2006 Turnaround Stocks

Pier 1 Imports (NYSE:PIR)
$8.50/share
52wk range: 8.50 - 19.50

2005 was not a good year for Pier 1, and the Home Furnishings industry in general. Same Store comps were down for the first time in several years. But it appears Pier 1’s recent problems are a speed bump rather than evidence that the business model is permanently broken. Very few retailers can operate with a high level of sales consistency for an extended period of time as Pier 1 has exemplified the last decade.

Pier 1 has Warren Buffett-type fundamentals. In fact, his Berkshire Hathaway company bought a sizeable chunk of the company late last year. After 2005’s sell-off, Pier 1 is extremely undervalued with a market cap of only $750 million on $2 billion in annual sales. They have consistently returned earnings to shareholders with a >10% ROE over the last decade & 4.5% dividend yield. With its small market cap & large amount of cash per share, Pier 1 is a rumored buyout candidate.

2006 should be a turnaround year for Pier 1. Management plans to close several unproductive locations, leading to higher sales and profits in the remaining store base. They also plan on aggressively advertising a more modern styling to the company's products. $12/share is a conservative target.


Shanda Interactive (Nasdaq:SNDA)
$15.30/share
52wk range: 14.80 - 43.28

Shanda was flying high in early 2005 before hitting several speed bumps. American shareholders found out just how risky it is operating in the Chinese gaming market with such intense competition, Chinese government regulation, and the threat of piracy. In hopes of fighting addiction, the Chinese government recently set a standard for online-game providers to limit the use of their games to three hours per session. As a result, Shanda struggled to keep up with its lofty growth expectations.

At $15/share, this may be the rare chance to invest in a highly-profitable Online Gaming company in the ever-growing Chinese market. Last year’s sell-off has left Shanda with just a 10 P/E ratio vs the 34 industry average. Shanda’s $6/share cash hoard now makes of 40% of its market cap. These conservative figures all come from a company with 48% profit margins & consistent 25% growth rate.

The Online Gaming business contributed more than 90% of their revenue in 2004. But Shanda has been focusing on expanding its products and services outside the online area. In 2005, SNDA announced that it would launch the EZ Station, a video gaming console. Pre-orders were more than 150,000 in mid-December. The EZ Mini, a handheld online gaming device, will be released later this year.

Shanda will continue to benefit from increasing personal computer and broadband penetration, as well as rising personal income levels in China. The stock should recover back to the $20-range.


Pfizer (NYSE:PFE)
$23.40/share
52wk range: 20.27 - 29.21

Patent expiration concerns hurt Pfizer investors in 2005. But a crucial victory last month ended 2005 on a high note. In December, a federal judge ruled in the company's favor concerning patents supporting its blockbuster drug, Lipitor. Pfizer's cholesterol-lowering drug is the best-selling prescription in the world & should generate upwards of $12 billion in sales in 2006.

Pfizer's existing drug portfolio is first-rate. Ten products hold dominant market positions and all generate more than $1 billion in annual sales.

To compensate for potential lower sales & patent expirations, Pfizer is pursuing aggressive cost-cutting to provide earnings growth until it can replenish its product portfolio over the next several years. In addition, Pfizer's late-stage drug pipeline has some promising candidates that could help boost sales in 2006.

Pfizer generates substantial cash flows and is investing heavily in R&D to fund new drugs. The company will be able to leverage its enormous financial and administrative resources to deliver a continuing stream of differentiated drugs.

The company boasts a credit rating of AAA and has more than $18 billion in cash and long-term investments on its balance sheet. With a 10.7 P/E versus an industry average of 21, Pfizer should return to the $30s.


Activision (Nasdaq:ATVI)
$13.50/share
52wk range: 10.50 - 18.03

Take-Two Interactive (Nasdaq:TTWO)
$17.75/share
52wk range: 16.92 - 29.60

Video game stocks struggled in 2005. The majority of publishers were unable to meet growth expectations as consumers awaited the introduction of next-generation game consoles. Microsoft’s Xbox 360 was released in November, and will be followed by new consoles from Sony & Nintendo later this year. While the transition period between consoles tends to be arduous for video game publishers, we expect the industry will resume its long-term growth once the transition is complete.

After 2005's selloff, a few video game publishers are now attractively priced heading into the next cycle of next-generation consoles. Activision and Take-Two Interactive appear to be the best bets for 2006.

Activision announced last week that disappointing sales during the holiday season would lead to revenue coming in below expectations for the remaining two quarters of fiscal 2006. The poor performance of the firm's GUN and True Crime titles, coupled with general weakness in the U.S. and European video game markets, are the primary drivers behind the sales miss. However, we believe both of these issues are short-term in nature.

2006's sales expectations are extremely conservative. With such blockbuster titles as Tony Hawk, Shrek, True Crime & Spiderman, Activision should blow away estimates in 2006 & return to a double-digit growth once the installed base of new consoles reaches a critical mass.

Take-Two Interactive is by far the most under-valued stock in the video game sector. Although there could be a longer term negative impact on the Grand Theft Auto franchise, we believe the recent selloff was overblown. In fact, the publicity could further strengthen the cult status of the Grand Theft Auto franchise. Plus Take-Two is no one-hit wonder. We believe other key releases will drive results such as Manhunt, Max Payne 2: The Fall of Max Payne, Mafia, and Red Dead Revolver.

Investors forget that Take-Two is still a relatively small, growing gaming company. But with a current PE ratio of only 15, the stock is priced as a mature company, not one that analysts expect to grow 25% annually for the next 5 years! Take-Two is cheap and poised for a near-term correction to fall more inline with its competitor's valuations:

TTWO vs Industry
Price/Earnings 15.6 vs 42.4
Price/Book 1.9 vs 6.0
Price/Cash Flow 14.4 vs 25.5
Price/Sales 1.0 vs 5.7

After all the supposed bad news this year, TTWO is still poised to earn over $1 per share in 2006 – a 100% year-over-year improvement. Plus it continues to churn out $60 million in Free Cash Flow. The balance sheet is solid with nearly $2.80 per share in cash/investments and no debt. This is a rare chance to invest in a small-cap, high-growth Gaming company that is poised for a valuation correction before the next cycle of consoles hit the market.


More picks to follow...