Turnaround Investing



Contrarianism

Do you enjoy being a contrarian investor, buying unloved stocks that every other investor has labeled as roadkill? Turnaround investing is exactly that – investing in struggling companies with great future potential. By being a contrarian investor, you can find value in places that others often overlook.

 

People consider this kind of investing as risky, but buying stocks with falling share prices doesn’t actually increase your risk exposure. Ironically, buying things at a lower price actually reduces risk. Think about it for a minute. If you buy a nice Ralph Lauren polo for $100 and stain it from chowing down some spaghetti, that’s $100 down the drain. However, if you buy a $10 polo from H&M and stain it – not a big deal. It works the same way with investing, which is why buying overpriced stocks like Tesla (NASDAG: TSLA) is much more risky than buying an old boring company like General Electric (NYSE: GE), which trades at a more reasonable price point.

 

Analyzing Turnarounds

 

Ultimately the key to making money in investing is to find value where others don’t. The idea for this article came to me as I noticed GE stock tumblling as it continues a challenging multi-year turnaround, and more recently analysts have noted that GE may have to cut its historical dividend. As a result the stock price has dropped by over 30% this year.  GE’s new CEO announced the company will reveal a strategic plan, scheduled for November 13th, to get the company back on track. This plan will include GE’s capital allocation strategy, which may include selling or spinning off some of its businesses.

 

GE stock sliding 2017
Source: Finviz.com

 

The first thing that came into my head as I saw GE fall this hard was, “A big profitable company like GE down 30% = Buy! Buy! Buy!”.

 

 

The basics of a turnaround play is determining if there’s potential value and then understanding the catalyst that will unlock that value. The timing of when that value will be unlocked is the tricky part, which is why you have to be willing to invest with a 3-5 year time horizon.

 

In GE’s case, the company is a conglomerate that has an interesting mix of highly profitable businesses with some not so profitable ones. In particular, the divisions relating to oil & gas, transportation, and lighting are not doing too well and are most likely on the chopping block. Ejecting these unprofitable businesses from GE’s portfolio actually creates an opportunity to unlock value for shareholders. As GE looks to spin off underperforming businesses, the company will experience an inflow of extra cash. That is not a bad thing! That cash can then be used to reinvest into its profitable businesses, pay down debt, or it can be distributed to shareholders via dividends or share buybacks.

 

As you can see below, some of GE’s business segments are good while others, not so much.

 

Source: GE 3Q ’17 Earnings Presentation

 

Basically, the four segments above are the problem children, while the four segments pictured below are the future of GE.

Source: GE 3Q ’17 Earnings Presentation

 

From looking at GE’s segment breakdown, I believe GE has some value here. The four divisions comprising of Power, Renewable Energy, Aviation and Healthcare are highly profitable and have defendable economic moats. Ejecting the other divisions not only will bring in excess cash, but it will also help the company become more focused on its core competencies.

 

GE currently pays ~4.8% dividend yield, which might be cut down, but still attractive nonetheless while waiting for a turnaround play to happen. The key driver in this potential opportunity is the capital allocation plan the company will lay out on November 13. This will give clarity into what businesses could be for sale and how much the dividend will be cut by. Hopefully there will also be a clear timeline, which shareholders can hold the management team by.

 

As in any turnaround play, the company needs to have a clear plan to get back on track, preferably with deadlines, which you can hold the company to. If you believe the plan is feasible and the company is trading for a low enough valuation, then that would be the signal to buy.


Final Thoughts

 

Turnaround plays are not always doom and gloom scenarios, and when you have a profitable company like GE, the opportunity for a turnaround is much more plausible. The damage brought on from GE Capital in particular really hurt the company as it tried to regroup after the financial crisis. With a new CEO at the helm, it may take a few more years to properly restructure the company, but patient investors may have an attractive opportunity as the share price has dropped quite dramatically.

 

There are not many opportunities on my radar at the moment so I feel obliged to share any potential opportunities that can generate excess returns for my readers. I briefly mentioned GE in my Portfolio Update: October 2017, and I plan to provide a more detailed analysis should an investment opportunity arise after the November 13 meeting.

 

If you have any questions or comments please feel free to drop a message below!