On the Lookout for Survivors

On the Lookout for Survivors

Many investors hope to find stocks that could skyrocket thanks to new technologies or hot-selling products.

But while everyone searches for the next Google (GOOG), the best opportunities may lie in industries beaten down by the weakening economy, high oil prices, and the credit crunch. Companies that outperform in tough times tend to be great investments when conditions improve, says Bernard Horn, president and fund manager at Polaris Capital Management in Boston.

The key to figuring out which industries and stocks will recover "is tuning out the noise that's distracting everyone," says Jeffrey Schwarz, manager of the Metropolitan Capital Advisors hedge fund in New York. He looks for companies with the financial strength to survive a few lean years so they can profit after bankruptcies and consolidation have reduced competitive pressures.

One sector Schwarz has been eyeing is North American paper producers. They've been in decline for years because of growing competition abroad and shrinking demand from newspaper publishers. But this year energy costs have hit them even harder, and they're shuttering mills. Shares of International Paper (IP) are down 25%, MeadWestvaco (MWV) is off 22%, and Domtar (UFS) has lost 27%. But Domtar has been closing less efficient plants, which bolsters its cash flow and makes it a likely survivor. That has attracted Schwarz and other deep-value investors. Domtar is a top producer of paper for copiers and printers, not newsprint, explains Schwarz.

Transportation companies have been among the hardest hit by high fuel prices. Delta Air Lines (DAL) and AMR (AMR) have lost more than half their value so far in 2008. Even the shares of shipping giant FedEx (FDX), which had held up because of repeated price hikes, lost 10% in the past month after the company warned it won't meet profit forecasts. And hundreds of small trucking operators have gone bankrupt, notes Kwame Webb, a transportation analyst at T. Rowe Price (TROW) in Baltimore. "This contraction [of smaller rivals] eventually becomes the basis of a strong recovery," leaving more business for survivors, he says. Webb won't say what companies T. Rowe has bought, but regulatory filings show that in the first quarter it acquired shares of Landstar System (LSTR) and Knight Transportation (KNX). Webb says both trucking operators have shown that they can grow profitably in challenging times.

High oil prices should be good news for natural-gas companies. But it hasn't worked out that way for producers of liquefied natural gas (LNG). A few years ago some investors theorized that when natural-gas prices rose, U.S. needs would be satisfied by liquefying gas from abroad, shipping it in special tankers, and re-gasifying it on arrival. Companies such as Cheniere Energy (LNG) built huge U.S. re-gasification plants only to discover that foreign players couldn't afford to build such plants yet. Cheniere's shares fell to under $5 from more than $40 last summer. Schwarz prefers Golar LNG (GLNG), a Bermuda operator of LNG tankers. New tanker construction has all but ceased, and Golar has converted some unused ones into offshore storage and re-gasification plants to boost revenue. Schwarz figures that when foreign plants are eventually built and the LNG market matures, Golar will be well-positioned to benefit.

The crisis in financial stocks also creates opportunities. Polaris' Horn has added shares of reinsurers such as Chubb (CB) and Munich Re. They haven't engaged in price wars or invested in risky subprime securities, he says. "The market's beating up good companies."

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