For Those Who Like Risk

Excerpts from Barrons about investing in some companies that have been pummeled in recent months.


Buying shares in financially leveraged companies isn't the standard investment advice that's being tossed out these days -- and for good reason. Given the tough economic and financial environment, investors generally are being told to stick with blue-chip stocks. Why mess with dicey investments when quality companies ranging from General Electric to Merck, Cisco Systems and Procter & Gamble carry reasonable valuations?
It's hard to argue with a prudent approach, but some investors see opportunity in debt-heavy companies whose shares have been pummeled in recent months. This depressed group includes stocks like Bon-Ton Stores (ticker: BONT), Idearc (IAR), Libbey (LBY), McClatchy (MNI), Carmike Cinemas (CKEC), FelCor Lodging Trust (FCH) and Gray Television (GTN).


Libbey: As the leading manufacturer of glass tableware in the Western Hemisphere, Libbey has exposure to the faltering U.S. restaurant industry, which has depressed its shares. The stock, around 16, trades for about 27 times projected 2008 profits, a rich-looking valuation. The high P/E, however, reflects a steep 13% interest rate on its debt that eats into earnings. Once the credit markets thaw, Libbey may be able to refinance debt, cutting interest expense by perhaps three percentage points and boosting earnings. Libbey is valued at a modest six times estimated 2008 pretax cash flow and has few direct competitors. Profits this year are expected to rise despite the economic slowdown. "There's a cost-reduction and interest-reduction story, as well as a significant moat around Libbey's business," says Hawks. If Libbey can hit its 2008 financial projections, the stock could be up 50%. Safer Choice: None.

Idearc: Any stock trading with a P/E ratio of two and a dividend yield of 25% is worth a closer look. Verizon Communications spun off its yellow-pages business as Idearc to its shareholders in 2006 rather than sell to private-equity buyers. Because it viewed the yellow pages as a stable business, Verizon put $9 billion of debt on Idearc, effectively creating a public LBO. That debt is proving a millstone amid a sudden weakening in phone-directory industry trends. The company's CEO resigned for health reasons last week, just a week into the job. Idearc's shares, which hit $38 last spring, now fetch under $5, valuing the company at less than $1 billion. At issue is whether recent troubles merely reflect a weak economy or a permanent shift by advertisers away from print directories. Despite its heavy debt, Idearc isn't going away anytime soon. This year's cash flow is expected to cover interest payments by a factor of two to one. Even with revenue declines in 2008, Idearc should have ample earnings to pay the annual $1.37 dividend. If revenue declines persist, Idearc could cut the dividend in order to focus on debt repayment. With its stock down 75% this year, Idearc could surge on any signs its business is stabilizing. No Safer Choice: Rival R.H. Donnelley (RHD) also has a lot of debt and similar business problems.

There aren't many mutual funds that specialize in debt-heavy companies. One of the few is the Fidelity Leveraged Company Stock fund (FLVCX) that has handily beaten the S&P 500 over the past one, three and five years. Its success shows the benefits of levered equities. It was up 17.9% last year, ahead of the 5.5% gain in the S&P 500 index. Some of its strong performance reflects a heavy weighting in energy and commodity stocks like Freeport McMoRan Copper & Gold (FCX), Forest Oil (FST) and Celanese (CE). Freeport took on debt in its 2007 purchase of Phelps Dodge, but it's not heavily indebted any more. It has a market value of $39 billion and debt of $7 billion.