Some of the Most Amazing Returns I've Ever Seen
A post-bankruptcy situation that I have mentioned a couple of times here in the past, Semgroup Corp. (SEMG), got hammered after it announced its recent quarterly results a couple of weeks ago. The company was essentially break even for the quarter, but it did not change its outlook for the year.
The reason for the weaker than expected quarterly results include worse margins in the company's propane and overseas segments.
Semgroup officials tried to put a positive spin on things during the company's conference call stating that things should get better in the second half of the year after the company increases its Cushing oil storage capacity (350,000 barrels’ worth right now and another 1.95 million barrels in 2012 at a time when there's not enough storage), expands its pipeline capacity, and renegotiates its credit facility, reducing its interest expense.
Here's a sample of a piece that I have been working on about the company:
"Over the years I have developed into a huge fan of special situation investing, a circle of investing where one looks for corporate events that can unlock hidden value in stocks. Perhaps the most profitable subsegment of special situations is companies that are emerging from bankruptcy.
A 1996 study by a team of researchers that included one of the world’s foremost experts on corporate bankruptcy, Edward Altman, found that the stocks of companies emerging from bankruptcy significantly outperformed the major market indices. From 1980 through 1993 the re-listed stocks of formerly bankrupt companies outperformed the major market indices by over 24.6% in the first two hundred days after they became publicly traded.
Check out these returns
Some of the most amazing investment returns that I have ever seen have come from companies that have emerged from bankruptcy with relatively clean balance sheets and depressed stock prices.
Take the specialty chemical producer W. R. Grace (NYSE: GRA) for example. The company went bankrupt as a result of asbestos-related claims earlier this decade. After its emergence, its stock traded as low as $1.50/share in 2001. Today the stock is just under $44/share, nearly a 30-bagger.
The list of astonishing returns from post-bankruptcy situations goes on and on...Walter Industries (NYSE: WLT) has been over a ten-bagger since it emerged from bankruptcy in the mid-90s.
Perhaps the ultimate example is that of Toys R Us, the business unit that emerged from the Interstate Department Stores bankruptcy. It was literally a hundred-bagger between the time that it re-listed in 1978 and when it hit its all-time high in 1993.
Look for over-leveraged companies with solid businesses
It is important to be picky when investing in post-bankruptcy situations, because not all of these stocks will be winners. Some companies just go bankrupt because they are bad businesses. The companies that seem to perform the best are the ones that have solid core businesses models that collapsed because they were overleveraged or for some other reason that isn’t related to their main operations.
A perfect example of this type of situation is Semgroup Corporation (NYSE: SEMG). The company owns a network of pipelines, terminals, and storage tanks that it uses to store and transport oil, natural gas, and refined products….a solid business. The problem with Semgroup is that instead of merely hedging its exposure to commodities, it was speculating and making massive bets on the direction of oil. During oil’s historic run up to $147/barrel in the summer of 1998, Semgroup’s then CEO Thomas Kivisto was short the equivalent of 20% of the country’s oil inventory…Oops. Needless to say, this move lead to a $2.4 billion loss for Semgroup and its eventual filing for bankruptcy.
Under new management, Semgroup emerged from bankruptcy in September 2009 and went public in November 2010. It reported a loss last quarter, but after backing out non-cash depreciation and amortization charges the company is doing fairly well on a cash flow basis. Semgroup expects its EBITDA for 2011 to be between $120 and $140 million.
So where’s the catalyst?
While Semgroup does not jump off the page as an obviously cheap company by many metrics, there is a catalyst that could cause its stock price to soar in the near future. The company is considering converting to a Master Limited Partnership (MLP), like most of the publicly traded pipeline operators such as Boardwalk Pipeline Partners (NYSE: BWP).
When a company announces that it is going to convert into an MLP, like Semgroup has openly mentioned is a possibility some time between now and June 30th, it means that it will significantly increase its cash payments to investors in the future. I said cash payments instead of dividends because in MLP-speak these companies pay “distributions” to “unitholders” not dividends to shareholders like conventional companies do.
The majority of investors won’t initially recognize Semgroup as a dividend-paying stock, because the company is not yet widely followed by analysts. Furthermore, its attractive distributions won’t be mentioned in any of its stock listings until after it has actually made its first payment. This phenomenon may create a window where investors can invest in the company when it is undervalued compared to its dividend yield and then ride along as the public becomes aware of the stock’s attractive distribution and bids its shares up."
I still think that SEMG represents an interesting opportunity for investors. As an added bonus, anyone who buys in today can get a better price than I did with my initial small position ;).
Today SEMG's share price is approaching the price that it was at when it re-listed on a major index last year. I just came across a good article on SemGroup that appeared over at The Complete Growth Investor:
A Semi-Sweet Post-Bankruptcy Morsel
The article contains a lot of the same information that I have mentioned in my previous posts on the company, but it goes one step further and talks about a potential valuation for the company, which is definitely useful:
At $100 million, if SemGroup were an MLP, it would need to distribute about $2.40 per share on the 42 million shares outstanding. That’s a 9.6% yield on today’s $25/share price. Once this gets known, Mr. Market will probably choose something closer to 7.5%, which implies $32/share. But I’ve used low estimates and ignored the growth prospects, so the potential for more is good.
Furthermore, the downside protection is strong, as there are many MLPs with low cost capital that would be happy to buy this cash flow below their 6% to 7% cost of capital, so we should be fairly well covered on the downside, as well.