Canny investors who have been around the sharemarket for more than just a few years will often say there’s only one thing better than a stock beaten up by a one-off event: a stock that’s been smashed by a whole range of events. Then, and only then, have investors got a real turnaround on their hands.
Since 1990, there’s been a few of these, and David Walker, a senior analyst at StocksInValue.com.au, has seen them all.
There was Westpac going broke in 1992 until Bob Joss stepped in and stopped the rot. There was BHP’s turnaround after the Magma Copper and hot briquetted iron project at Port Hedland, and Suncorp in trouble after the financial crisis. There was IAG’s exit from the United Kingdom and QBE’s return to normal after its frenzy of acquisitions, and then AMP’s exit from the UK.
In November 2010, it was Telstra’s turn, when its shares traded at $2.56 – the lowest ever. Now the stock is closer to $5.50.
Indeed, the sample in the top 50 stocks is so large that the turnaround is a reliable investment strategy. It can be painful at times and it might not happen overnight but buying those clapped out blue chips can be a genuine way of enhancing returns.
What investors need to do is look out for stocks that are especially vulnerable to disasters or shocks.
Right now, Woolworths fits the bill for Walker. The stock is being hammered by the hedge funds and everything that can go wrong is going wrong. But that’s exactly what you want with a turnaround.
ONE OF THE MOST SHORTED STOCKS
Walker points out that this week’s third-quarter sales for the 2016 financial year were very poor, and if not for the early timing of Easter they would have fallen further.
But that’s good. Get all that bad news out there, let the hedge funds get short – again. Woolworths is one of the most shorted stocks in the S&P ASX 200 index but again, that’s good, as it means it will get way oversold and when the good news eventually comes through, the short squeeze will be on.
Right now, Coles is way ahead on all sorts of measures and as the last quarter for 2016 plays out, it all looks bad thanks to price competition as Aldi continues to take share and Coles matches price cuts by Woolworths.
Walker expects the company to downgrade its 5 per cent margin guidance.
But on the bright side, the management and some of the directors who caused the mess have left.
In addition, there is nothing but bad news and little visibility to when the stock’s fortunes will improve. That’s good news for a turnaround. Woolworths trades on a forward price-earnings ratio of 16 times, just under the market’s P/E of 16.2 times, which is still on the expensive side given the longer term P/E is close to 14.5 times. The stock is down 15 per cent this calendar year and down 47 per cent since its record high of $38.49 was reached in April, 2014.
LONG AND PAINFUL WAIT
“It looks like a long and painful wait,” Walker says.
But he’s also quick to point out that the company will not go broke, the stock is undervalued and now disowned by a large number of fund managers.
“Fund managers are underweight in the stock but have to be interested given Woolworths’ large weight in the index. Therefore there is intense pressure to turn Woolworths around and if this doesn’t happen private equity will make a bid,” he says.
He expects further competition, but thinks the company has been so badly run there is upside just from better management.
“This is a good catalyst to have because many companies have little control over their earnings drivers,” Walker says.
On his numbers, Woolworths can get above $30 by the end of 2019, plus dividends, without a takeover premium.
“This is not a very large rate of return but between $20 to $22 the downside is limited. We will buy the stock on further bad news or sentiment,” he says.
Written by Philip Baker, Markets Columnist. The following article appeared in The Australian Financial Review, 6 May 2016.