2 Unsexy but Very Attractive Stocks

09/20/2011 7:30 am EST

Focus: STOCKS

Taesik Yoon

Editor, Forbes Investor and Forbes Special Situation Survey

These stocks may not be in the most compelling sectors but they’re very good at what they do and they make money for investors as well, says Taesik Yoon of Forbes Growth Investor.

Cloud Peak Energy (CLD) is a leading domestic coal producer. The company operates three surface coal mines in the Powder River Basin (PRB) located in Montana and Wyoming, which is the lowest-cost major coal-producing region in the US.

Additionally, the company owns a 50% interest in the Decker mine, also located in the PRB.

The majority of coal produced domestically is of the bituminous and subbituminous variety. CLD specializes in the production of the latter, which produces less energy (as measured in Btu) but has far lower sulfur content and thus, burns much cleaner.

Due to costs associated with reducing sulfur emissions resulting from stricter pollution emission regulations, subbituminous coal is actually more economical for energy generation.

This has resulted in greater coal demand from the PRB region over the past decade. In its most recent quarter, however, CLD actually saw coal volume from its company-owned mines decline due to flood-related disruptions in rail transportation resulting from unusually heavy rain activity in the Midwest.

Fortunately, this was more than offset by 6.1% increase in the average revenue per ton (stemming from higher coal prices), greater production from Decker mines, and an 85% jump in exports to Asia, which climbed to 1.4 million tons.

As a result, total revenues climbed 13.4% in the second quarter, from the prior year, to $387.8 million. The operating margin improved 220 basis points to 19.27%. Adjusted net earnings, which exclude charges and benefits related to tax items, rose 41% to 72 cents per share. This was 21 cents above the consensus estimate.

Despite the flood-related shipment disruptions, CLD still expects to produce 93 to 96 million tons of coal in the current year from its three operated mines. This implies second half production of 46.9 to 49.9 million tons, and growth of as much as 4.4% from the same prior year period. The majority of this production is already sold.

CLD’s outlook remains positive over the longer term as well. It has already contracted to sell 81 million tons of coal—85% of which is under fixed-priced contracts with a weighted-average price of $13.22 per ton.

Its Asian exports should also continue to climb at a rapid pace, supported by strong economic growth in China and India. The former is expected to enjoy GDP growth close to 10% in the current year while a recent government forecast pegs India’s GDP growth at 8.2%.

While coal mining may not be the most glamorous business to be in, it could prove to be a profitable one for those willing to get their hands a little dirty.

Rock-Tenn Co. (RKT)
This company is a leading vertically integrated global maker of paper packaging, paperboard, containerboard, and store display products. Following the acquisition of Smurfit-Stone in May 2011 (the leading domestic producer of paperboard and paper packaging), the company realigned its operations into three business segments.

Its Corrugated Packaging segment manufactures linerboard, corrugated medium (i.e. containerboard), corrugated sheets, and preprinted linerboard used by makers of industrial products and consumer goods.

The Consumer Packaging segment produces coated recycled and bleached paperboard used to make folding cartons for packaging food, beverages, household products, health and beauty products, and a variety of other products. The segment also designs and sells point of purchase merchandising displays.

Finally, RKT’s Recycling and Waste Solutions segment collects waste paper (e.g. old corrugated containers and office paper,) and trades these recycled fibers via its marketing and brokerage group.

Contributions from the acquisition led to a 79.1% jump in fiscal third quarter net sales from the prior year, to $1.38 billion. The realization of cost-saving synergies, which have materialized quicker than anticipated, helped adjusted net income (excluding acquisition-related inventory step-up costs, restructuring expenses, and early debt extinguishment costs) climb 47.0%, to $66.6 million.

Due to the dilution in total share count stemming from the acquisition, adjusted earnings per share growth was limited to 13.2%. But the $1.29 per share earned still topped the consensus estimate by 9 cents.

Despite these impressive results, the stock has seen its shares tumble more than 30% since closing on the acquisition. We believe the main catalyst for the decline is the concurrent sell-off in the equity markets.

But this selling was likely exacerbated by concerns regarding the large amount of debt assumed to finance the acquisition. Total debt at the end of Q3 stood at $3.48 billion—more than triple the $1.01 billion at the end of the second quarter.

Even with the share count dilution, the acquisition should be highly accretive to earnings on an adjusted basis. The best part is, due the stock’s slide, this impressive earnings growth potential can be had at a price-to-earnings ratio of just ten times forward earnings.

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