MarketWatch writes article about Caesars Entertainment and five other stocks to sell short:
By Philip van Doorn
Published: Sept 30, 2015 5:19 p.m. ET
George Schultze of Schultze Asset Management explains how to make money
from distressed companies
George Schultze of Schultze Asset Management says Caesars Entertainment
is a good stock to sell short because the company is in bankruptcy yet
trades for close to $7 a share. ‘We believe that stock will ultimately
go to zero,’ he said.
By
Philipvan Doorn
Investing columnist
Has the six-year bull market in stocks come to an end?
Judging from daily swings in the stock market, it seems investors are
looking for any opportunity to hit the panic button.
But even in a down market, there are plenty of opportunities to make
money.
‘… There is no other company of this size and this scope
approaching this valuation today.’ George Schultze on the
attractiveness of GM’s stock
Even the solid health-care sector has taken a beating, although the big
decline registered on Monday might have been an over-reaction to
questions from members of Congress about drug manufacturer’s price
increases and Hillary Clinton’s recent tweet pillorying
pharmaceutical companies.
But there are so many warning signs. Federal Reserve Chairwoman Janet
Yellen last week said she anticipated an increase of short-term
interest rates ‘later this year, followed by a gradual pace of
tightening thereafter.’
With the federal funds rate locked in a range of zero to 0.25% since
late 2008, bond prices are high and the inverse relationship between
interest rates and bond prices means there will be tremendous pressure,
especially on high-yield bonds. That can exacerbate the budding credit
problem for energy-production companies, already reeling from the epic
decline in oil and natural gas prices, since they may not be able to
renew financing.
The S&P 500 Index SPX, +1.91% is down 8.5% this year, even with
dividends reinvested, setting up the first down year for the benchmark
since 2008. On a total return basis, the index was flat in 2011, after
which it returned 13% in 2012, 30% in 2013 and 11% in 2014.
The S&P 500 trades for 16 times weighted aggregate consensus 2015
earnings estimates among analysts polled by FactSet. That’s down from
17.7 times two months ago. But even after the stock market’s decline,
the index hasn’t traded at this high a current-year price-to-earnings
ratio at this time of the year since 2005.
In a down market, you still might find investment values, such as two
we discussed on Tuesday with George Schultze, managing member and
founder of Purchase, N.Y.-based Schultze Asset Management.
Schultze, who has served on boards ranging from Chrysler to United
Airlines, has $250 million in assets under management at his firm. He
uses both long and short strategies, focusing on distressed companies
or those with special upside ‘catalysts.’
You might also find opportunities to short stocks ‘ borrowing shares
and immediately selling them, expecting them to drop so you can buy
them back on the cheap later, return them to the lender and pocket the
difference. But this is much more risky, since your potential losses
are unlimited, as your broker can explain.
The following is a discussion we had about sectors, stocks, bonds and
valuations.
Are we in a bear market?
George Schultze: We are starting to enter a bear market for high-yield
bonds. We’re on the verge of seeing interest rates hike, and with that,
the prices of fixed-income securities can be expected to drop for a
long time. We think it will be very difficult for companies in the
junk-bond market to refinance, which means capital losses for
fixed-income investors.
George Schultze, managing member and founder of Schultze Asset
Management
What about stocks?
Schultze: I think we will continue to see lots of volatility. It is
very much a stock picker’s market. We have had a very long bull run.
We have certainly had an increasing amount of our client assets
invested in the short book, with an increasing concentration of shorts
in the energy space.
Is it getting expensive to borrow shares to sell short?
Schultze: Yes. Borrowing has become expensive for some energy stocks
that are priced below $2 or $3 per share. But these three, Ultra
Petroleum UPL, +1.43% Range Resources RRC, +3.38% and Pioneer
Natural Resources PXD, +2.69% still have reasonable costs for
borrowing shares. A couple of other interesting potential stock shorts
are Diamondback Energy FANG, +2.54% and Continental Resources
producers.]
Company Ticker Percent of shares available for selling short Stock
price decline from 2015 high Total return – 2015 Total return – 5 years
Ultra Petroleum Corp. UPL, +1.43% 21% -65% -52% -85%
Range Resources Corp. RRC, +3.38% 12% -52% -43% -19%
Pioneer Natural Resources Corp. PXD, +2.69% 6% -34% -20% 82%
Diamondback Energy Inc. FANG, +2.54% 5% -25% 5% N/A
Continental Resources Inc. CLR, +3.35% 23% -47% -27% 22%
Sources: George Schultze, FactSet
Schultze: Earlier this year, we looked at a number of coal companies,
including Alpha Natural Resources ANRZQ, +2.17% as potential
shorts, and that worked out well. For just about anything in the energy
production or related supply space, the outlook is terrible. We try to
find companies not just with a focus on troubled industries like those,
but also companies that have a high level of debt. It just so happens
that the junk-debt new-issuance market has been a big provider of
capital to the energy space over the past few years. In fact, it’s been
about 20% of total high-yield debt new issuance. So 20% of a huge
high-yield debt market, which has grown tremendously over the last
several years, has been issued to three industries where you have seen
a tremendous drop in commodity pricing: coal, natural gas and oil. As a
result, we have already seen a number of bankruptcies, and we’re likely
to continue seeing more.
There is a whole group of retail investors that buy stocks of
companies after they go bankrupt. Shorting those is a pretty
high-probability trade. George Schultze
Just two weeks ago, Samson Resources filed for bankruptcy, and it was
the largest recent bankruptcy in the oil and gas space. A few years
ago, it was also the largest leveraged buyout ever in the energy space.
Those are the kinds of things we are seeing now, with commodity prices
so low. If you can find companies in these three industries with pretty
high leverage, they may make for excellent short-sale candidates.
When companies go bankrupt in the U.S., more than 90% of the time their
stockholders get nothing at all. There is a whole group of retail
investors that buy stocks of companies after they go bankrupt. Shorting
those is a pretty high-probability trade.
How about short plays outside the energy sector?
Schultze: Caesars Entertainment CZR, -11.96% is a company
currently in bankruptcy, but its stock, amazingly, is trading close to
$7 a share. We believe that stock will ultimately go to zero. It is
very rare that a company already in bankruptcy has its stock trade
above $2 or $3 a share. The reason is that there is a lot of litigation
about how Caesars will be restructured. Our view is that the only way
to fully restructure Caesars is to wipe out its debt and give the
equity to bond lenders and bondholders. We think the chips are in and
that Caesars equity holders will either be wiped out entirely or
substantially diluted.
What about long stock plays?
Schultze: On the long side, we are finding post-reorganization
opportunities with very clean balance sheets, attractive tax assets and
very high cash flow as compared to their current market valuations.
Some have very interesting catalysts, including increasing dividends
and/or stock buybacks.
One example is General Motors GM, +2.98% GM restructured through
bankruptcy a few years ago. It was the fifth-largest bankruptcy of all
time. When it restructured, the company eliminated over $60 billion in
liabilities.
One analyst estimated the company has about $25 billion in cash and
equivalents.
Yes, it has that estimated number of cash, but if you include the net
cash from the finance business, it has even more cash. Another
consideration is that it has $30 billion in tax assets.
For GM, all things being equal, the company will pay much lower taxes
than its competitors. For that reason alone, GM deserves a higher
multiple than other companies in its industry.
The stock trades for only 5.6 times the consensus 2016 earnings
estimate.
If you make adjustments for the value of the NOL [net operating loss
carry forward, or deferred tax assets], then the company is even more
cheap, about 2.1 times EBITDA for this year. And their dividend yield
approaches 5%. In fact, there is no other company of this size and this
scope approaching this valuation today.
The long-dated class B warrants are a great way to play GM as well.
They require up-front cash and you also get the benefit of the
underlying appreciation for the stock. The class B exercise price is
$18.33 and they expire in July 2019. They cost $12.06 vs. buying the
stock for $28.58.
Are there other attractive stocks you like?
Fiat Chrysler Automobiles FCAU, +8.19% is a similar case to GM.
The only thing is that Fiat itself didn’t go bankrupt. But Chrysler
did. So Fiat really benefits from having bought Chrysler. In effect,
they got it for free. The combined company, which has about 112 billion
euros of revenue and about 10 billion euros of EBITDA, trades for only
2.3 times EBITDA.
Fiat didn’t eliminate as much debt during the crisis, but it does have
about $6 billion in deferred tax assets.
There is an interesting catalyst with Fiat as well. You have the
spinoff of Ferrari. They are in the process of finalizing the Ferrari
IPO imminently. In a couple more quarters, the company will spin off
the entire division to Fiat shareholders. In our view, the Ferrari
company will command a much higher multiple ‘ perhaps 10 times EBITDA.
So disposing of that asset, when the existing parent trades for only 2
and change, should be an accretive event and interesting catalyst for
Fiat shareholders.
MarketWatch Article Source Here.