rknapton (84.18)

Short and Long Term Pick: ZZ (Sealy Corp.)

June 30, 2009 – Comments (3) | RELATED TICKERS: ZZ , LZB , TPX

Short and long term pick: ZZ (Sealy Corp.)

 

I recommended this stock to some family and friends on March 9th, 2009, when it was at $0.57.  It proceeded to run over 900% over the next ten weeks! 

 

I couldn’t recommend it anymore after that run, but now that it has pulled back substantially, and formed a new base, I would like to re-recommend this stock, and I will go far beyond my original March 9th quick analysis of:

 

“Sealy's ticker symbol is ZZ.

at $0.57 now for a market cap of less than $53 million dollars... for a company that does over a billion in sales annually. 

This is a company that made $0.67 in EPS during 2007.  If they can stay out of bankruptcy, anywhere near these price levels will be rewarded many times over once the earnings return.  The low estimates are no earnings for 2009 and $0.25 during 2010.  The high estimates are $0.18 for 2009 and $0.35 for 2010.

RK”

 

So, unto my further analysis.

 

The three factors I like about this stock, and will focus this writing on will be:

 

The attractive valuation based on fundamental analysisThe recent divergence it has had from La-Z-Boy Inc.The technical price pattern the stock has exhibited

 

1.  Now upon this pull-back, ZZ is trading at just ten times the average consensus earnings estimate for 2010.  This is the best of both worlds as it represents a discounted multiple, on top of depressed earnings.  This actually leads to a triple threat for price appreciation as: 1. The multiple deserves to be higher based on the fact that this is a cyclical company, and the earnings are currently depressed.  2.  The currently depressed earnings, will eventually return to normalized levels as demand returns for high ticked items that eventually need replacing (think beds).  3.  The analyst estimates may well be too low and be adjusted higher (already over the past month the expectations have risen for all the current quarter, next quarter, current year, and next year estimates). 

 

Many of the stocks I have written about recently have the added benefit of having quite a bit of cash on their books and no debt.  I wish the same was true with ZZ, but it is not.  None the less, I do not see their $750 million in debt as such a big problem that the stock needs to be avoided.  The majority of their notes are now not due until 2016, and even during the first quarter this year, even on their depressed revenues, they still managed to have an EBIT of 1.44 times their interest expense on their debt.  Of course with my expectations that demand for beds will return over the next couple years, this ratio will only get better.

 

The best explanation I can give for why it’s best to get in this stock before the numbers actually really turn around is from Richard Schabacker’s 1934 classic Stock Market Profits, where he wrote:

 

“Our whole theory of anticipating fundamentals was based upon this type of psychological “crossing” operation.  The operator who decided that a broad public demand for automobile replacements would develop in 1933 would not have reaped a very large profit if he had waited to buy motor stocks until that demand had actually appeared.  Because by that time the balance of trading would be definitely on the buying side, and he would be competing on the same side of the market with everybody else.

His proper course was to “cross” the balance of trading, which was on the selling side in 1931 and 1932, thus making it easy for him to buy.  Likewise, his proper course was to sell and take profits when the public turned to the buying side on actual development and public realization of the revival in motor demand.”

 

This relates perfectly to ZZ as we are currently seeing lack of demand for beds (Q1 revenues down 20%), and the stock price fully reflects that with being down 90% from its highs.  So to play this “crossing operation”, this is indeed the time to buy, before demand picks back up.  With ZZ, we even have some historical data of how well the company has done right after recessionary periods.  During the two year periods after the 1981-1982, 1990-1991, and 2001-2002 recessions, ZZ grew revenues by 23%, 16% and 20% respectively.  Would we expect to see anything different after we come out of this recession?  I wouldn’t.  Data found here: http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MzQyMDU4fENoaWxkSUQ9MzI4MjAxfFR5cGU9MQ==&t=1

 

 

2.  Generally, ZZ and La-Z-Boy (LZB) have been highly correlated in their movements of their stock price, which would obviously make sense for any two similar companies in the same sector and industry.  Just for kicks I ran my first correlation coefficient and R-Squared in Excel since graduating college.  Lol.  The results from July 1st 2006 to June 1st 2009 was a correlation coefficient of .874,  and an R-Squared of .764.  So basically you can interpret this to mean that 76% of a move in one of the companies explains the movement in the other company.  Thus they are highly correlated. 

 

However, this correlation has recently diverged widely, and now presents an opportunity since eventually these two correlations will re-converge to more normalized levels.  Since the beginning of June of this year, LZB’s stock price has ran up in price by 140%!, but yet ZZ remains basically completely flat during that timeframe.  At some point, and I think soon, ZZ will have a nice run that will prove that this divergence in prices is just an opportunity and not a long-term change in their correlations.  And just for kicks, the correlation coefficient since June 1st, 2009 to today the 30th, is now at -.385.  Far from its .874 average that I calculated earlier.

 

And it’s not that their actual business operations have diverged either.  Similarly to ZZ, LZB’s revenues were down 23% during their latest quarter, yet both were able to post a surprise profit during the quarters due to well executed cost-controls.  So why the run in LZB and not ZZ?  Well, I’m expecting ZZ will catch back up to LZB soon.

 

3.  Although I mainly like this play based on fundamental analysis, technically the stock looks poised to pop too. 

 

During the early part of this year, this stock completely fell apart and couldn’t find a support level anywhere.  Eventually it hit what appears to be a bottom in early March, at which point it rose over 1200% from its lowest trade.  Finally the stock had a nice pull back during mid May though, when it dropped by over 65% down to its current levels, where it has formed a real nice base over the past month with a tight consolidation around the $2 range.

 

Another technical pattern some of you may like (if you’re a fan of IBD and William J. O’neil) is ZZ also appears to have formed a “cup with handle” chart formation.  Looking at a 3 year chart, we can see the start of the “cup” at the beginning of February 2009, bottoming the beginning of March, and finishing at the end of March.  Which is followed by the “handle” that has formed since the end of May, and continues through today.

 

So to recap.  I think we have three reasons to buy the stock.  The last two may be a catalyst for a short-term pop, but the first (and more important) presents itself with a great multi-year opportunity, upon which the stock can be sold a year or two into the post recession.  Therefore, both short-term and long-term this stock looks attractive.

 

RK