The Top 5 Stocks to Buy for 2015

Bret Jensen

I have learned and employed many successful investing strategies during my three decades of investing. Few have brought higher overall returns on average than finding and investing in stocks that have seen better times but decide and execute successful turnaround plans which deliver outsized shareholder returns.

The strategy is not for everyone. Not every turnaround strategy works and the rate of failure is high companies would not need a turnaround strategy if everything was going well with the firms current business model after all.

Employing this type of investing requires discipline, patience and the willingness to be a contrarian and go against the herd traits not every investor possesses. However, the huge returns that typically occur when a company executes a well thought turnaround plan makes this investing worthwhile for those are willing to do the work to find these companies and patiently wait and watch as these companies execute against their plans.

I have found over the years that I am quite good about ferreting out these plays. I have also found I am usually early in investing in these turnaround stories. I now slowly build positions in these types of investments over time after catching one too many falling knives. Many of the stocks in my Small Cap Gems portfolio are or have been at various stages considered turnarounds.

Solid turnarounds come in many flavors, forms and sizes. They cut across sectors and industries and run the gamut from A to Z. Over the past few years I have more than doubled my money in Alcoa (NYSE: AA) as it transitioned from a commodity play into a value added seller to the auto and aerospace industries. I also more than tripled my money in a busted IPO called ZELTIQ Aesthetics (Nasdaq: ZLTQ) whose razor and razor blade model took a while to gain traction with investors.

The turnaround that has created the most shareholder value in history is Apple (Nasdaq: APPL) which was on the verge of irrelevancy when Steve Jobs returned to the company he co-founded. He then went on to create the most successful company by market capitalization in the world.

One of my first investments when I was a teenager was a small purchase in Chrysler at the beginning of Lee Lacocca’s efforts to bring the American manufacturing icon back from the brink of bankruptcy. That investment turned out to be my first five bagger in the market. It was also the first of many successful turnaround bets that have benefited my portfolio to a significant degree over the years.

Over the past few years I have more than doubled my money in Alcoa (NYSE: AA) as it transitioned from a commodity play into a value added seller to the auto and aerospace industries. I also more than tripled my money in a busted IPO called ZELTIQ Aesthetics (Nasdaq: ZLTQ) whose razor and razor blade model took a while to gain traction with investors.

Turnarounds have the unique position where investor sentiment is usually so negative on the stock and company that any piece of positive news or traction executing with the firm’s turnaround strategy can cause a significant rally in the shares.

It is these types of gains I am constantly on the lookout for both within my own portfolio and as editor of The Turnaround Stock Report, a service for investors looking for long-term profitability from stocks on the rebound.

In this report Ill highlight five companies found in my personal portfolio as I believe they can successfully turn around their businesses and deliver outstanding performance to their stockholders. Ill spend some extra time profiling one of my favorite stocks first, Chesapeake Energy.

1) Chesapeake Energy (NYSE: CHK)

To start I want to discuss a mid-major energy play I have started to accumulate and believe has substantial upside as the company starts to make significant progress on its turnaround plan. This exploration & production company is named Chesapeake Energy.

Under its previous founder and CEO, Audrey McClendon, the company pursued a growth at any cost strategy. This helped Chesapeake develop into one of the largest independent natural gas producers in the country. This philosophy worked great when natural gas was selling at north of $10 MMBtu but not so well when prices plunged hitting $2MMBtu two years ago.

Chesapeake had taken on a large amount of debt in order to finance its huge production expansion. When prices plummeted it found itself in a precarious position. After much conflict the company booted its founder who left the company completely last year.

The company brought in a well-respected leader from Anadarko Petroleum (NYSE: APC) to be its new CEO. At Anadarko this individual was known for his ability to optimize a production portfolio, rationalize operations and drive drilling costs down. Chesapeake hoped to execute a similar game plan under his leadership.

Turnaround Strategy:

The company’s turnaround strategy consists of selling off non-core assets to reduce its substantial debt load, become more “oily” in its production which currently is heavily tilted to natural gas and lower overall operational costs.

The company has made substantial progress in these goals over the past year. In the third quarter alone, Chesapeake spun off its oil services business as a standalone entity called Seventy Seven Energy Inc. (NYSE: SSE). sold some natural gas compression units for $135 million, as well as some non-core acreage in the Marcellus for over $300 million. This continued a major trend in reducing leverage which the company also made substantial progress against in the second quarter. These proceeds helped drive a further reduction in the company’s balance sheet.

The company then put those efforts on overdrive recently by selling almost $5.5 billion of western Marcellus acreage, a sale that is expected to close this quarter. This acreage represented 7% to 8% of Chesapeake’s overall production. However, this will allow the company to cut its remaining debt in half. I expect a rash of credit upgrades from the major credit agencies once the transaction closes. These upgrades will lower overall financing costs further and will also be a positive catalyst for the stock.

This will also increase Chesapeake’s financial flexibility which is critical as asset values in the oil patch have declined recently due to the drop in oil prices. The company should be able to do some small strategic acquisitions at lower prices than available earlier in the year in its efforts to grow the amount of overall production that comes from oil. This transaction must be viewed as extremely positive within the company as a director bought over $10 million in new shares earlier this month, a giant vote of confidence.

The new CEO, the asset sales, shedding of non-core activities, and improvement of credit ratings are all part of a domino effect seen with turnaround plays. In fact, I call it the Domino Strategy.

Net Asset Value:

Despite the recent fall in energy prices, Chesapeake has remained solidly profitable. Probably the best way to value Chesapeake over the long run is by looking at the current discounted net asset value (NAV) of its productive acreage. As the company continues to execute against its turnaround strategy, its stock price should slowly close the gap to where its sells for discounted NAV.

The company has done a marvelous job reducing leverage as well as its capital budgeting needs over the past year. It has a geographically diverse portfolio of attractive acreage and an increasing amount of its overall production will come from oil in the years ahead. The company recently estimated its true discounted net asset value is some $40 a share. My opinion is that it might take two or three more years executing against its turnaround strategy to achieve those levels. However at a current $20 a share price level, that bogey represents 100% upside from here, something a patient investor can surely accept.

Turnaround stocks should be in every investor’s portfolio, even if just a few, for those investors looking for the more than the occasional high double digit, even triple digit, return. Many years ago I got started with my own investing with turnaround stocks and have been able to make tremendous gains from them in the years since. In fact I was able to retire in my early 40s in part due to the gains I’d made from turnaround stocks.

To help investors who want big winners in their own portfolios I launched a turnaround stock service earlier this year with the sole purpose of delivering solid, unbiased, independent research on stocks on the way back up. I find them using the Domino Strategy I mentioned earlier.

2) Devon Energy (NYSE: DVN)

The mid-cap exploration and production company has been in my portfolio for about a year and has delivered an approximate 30% gain so far, even with the recent turmoil in the energy markets. The companys strategy is to transition from a primarily a slow growing natural gas producer to a more focused and faster growing production concern that gets a significantly higher percentage of overall production from more lucrative oil.

The company is about halfway through this transition. Earlier this year, Devon sold off about $3 billion in natural gas assets and facilities in Canada. It also spun out its midstream assets into a separate entity with a partner. It used these proceeds to start to pay down a $6 billion purchase in the Eagle Ford shale region in Texas late in 2013. This acquisition substantially bolstered Devons production growth and boosted its overall oil production as well.

After pulling back recently as the result of oil prices that have fallen $10 a barrel over the summer the stock is offering a solid entry point at just over $60 a share. The consensus has Devon delivering a 10% to 15% earnings increase in 2015. The stock goes for just over 11 times next years earnings estimates; a 25% discount to the overall market multiple.

Lets move on to a couple of emerging turnaround stories in the consumer discretionary space; sectors that have underperformed the S&P 500 all year.

3) Coach (NYSE: COH)

In the retailer sector, I have just taken a small stake in tarnished handbag purveyor Coach. Many investors shy away from retail, though its certainly not their most hated sector. Newcomer Michael Kors (Nasdaq: KORS) has eaten Coachs lunch in some of its core segments over the past year. The stock is down some $20 a share this year to currently around $37 a share.

The company has seen better times but still has some things going for it including a strong and recognizable brand. The company is also seeing mens sales increasing in the low double digits even if it is off a small base. Coach has a strong balance sheet with over $700 million in net cash.

Coach recently brought in a new Chief Operating Officer and is now focusing on returning to best-in-class profitability. The shares sell at around 10 times 2012 and 2013 earnings and the company has solid opportunities for growth in Asia. Finally, the shares yield almost four percent at these levels. I will add more to my initial stake once the company provides more detail and proof that a solid turnaround plan is in place.

4) Chicago Bridge & Iron (NYSE: CBI)

I am also building a significant position in engineering and construction firm Chicago Bridge & Iron (NYSE: CBI). The shares have moved from around $85 a share to begin the summer to a current $40 a share. The first $10 to $15 a share of this decline was triggered by an obscure quasi-research firm accusing the CBI of taking liberties with its purchase accounting as it integrated its major acquisition of fellow engineering and construction firm Shaw Group. These concerns have not been echoed by any of the over dozen analysts that cover the shares at major investment shops.

The major part of the pullback in the shares has occurred due to increasingly negative sentiment in the commercial construction sector as well as on the energy industry where Chicago Bridge & Iron gets approximately half of its revenues building huge energy facilities like refineries and storage tank farms.

Despite concerns around the impact of falling oil prices on capital budgets, Chicago Bridge & Iron keeps winning new contracts all across the globe. The company has an enterprise value of approximately $7 billion. In contrast, the firm’s order backlog stands at over $30 billion. In addition, consensus earnings estimates remain pretty much the same as they were three months ago. Earnings are tracking to just under a 25% year-over-gain this year and the consensus has another 15% earnings increase in store in 2015. The stock is very cheap at just over nine times this year’s earnings.

5) Darden Restaurants (NYSE: DRI)

I have recently upped my allocation to this restaurant holding company. Starboard Value, an activist fund manager, has taken a substantial stake in Darden and has been pushing hard for changes at the company to unlock shareholder value.

Starboard has pushed for Darden to put its Red Lobster and Olive Garden chains into a separate entity and puts its real estate portfolio in a more efficient capital structure as well as to improve its food menu to offer healthier choices. This will allow the remaining company to concentrate on its faster growing restaurant chains such as Capital Grille and Bahama Breezes.

Darden has recently divested itself of Red Lobster and announced that its embattled CEO will step down at the end of the year. Darden has also recently agreed to give Starboard some board seats. Same store sales declines at Olive Garden improved in the last quarter.

When I first brought Darden to the attention of Investors Alley readers it was trading at $48. Its now just below $60. Starboard believes its plan can add $15 to $26 a share in shareholder value to the company. I have a more conservative estimate of $10 to $12 a share and have been encouraged by recent events at Darden. The shares also provides a 3.7% dividend yield which should put a solid floor under the stock near these levels.

My Small Cap Gems portfolio has five more stocks in what most investors would surely have called turnarounds only a year ago. Now theyre all up big in the hottest sector in the market. Theyre the kind of stocks Ive used in the past to accelerate the growth in my portfolio.

Positions (as of publishing of report): Long DVN, CHK, DRI, COH, RLOC

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