Loeb at Third Point LLC. While there has been talk of a $30+ bid rejected by the former CEO, the stock is under $24 right now and could be ripe for a purchase if new management helps the company (and investors) realize the value of its assets. Look for more on the Dow components soon... |