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Three Debt-Riddled Companies Worth A Gamble

February 26, 2008 – Comments (0) | RELATED TICKERS: SORC , MESA , TOPS

Source Interlink Corporation

A publishing company? I know…pull yourself up off of the carpet, I did indeed just throw a media company on a buy list. Source Interlink is involved in the distribution of CD’s, DVD’s and magazines to major retail outlets, the largest being Barnes & Nobles and Borders Group, which together make up just over 25% of SORC’s sales. Increasing sales is not a problem for SORC which has shown a marked 20%+ increase in sales and has guided at a continued long-term growth rate of 18-20%. Other than one-time charges in their most recent quarter, they have shown massive operational profit growth of 175%+! On a GAAP basis the company has reported 43 cents in earnings in the trailing 9 months which is, get this, a trailing p/e of about 4.7! They are trading well below book and sales value, but as mentioned in the title here, they maintain over 1.3 billion dollars in long-term debentures. The thought here is AEC Associates, a private arm of an investment firm, already owns 30% of the outstanding shares of SORC. Usually investment firms won’t make that large of a commitment to a debt-ridden company if they don’t have some ideas that a takeover could be in order. I consider SORC a strong takeover candidate at these levels and despite the 1.3 billion dollars in debt, I’d recommend the purchase here.

Mesa Air Group

Yes, now I’m really getting sadistic on you, an airline! Oil prices are rising to record levels over $100 a barrel and I’m recommending you purchase an airline, and a discount airline at that! Mesa Air Group targets 180+ different cities, usually outlying non-major cities, and services routes under three brand names for companies like United Airlines, Delta Airlines and US Airways. Mesa has definitely been feeling the pinch of rising fuel prices recently with a few recent weaker profits than analyst expectations. One thing in Mesa’s favor however is that very few analysts follow the company making any earnings misses somewhat irrelevant. What really matters to me is that their passenger load rate levels off. If I see that ratio level or rise I will feel incredibly confident in MESA at these levels, which by the way are 0.5 times book and 0.05 times sales. Mesa does maintain 90M in cash, but is sitting on a hefty 640 million in debt or roughly 5 times their shareholder equity. What draws me to MESA is their rich history of profits. Even in rough times MESA can pull in 55-70 cents a year in EPS. I don’t know how much of a takeover target they appear, but their markets do interest UAL and DAL so I wouldn’t be shocked if I saw a bid from one of these two within 36 months. The debt levels are up there and higher fuel prices are a pain, but MESA has the juice to stay in the air.

TOP Ships

I know, even more transportation! TOP Ships operates 19 vessels which primarily service the oil service industry carrying refined petroleum worldwide. The majority of their ships are contracted out for two or more years with all but three of those contracts well above the base rate. In addition, just to diversify operations, TOPS also purchased three dry bulk vessels in the last five months and those will typically command a higher contract rate. If you look at the balance sheet for TOPS you’ll see a company that almost grew too quickly for its own good from 2004 to 2006. TOPS went heavily into debt buying vessels in 2006 and now sits atop a 335 million dollar debt pile versus just 15 million dollars in cash. Luckily management has been smart with apportioning their contracts and it now looks like TOPS is sitting pretty trading at less than 8 times future earnings. Other fundamentals "wow’s" include the 0.52 times book and 0.42 times sales figures. They have a fiercely competitive space with which to contend, but they look solidly poised to rebound in 2008/09 and should approach $1.00 in EPS full year earnings by 2009. It’s worth a shot at these levels.

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