Generally speaking, the stock market does more than an average job of pricing a stock right where it should be at a given moment. The stock market leverages all of the publicly available information about the company, including things such as SEC filings, industry trends, and even less definitive things such as earnings expectations. Furthermore, with the availability of information out there and the speed at which information travels, it becomes increasingly difficult to find companies that appear to have more value to them than the market is currently giving them credit for. Now, obviously, we should pay careful attention to defer to the stock market, as since it is a reflection of all current information and a multitude of investors, odds are, you will not outsmart it. However, to outperform, you have to take risks, and for lack of a better phrase, take bets on the unexpected or unanticipated.
Now, when a stock takes a nosedive, there is typically a good reason for it. For instance, if a company is trading at less than book value, well, there is likely a reason for it. They may be burning cash and in one year's time, the price to book will go from say 0.8 to 1.6, so it is not as good of a deal as it seems. However, sometimes companies seem to be undervalued or take a massive hit without any real justification for it. Sure, there is a news item that is driving the selling, but if you look at the numbers, it just does not make sense. This is where value can be found, though, it can sometimes take months or even years to materialize and the world to wake up.
Corus Bankshares, Inc. (NASDAQ: CORS)
CORS is a bank that primarily provides financing and loans, particularly in the commercial real estate and condominium construction arenas. CORS is typically not financing the consumer, but the developer of a condominium. The stock has basically been halved in the past year, although they continue to maintain strong book value and pay out $1 share in dividends – a 5.9% yield at current prices. CORS has also increased the dividend payable to shareholders every year the past 27 years. CORS also operates as a holding company and has an extensive portfolio of securities, primarily the common stock of other banks – about $203M, or 20% of market capitalization, per their April 30, 2007 filing with the SEC.
CORS has taken a beating during this subprime lending slowdown, and rightfully slow. CORS has increased their reserve for loss and acknowledges they will have some losses in 2007 and perhaps in the future. However, if you look at the nature of the beat down, there are many things that are not adding up.
CORS is run and owned by the Glickmans, who are regarded as very astute bankers. Now, any company or bank is potentially subject to going under or making bad decisions, but if you read the method in which this company provides financing and operates as a lender, anyone would find it hard to believe that this bank is going under – especially since it has been around for nearly 50 years. CORS is trading at 5.7x current earnings and at 7.6x forward estimated earnings – and yes, the analysts have thought hard about the increase in bad loans, loss reserves, and other negative items. CORS has raised the dividend every year the past 27 years and the other day announced a $1 special cash dividend to shareholders on top of the regular dividend. While handing out cash can look bad, considering that CORS is trading at 1.12x book value as of March 31, 2007, and it is likely that the company's book value has increased since then, this distribution has a nominal impact on the per share ratios when it comes to book value. Sure, the $1 payout will take the $1 out of the price and book value, which are essentially the same, but CORS feels pretty strongly about their position, especially considering they have a $300M free and clear cash cushion to be considered well capitalized per their recent press release.
Also playing a factor is that as of May 15, 2007, a little over 19M shares were reported as being sold short. That is impressive considering CORS has 56.25M shares outstanding and only 19.5M in the float. So, this is suggesting that the entire float is sold short? It has also been suggested that there is extensive naked shorting of CORS taking place.
Let's look at the dynamics here. We have a 50-year old bank, that yes, has taken some hits – but they have proven they are prepared for such and expected these hits. CORS continues to pay out dividends to shareholders, at only a 30% payout ratio, and has a $300M cash cushion that they will use to fund the special dividend – and perhaps additional special dividends. Furthermore, assuming the 19M shares short number holds true, in 2007, we are looking at a total of about $150M in payouts to long shareholders. $56M comes from regular dividend, $56M comes from special dividend, and $38M comes from each of the short sellers paying their $2 to the lender of the shares they have shorted. Now, it is unclear exactly where that excess $38M will go, but it will go somewhere into the hands of the longs. Some longs may not get any of that additional special treatment, but someone will. In short, we are looking at a total yield of up to 15.4% to long shareholders. Additionally, the bank remains to be well capitalized, profitable, and have plenty of breathing room – both in terms of cash in the bank and bad loan strategy.
It honestly does not seem like this bank is in as much trouble as the market is suggesting it is. I do not know how much longer the shorts will want to be writing checks to the long shareholders simply to bet that CORS will continue to go down. Sure, CORS could have bought back stock, but why? To drive the prices up only to have the short sellers drive it down? CORS is saying the special dividend is a function of having some extra cash and wanting to take advantage of the 15% tax rate on qualified dividends while it lasts. Those absolutely make sense, but there is more going on here. Without sounding too vindictive, if someone wants to bet against me and write me a check for the privilege to do so, well that is beautiful news for me. That is exactly what seems to be happening here.
Now, it is possible that CORS is trying to clean out the coffers to give back to the owners before they go belly-up, but that would be borderline fraud and illegal, so that does not sound like what is going to happen. CORS may also have nothing to do with their extra money, which is doubtful considering they could easily just invest more in banks (as they have done historically) if their prospects for new loans are slow. I am not a sophisticated banking expert by any means and yes, there is a degree of unknown risk here so zero is a possibility, but should CORS really be trading at 7.5x future earnings and right at book value? The potential for a short squeeze alone, plus the excess cash being put into the pot from the shorts is indicative of how shrewd CORS can be. It is hard to say what the actual valuation of CORS is – I have read anywhere from $0 to $40 – but nevertheless, it appears that a war is being waged here between a family of established, reputable bankers and a stock market trying to fairly value the stock based on current information. It is difficult to forecast where this one is going – it certainly can go down more, but it does not look that way. However, the stars are lining up for some very aggressive movement in the stock price – and since it is trading at book value with a slew of news priced in and a big cash pile, well, do the math and figure out what bet makes the most sense here.
Brush Engineered Materials, Inc. (NYSE: BW)
I have never been a big fan of earnings guidance, particularly for companies that are not as widely followed or held as the big blue chips. These smaller companies, relatively speaking, are more susceptible to the impacts from all sorts of factors that can have significant impacts on their operating revenue. Furthermore, because of this increased susceptibility, volatile movements in the stock price – both up or down – become more likely to happen. It is not like companies to try to sandbag their guidance or get too aggressive with it to drive the stock price to the brink, but sometimes it just pans out that way. Of course, such volatility, especially downward volatility, can bring buying opportunities into the mix.
BW engineers and supplies worldwide markets with beryllium products, alloy products, electronic products, precious metal products, and engineered material systems. Specifically, BW services a wide array of industries including telecommunications, automobile electronics, and industrial components. The beryllium and alloy products they produce help electronic devices, such as PDAs, perform better. Additionally, BW is the only fully-integrated producer of beryllium and related products in the world, giving them somewhat of a lock on the market.
BW is off about 33% from its 52 week high and when they reduced their earnings guidance for Q2, the stock took nearly 20% hit on a single day. BW altered its earnings guidance range to $2.00-$2.55 from $2.20-$2.75. While it is no fun to make less than what you thought you might, there is a strong chance that their results will fall within their original estimated range. The reason for the lower guidance? Production problems and ramp-up problems – which will impact 2Q results and hence the total year results. >However, these issues are cited as being temporary and are resolved. Additionally, the weaker market BW is blaming for some of the slowdown is not a disaster as it appears it is seasonal in nature and their other divisions are performing exceptionally well. In other words, although growth may slow somewhat, BW is still going to make a lot of money and they are serving industries that are growing and continuously have the need for better products, that BW can help provide.
Although empirical results are not the best to go off of, this is reminding me a great deal of Astec Industries' (NASDAQ: ASTE) 50% decline from its early 2006 highs. ASTE ran up to around $42 on the excitement of the 2007 Highway Spending Bill. They missed expectations and the stock took a 50%+ hit. Ignored was the fact that ASTE was producing record sales and net income and had record levels of backlog. Value investors took the time to load up – and thus far, they have been rewarded. ASTE has exceeded its previous 52-week high in recent weeks. Notably, Tontine Capital Partners led by Jeffrey Gendell was and big buyer of ASTE post-decline. Gendell is also a 10% holder of BW – and added to his positions on the BW decline to the tune of 485,000 shares purchased around $41.
Downside for BW is limited and the upside is there. BW has had a huge run up as it is still up over 100% from its 52-week low. I anticipate a return to $50 and this healthy breather may allow BW to exceed its previous 52-week high in the coming 12 months. I am hesitant to put a $75 price target on it, as I have seen floating around, but I feel it is a fairly safe bet for a deep-in-the-money options strategy – both September 2007 and December 2007 calls with a $40 strike price should yield some significant returns – and that is exactly where I am putting my money.
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