It’s hot here in San Jose. With a record streak of record temperatures (many over 100 degrees), newspapers are reporting that every local store selling air conditioners has been cleaned out. Similar stories are being heard around the country.
Naturally, that led me to think again about companies selling air conditioners. I already wrote about Lennox which, while down from when I originally looked at it, still looks like a good medium term play. Their plan on building up an extra large inventory this season looks like it will pay off big time, though it may not be until their next quarter report that we’ll really know the results.
But Lennox mostly sells larger units. Today I went looking for companies that sell the portable and window units that have been selling like crazy, and I found Fedders Corporation (FJC).
Fedders is at best a turn around story. They’ve certainly had a couple of tough years. 2005 sales dropped considerably due to an unseasonably cool summer in the U.S. in 2004. Note the one year lag time – a cool summer in 2004 builds up inventory that sells in 2005, so it reduces 2005 sales. All the 12 month numbers and ratios are based on 2005 and thus actually reflect the summer of 2004. Do you see where I’m going with this?
2005 was a hot summer, which led to a significant sales increase in early 2006. Given what we’ve seen this summer, an empty inventory pipeline should result in significant sales through the next two quarters, maybe more.
Earnings were depressed earlier because material costs rose beyond what they could pass through due to existing sales contracts. This should be mitigated going forward as sales prices increase.
Fedders has also consolidated several manufacturing plants which might produce savings. They’ve started addressing problems in their financial controls. And they’ve started diversifying into some less cyclical areas to expand their product line beyond air conditioners.
Normally I don’t like buying into companies that are losing money – even if they are cyclical (where they lose money some quarters and run a profit on others). And while the story seems like a potentially good turn-around play, it still strikes me as a fairly high risk proposition. At least it did until I noticed another possibility.
Fedders previously paid a dividend. A small dividend (about 3 cents) on the common stock and a fixed dividend of $2.15 on their series A preferred stock which represented about a 9.0% yield on the $23.75 original buy-in. Not a bad yield even by today’s standards. But, they haven’t paid the dividend recently (though it continues to accumulate). And today the stock can be bought for $12.10.
This represents an interesting opportunity. Should the company become profitable and start paying dividends again, the yield will be 17.7%, which is certainly nothing to complain about. But it’s even better, because if they recover to the point that shareholders feel confident in their ability to continue to pay dividends, the shares will probably quickly return to their actual value, which is currently $27.15 ($25 liquidation price plus $2.15 in deferred dividends).
The nice thing about preferred stock is that it is somewhat less risky than common stock. If the company is bought or liquidated, the preferred shareholders get paid first. So even if the company collapses (which does not seem likely at all), chances are you’ll recover something (unlike the poor common stock shareholders). Plus, for every quarter Fedder doesn’t pay a dividend, the potential value of the shares increases further.
And don’t forget – those dividends get the favorable dividend tax rate!
Also, if Fedders does recover, the share price on the preferred stock is likely to increase before the common stock does. Why? Because it depends on the ability of the company to pay the dividend, not on the net earnings (remember, those dividend payments reduce net earnings).
It’s unclear how Fedders is going to do. It does have the potential to return to profitability – and if it can’t do so given the sales rates it’s going to see, then all bets are off. , but if you do see it as a turnaround, the preferred shares just might be the way to play it.