Earlier in the week I outlined the difficult environment facing value investors. Finding new investments meeting a value criteria has not been easy after a nearly tripling of markets in less than five years. A couple of months ago my cash pile was growing as many of my investments reached their target and I could not find new investments to replace them. Much to my own surprise I have recently been able to put money to work and am excited about my portfolio. Four of my investments, which I will outline, have catalysts coming up in the first quarter of 2014.
Two of the investment ideas came along as a result of tax loss selling. Tax rates have gone up this year and many market participants have large gains. Those looking to offset gains with losses have very few choices this year, so a small group of losing stocks have bore the brunt of this selling. Tax loss selling is similar to forced selling in that sellers are not basing their sell decision on the merits of the stock. The good news is that there are less than four trading days left in the year and tax loss selling will soon be over. The other two ideas are are long/short ideas with company specific catalysts. Without further ado here are my four investment ideas:
Air Products and Chemicals (APD)
Catalyst: Announcement of new CEO
Bill Ackman took an activist position in Air Products and Chemicals earlier this summer. He was quickly able to gain board seats and remove the CEO. Normally, this would cause the stock to fly but due to the adverse publicity Bill Ackman has received from Herbalife and J.C. Penney the stock has barely outperformed its peers. Bill Ackman has had many successful activist campaigns and a small handful of failures. Air Products and Chemicals has a lot more in common with his successful campaigns.
Air Products has strong, recurring free cash flow that is being masked by a capex binge. Only $300-$350 million of Air Product's $1.52 billion a year in capex is maintenance capex, while the rest is expansion. New plants take three years before they are built and operating at the capacity needed to create strong cash flow. The benefits of the capex binge of the past few years has not been realized but will be realized over the next few years, resulting in higher cash flow. The new CEO is likely to reduce capex spending on new projects and direct more of free cash flow to investors.
Air Products has the lowest margins in its industry. It largest competitor, Praxair, has margins nearly 50% higher. There is a lot of room for cost cutting and increased sales productivity to improve margins. With modest margin improvement and the realization of the benefits of their capex binge, Air Products could see over $14 in free cash flow per share annually some time in the next few years.
Many people I have discussed Air Products with have been scratching their heads as to why Bill Ackman has chosen the company. Bill Ackman has still not laid out a detailed case for this purchase,as he is likely waiting for the new CEO to be announced. A new CEO has not been chosen yet but is likely to be chosen in the first quarter of 2014. The appointment of the new CEO is likely to act as a catalyst for the stock as the new CEO lays out his strategy and Bill Ackman lays out his investing case. I am long APD / short PX ARG
Annaly Capital Management (NLY)
Catalyst: End of tax loss selling
I recently laid out a detailed case for owning Annaly Capital Management. In summary, Annaly trades for an unwarranted 20% discount to book value. Annaly has lowered leverage, hedged and diversified into commercial mortgage backed securities. Annaly is positioned well to withstand future interest rate increases with minimal damage to book value. I believe the reason for this deep discount is primarily end of the year tax loss selling and the fear of the effects tapering will have on Annaly's book value. Tax loss selling will soon end and as time passes the market will eventually become more comfortable with the effect tapering has on Annaly's book value. I am long Annaly.
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