Two Post-Chapter 11 Stocks You Can Love

09/15/2010 12:00 pm EST

Focus: STOCKS

George Putnam

Editor, The Turnaround Letter

George Putnam III, editor of The Turnaround Letter, says investors tend to shy away from post-bankruptcy companies in bad times, but he says they can be big winners.

It’s amazing how quickly investors can swing from loving a stock (or a group of stocks) to hating it. Particularly these days, there seems to be no middle ground for many stocks. And when investors decide that they hate certain stocks, they may push the prices down so far that the stocks become very attractive for more patient investors.

We’ve seen quite a lot of this behavior over the last few months. Investors loved stocks in general, and certain groups in particular, up until April. Then, in May and June, they decided that they hated stocks in general and especially hated some of the stocks that had been darlings earlier in the spring. In July it was love again, followed by loathing in August.

[One] group with which investors have had a love/hate relationship in recent months is post-bankruptcy stocks. When the market is strong, investors are willing to “take a chance” on these stocks (although post-bankruptcy stocks are often less risky than many other stocks, because the companies were able to clean up their problems through Chapter 11.)

But then, when the market dips, these post-bankruptcy stocks are often the first to be sold. Further selling pressure may come from bankruptcy-related hedge funds who need to sell these stocks—which are among their more liquid holdings—when they get redemptions.

Calpine (NYSE: CPN) is an independent power producer that operates primarily natural-gas plants, but is also the largest geothermal operator in the US. In the latest quarter, operations were constrained by the continuing sluggish economy that led to lower competitive energy prices. Even so, the company was able to maintain an attractive measure of free cash flow and expand operations.

The company was also able to recapitalize its debt structure to create a more favorable maturity schedule. Increasingly volatile weather could increase power demand, which would be a boon for Calpine. (The stock closed below $13 Tuesday—Editor.)

Federal-Mogul’s (Nasdaq: FDML) outlook, as a provider of power-train and other safety technologies to auto and truck manufacturers, is quite directly tied to new car sales. As such, the company has benefited from rebounding demand for autos and light trucks, and sales grew 22.6% in the latest quarter.

A strong focus on cost containment has helped achieve profitability in each of the last four quarters, and solid cash flow is helping maintain a very liquid balance sheet with over $1 billion in cash. New products should spur additional operating gains. (The shares closed below $18 Tuesday—Editor.)

Subscribe to The Turnaround Letter here…

Related Articles on STOCKS