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John Dorfman

Dorfman: Phillips 66, American Railcar make Casualty List

John Dorfman
| Tuesday, Jan. 20, 2015, 12:01 a.m.

Buying good companies on bad news is an excellent investment tactic.

That's the reason I publish a Casualty List each quarter, containing stocks that have been wounded and that I believe will recover.

Among the fourth-quarter's losers I particularly like is Phillips 66 (PSX), a large oil refiner based in Houston. Phillips 66 operates pipelines and gas stations as well, but refining is the heart of the company and the part that interests me most.

Oil prices have fallen more than 50 percent in the past seven months, which lowers the price of refiners' main raw material. History has shown that refining stocks generally do well in the year succeeding a big drop in oil prices.

Yet investors have been punishing refiners along with other energy stocks. Phillips 66, for example, dropped 11 percent in the fourth quarter, even once dividends were taken into account. The stock offers an annual dividend yield of more than 3 percent.

Cloud Peak

Down 27 percent in the fourth quarter was Cloud Peak Energy Inc. (CLD), a coal mining company in Gillette, Wyo. Almost every bad thing you've heard about coal mining is true. Coal is a polluting fuel, mine safety is a perennial issue and cheaper natural gas and oil give coal stiff competition.

But sometimes a stock is priced so low that it fully reflects all the bad news, leaving room for pleasant surprises. At a price below $8 — down from $24 in late 2011 — I believe that Cloud Peak is so priced. It sells for less than six times earnings, and less than half of book value (corporate net worth per share).

Coal supplied 39 percent of the energy used for electricity generation in the United States in 2013. That percentage has dropped but remains substantial. There is an export market for coal — moderate but likely to grow over the next five years.

American Railcar

American Railcar Industries Inc. (ARII) of St. Charles, Mo., fell nearly 30 percent in the quarter. In the 12 months before that, it had risen almost 93 percent, so some of the decline was simple profit-taking.

Investors got really excited by the big increase in the amount of oil carried by railroads in 2014. As the price of oil came down in the past seven months, investors' euphoria turned to disdain. Both reactions were exaggerated in my judgment, as oil is only about 3 percent of total railroad freight traffic.

American Railcar manufactures hopper cars and tank cars, sells some outright and leases the rest. It also makes railcar parts and does repairs. In the past four years, its sales have increased from $274 million to $750 million.

The stock sells for 10 times earnings and yields 3.3 percent in dividends.


Ubiquiti Networks Inc. (UBNT), a San Jose, Calif., maker of computer networking equipment, dropped about 21 percent for the quarter on what seems to me a garden-variety earnings disappointment.

Considering that Ubiquiti has an excellent long-term record for earnings and revenue growth, I'm inclined to allow it a blip. The stock sells for 15 times earnings.

The record

This is the 47th Casualty List column I've written. The series goes back to 2000, but I missed some quarters in 2007-09. During part of that time, I was temporarily retired as a columnist.

One-year results can be calculated for 43 Casualty Lists. The average 12-month return (including dividends) has been 23 percent. By comparison, the average 12-month return on the Standard & Poor's 500 Index for the same periods was 9.6 percent.

Of the 43 lists, 32 were profitable and 27 beat the Standard & Poor's 500 Index.

Bear in mind that past results don't guarantee performance. The figures for my column recommendations are theoretical and don't reflect trading costs or taxes. And my column results shouldn't be confused with the performance of actual portfolios I manage for clients.

The list from a year ago was a dud, due mostly to a 36.9 percent loss in Diamond Offshore Drilling Inc. (DO). No one I know predicted the hideous slide in oil prices that has occurred the past seven months. I certainly didn't.

Also in the losing column was Schweitzer-Maudit International Inc. (SWM), down 10.7 percent. Better performers were Kewaunee Scientific Corp. (KEQU), up 11.3 percent; Old Second Bancorp (OSBC), up 18.5 percent; and Jabil Circuit Inc. (JBL), up 20.1 percent.

The net result was a tepid return of 0.4 percent, which trailed far behind the 11.6 percent total return on the S&P 500. Results were measured from Jan. 14, 2014, through Jan. 14, 2015.

We'll see if the new selections can get back to the Casualty List's winning tradition.

John Dorfman is chairman of Dorfman Value Investments LLC in Boston.

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