(02/27/12) An Odd Couple with Lots of Headroom

These two stocks don't share a sector or a growth model, but both are well positioned to score big in coming months and years, writes Jack Adamo of Jack Adamo's InsidersPlus.

One of the world markets that is doing well is the Philippines. The whole Pacific Rim is feeling the positive China effect—except China, ironically, although it may get back in step sometime this year.

I’ve long known that the Philippines attract capital as a source of inexpensive labor, but there are few stocks from the region that are buyable in America. Thankfully, one very good one is Philippine Long Distance Telephone (PHI).

PHI is a full service phone company that has everything you’d expect: land lines; cell phones; wired and wireless Internet, etc. As of December 31, it had 49 million customers.

The company has a good balance sheet, with earnings covering interest payments more than seven times and cash flow consistently much higher than earnings. That is mostly due to depreciation expense, which is higher than actual cash-replacement costs for the depreciated assets, and amortization expense, which is a non-cash expense that measures the declining value of certain non-tangible assets.

The stock is up more than eightfold in the last ten years. Though that rate has slowed significantly, it is still up 12.8% annually, compounded for the last five years. Not too shabby.

Dividends have grown in each of the last nine years, and are up a total of 62% in the last five years. As with most foreign companies, dividends vary year to year, but the shares are yielding 7.2% based on the average of the last three years, and 7.8% based on 2011’s payout.

The payout ratio is high, but with consistent, strong cash flow and comfortable debt servicing, it does not need much capital to grow. Issuance of stock, even including stock option compensation, has been very small.

The foreign accounting doesn’t state the actual number of shares issued (it just gives the dollar amount), but by my calculations they averaged less than 205,000 shares over the last three years, out of a total of more than 186 million shares outstanding.

The stock’s current P/E is 13, but earnings are expected to slip a bit next year, so it’s 14 based on forward earnings. I’ll take it.

Growth may slow, especially if China takes time to recover, but even if we get low digit earnings growth over the long term, we will probably get help in the form of currency translations, as the US Dollar continues to weaken against Asian currencies. Buy Philippine Long Distance Telephone up to $68.50.

Kinross Gold Corporation (KGC)
Gold may not tarnish, but gold stocks do. In fact, it seems they tarnish more than most stocks when they have problems.

Kinross is one such company. It has had a couple of bad quarters recently that call into question management’s ability to get the job done.

Between 2002 and 2008, the stock soared ninefold, matching its peers in the industry, but since then it has fallen more than 60%. The latest boondoggle was Kinross recording a $2.94 billion “non-cash” charge for the company's Tasiast project in Mauritania, leading to a loss for the year.

On the flip side, however: on an operational basis, 2011 was the best performance in the company's history. Despite its stumbles, it produced 2.6 million gold-equivalent ounces, growing revenue 31% to $3.94 billion.

Furthermore, in the face of rising costs for fuel (substantial in mining), cash margins grew 32% to $906 per ounce sold. “Cash” in this instance means excluding corporate costs. It’s a legitimate measure, though it’s the bottom line that counts in the end.

Given these results, it seems to me that Kinross simply bit off more than it could chew with some of its recent acquisitions. It’s cranking out a lot of gold in some places, but blowing it in others. That conclusion aligns with the company’s decision to scale back some operations, cutting back on plans at specific mines for the time being. I think it’s a wise decision that should pay dividends later.

Which reminds me: the company’s cash flow is excellent (remember, the write-off doesn’t effect current cash, just past investment), so Kinross raised its dividend 33%. It only comes to about 1.5% annualized...but it’s cash coming in.

The real reason to buy Kinross comes down to something else, however. After all the recent trouble, write-offs, etc., the company’s proven and probable reserves are being valued by the market at less than $130 an ounce.

“Proven and probable” is a legally prescribed definition. It means the gold can be economically mined, though it doesn’t specify at what margin. But at that price, there’s likely to be a lot of room for profits.

If the company doesn’t get its act together, I can see a bigger company like Barrick (ABX), Newmont (NEM), or Goldcorp (GG) scooping it up. It’s small enough (at $12 billion) to be edible, but large enough to add meaningfully to an acquirer’s girth. Buy Kinross Gold Corporation up to $12.

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