Wednesday, May 4, 2011

3 Cheap Stocks Set for a Big Rebound

In a rising market, bad news for a company can be shrugged off as investors focus on the positives. But in recent weeks, investors have been less forgiving, meting out punishment to any company that delivers bad news. Let's take a look at all of the companies that have lost at least 25% of their value in the past month (and that have at least $200 million in market value) to see which ones might bounce back nicely when investors change their mood.

 
KV Pharma (NYSE: KVA)
Talk about a roller-coaster ride. Shares of this biotech firm lost 90% of their value from November 2008 to February 2010, after the Food and Drug Administration (FDA) questioned the company's manufacturing practices. Yet the stock got a second wind in February of this year, after the federal regulator approved KV's drug that reduces the chances of premature births. From Feb. 3-18, sharesrose from less than $2 to almost $10. The air has been leaking out ever since, pushing sharesdown to $4 and making this the biggest loser in the stock market in the past month.
Several reasons for the sell-off can be noted: First, a subsequent equity offering coupled with existing debt, and a $90-million loan that will need to be re-paid to medical-device maker Hologic (Nasdaq:HOLXpushed the company's enterprise value down to $1 billion. This seemed awfully rich to analysts at Needham, who wrote on Feb. 15 that KV carried a high level of expenses. Second, the path for the newly-approved drug, known as Makena, may not be the blockbuster some had been anticipating.
Yet, if management can deliver on updated guidance, then Needham's analysis may prove far too bearish. KV thinks it can generate $92 million in sales from Makena in 2012 and $420 million by 2013. At that rate, Makena could earn up to $1 a share (according to my very back-of-the-envelope math, which should be taken with a grain of salt). To reach those targets, KV will need Medicaid and other health care payers to reimburse the drug's $690 cost per injection. If not, then that $420 million 2013 sales target will never happen.
By the way, compounding pharmacies currently make a similar version of the drug for $10 to $20 a dose. And although the FDA said it would not take action against pharmacies that compound the drug, KV is now the only FDA-approved maker of the treatment and has seven years of sales exclusivity under the Orphan Drug Act. This created a publicity nightmare. To be fair, KV will offer steep discounts for most lower-income and middle-income consumers who can't get insurance reimbursement. But the gesture may not help: Congress is now looking at KV's moves to see if the company is gouging on price.
Yet, as noted earlier, KV recently took on a lot of debt, assuming eventual cash flow would help shoulder the load. Well, this just became a really risky story now that KV is seeing a big backlash. If the company's pricing strategy is taken down, then it will eventually stumble on debt covenants and possibly into bankruptcy. Despite the 57% pullback in the name, this stock appears too hot to handle.
American Superconductor (Nasdaq: AMSC)
This is the other big loser of the month, which dropped a hefty 44%. I broke a cardinal rule when I've recommended this stock in the past The rule -- never buy shares of a company that has most of its revenue tied to just one customer -- came back to bite investors in a bad way. Sinovel, a leading vendor of wind turbines in China, abruptly notified American Superconductor that is was sitting on far too much raw inventory and would curtail orders. How long will the delay last? Nobody knows, not even American Superconductor.
Watch this situation closely. If Sinovel and American Superconductor come to a new agreement and shipments eventually resume, then this stock would suddenly look quite cheap. But there's no reason to buy before then.

The best plays in a bad group
As I noted in this article, shares of A123 Systems (Nasdaq: AONE) may finally see a sustained upturn after a downdraft that began soon after the company's 2009 IPO.
Of all the stocks that took a beating in the past month, perhaps the most appealing resides in the energy sector. Voyager Oil & Gas (NYSE: VOG) has been under pressure by factors that may soon abate. As that happens, shares look to have meaningful potential upside.
Voyager is sitting on very valuable land that has the potential to produce a significant amount of natural gas in coming years. According to Dougherty & Co., Voyager has untapped potential reserves of natural gas of about $340 million (50% higher than the company's current market value) --based on currently depressed gas prices. To access those energy fields, the cash-strapped company has been raising money. 
Right now, investors just want to be sure any further capital-raising doesn't dilute shares anymore, and they've been selling shares in fear of such an event. Analysts at Global Hunter Securities predict the next money-raising effort will happen with debt, not equity. If that's the case, then shares could quickly rebound, perhaps above $5, as Global Hunter predicts, or as high as $7, as Dougherty & Co. predicts. Either target represents solid upside to the recent $3.75 price.
Action to Take --> Each of these stocks brings greater risk than most, but each also possesses significant upside if the recent hurdles can be overcome. The energy plays cited above are likely to be the first to rebound, but KV Pharma and American Superconductor may also see a solid rebound down the road if they can deliver on what were once high expectations.

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