By: Frederick L. Harris III
The investing world is often broken down into two broad camps: growth and value. The growth group looks for companies with earnings that are advancing at a material clip. The value camp, meanwhile, looks for stocks that are trading on the cheap. The desire to find undervalued stocks is both emotionally and intellectually appealing—after all, who doesn’t like to take advantage of a sale? Moreover, value investing follows one of the oldest, and most obvious, sayings on Wall Street, “buy low, sell high.”
The problem is that everyone is trying to buy low and sell high, even the growth investors. So it’s important to properly define “cheap” and have a systematic way of identifying candidates that meet that criterion. Equally paramount is remembering that some merchandise winds up on the sale heap because it is damaged in some way. A fact that is as true for stocks as it is for consumer goods.
To help investors cull through the list of potential investments, Value Line provides weekly screens. One of the more useful screens for value investors is the Bargain Basement Stocks screen. The screen is fairly simple, highlighting companies with price-to-earnings multiples and price to “net” working capital ratios near the bottom of the Value Line universe. The idea is to identify companies that are trading cheaply relative to earnings and to the money that would be “left over” if the company were to be liquidated. Note that most stocks never trade below their liquidation value, but even trading at two or three times that value is noteworthy.
This screen is available every week in the Index section of The Value Line Investment Survey. Subscribers can access the most recent Index here to see all 35 names on the list. Two companies of interest that we have highlighted are SodaStream International (SODA, Financial) and Fuel-Tech Inc. (FTEK, Financial).
SodaStream International
SodaStream International manufactures beverage carbonation systems, which transform tap water into carbonated soft drinks and sparkling water. These products are environmentally friendly, cost effective, promote health and wellness, are customizable and fun to use. Also, the products offer convenience by eliminating the need to carry bottles home, store them, and dispose of empties. SodaStream’s products are available at more than 60,000 retail stores in 45 countries around the globe.
The company has generated disappointing earnings in 2014, compared to last year’s tally, and we look for more of the same over the near term. Indeed, the U.S. operations are underperforming, reflecting lower-than-anticipated demand for soda makers and flavors. Although SodaStream has been fairly successful over the past few years in establishing a solid base of repeat users in America, management concedes that it has not succeeded in attracting new consumers to the home carbonation system at the rate it thinks should be achieved.
To help remedy the situation, various initiatives are being implemented, supported by the healthy balance sheet. One move involves a shift of the company’s product and marketing strategy towards health and wellness, primarily in the U.S., since consumers there have become more concerned about fitness, partly because of greater media attention on the dangers of obesity (which include diabetes and heart disease). Furthermore, SodaStream is developing a comprehensive growth plan that encompasses such key areas as marketing, product and innovation, and distribution. On the marketing end, SODA’s tagline is changing from “Your Home Soda Factory” to “Water Made Exciting.” The SodaStream name will still be present, but there will be an increased emphasis on “water-inspired” names such as Source and Splash.
The stock is presently trading around $22.00, substantially lower than its high-water mark of $79.70 in 2011. But that’s not surprising, given the company’s weak operating performance during this year. Even so, we see some speculative appeal here, due in large part to media reports about SodaStream being a potential takeover target. Nevertheless, we believe that if management is unable to turn things around in a timely fashion, interest could diminish further.
Fuel-Tech Inc.
Fuel-Tech, Inc. engages in the worldwide development and application of technologies for air pollution control, process optimization, and advanced engineering services. It operates in two segments: Nitrogen Oxide (NOx, a byproduct of fossil fuel combustion) reduction technologies; and Fuel Chem technologies, which improve the environmental status of combustion units. The company provides its services to industrial firms and utility power-generation facilities worldwide.
It has been a challenging year for the company. Specifically, sluggish orders in the domestic Air Pollution Control segment, along with a decline in business activity from a large project in Chile that’s nearing completion, are hurting earnings. But one positive was the earlier acquisition of two air pollution control companies: Cleveland Roll Forming Environmental Division, Inc., known as PECO, and FGC Corporation, purchased for a total of $8.25 million in cash. Both companies deal with particulate control technology, which should increase in importance as domestic regulations become more stringent. Also, the acquired technologies ought to be immediately beneficial to Fuel-Tech’s operations in China.
China represents an attractive growth opportunity for the company, since regulators in that nation have set pollution control as a top priority as its economy (and carbon emissions) expand, it attempts to gains stature as a leader on the world stage, and it participates in more international events and organizations. Coal currently accounts for roughly 80% of China’s electricity generation, and this is not expected to change anytime soon. Indeed, according to the company, China is forecasted to account for 76% of the projected increase in world coal use through 2035.
Looking stateside, it appears that FTEK’s prosperity will also be heavily reliant on the impact of the Cross State Air Pollution Rule (CSAPR). The U.S. Supreme Court has ruled in favor of the measure, although the timeline for specific regulatory requirements remains uncertain. Also, it is likely that the rule may take longer to come into effect, due to appeals from several industry groups. In our view, CSAPR stands to be a major catalyst for domestic growth once implemented, and may potentially drive annual sales to just under $200 million.
Not surprisingly, given Fuel-Tech’s unimpressive 2014 operating performance, the equity has struggled of late. But the stock-price movement has elevated the shares’ bounce-back potential out to late decade, which is substantially above the Value Line median. All things considered, we think investors with some tolerance for risk might find something to like here.
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