Time to catch the falling knife in Bon-Ton Stores?

Posted Jul 19th 2007 7:19AM by Kevin Kelly
Filed under: Columns, Bargain Stocks, Stocks to Buy

Trying to catch falling knives is a tough and dangerous game. The floor is falling every day in the stock and many times, investors allow their egos to prevent them from making the right decision. But even though that's the case, I sometimes still choose to make the move if I believe it's clear that fear has taken over in the emotions of investors and the stock is clearly undervalued. As the often-quoted Warren Buffett saying goes, "Be fearful when others are greedy and be greedy when others are fearful." Often the best types of investments are those made against the crowd, or contrarian.

One such stock is Bon-Ton Stores (NASDAQ: BONT). Plagued by lower outlooks and falling sales figures, the stock has been getting killed recently.

However, I think the stock is a very interesting buy at these levels for a couple reasons. It looks cheap, insiders are buying, and it has an interesting pool of owners, among other things.

Although the company has a lot of debt ($1.3 billion), Bon-Ton looks very cheap right now. I think the stock is cheap because investors are afraid to purchase companies in this market environment that aren't showing short-term growth -- the fad in hot markets. Trading for only 6.5 EV/EBITDA (a popular metric used for companies with significant amounts of debt), the stock trades in-line with competitor Dillard's (NYSE: DDS) despite a history of faster growth and expectations of faster growth rates going forward into the next two years. And the recent cut in guidance has lowered the company's earnings per share estimates down to $3.10-$3.30 per share -- making the stock about 10x earnings at current levels. If the company can match these hopes it will beat analyst expectations for $3.09 in earnings per share and be well undervalued compared to the industry, which fetches 19.5x earnings. While the company definitely doesn't deserve full industry valuation due to its debt load and recent string of bad news, it should probably be given a higher multiple than it has now.

Bon-Ton's insiders are also bullish on the stock. Two different directors bought shares in June at prices ranging from $39-$46. I think insider buys are huge bullish tells because insiders only buy stock for one reason: to make more money. I also I love being on the same side of the table as the people sitting inside the board room.

Lastly, according to StockPickr!, the stock is in the portfolio of George Soros -- the legendary investor who used to run the Quantum Fund with tremendous success. Deltec Asset Management, a very popular long-term-minded hedge fund, is also long the stock. I wouldn't be surprised if an activist surfaced in this stock and made the common and popular demand for board seats or the "exploration of strategic alternatives." If this was to occur, it would most certainly serve as a catalyst for the stock.

There are several risks with this idea. First and foremost, like many undervalued stocks, Bon-Ton is currently out of favor with investors. Therefore, significant "quotation risk" exists in owning the name. Bon-Ton also tends to miss analyst estimates -- it has three of the last four quarters -- but I'm betting that the company's latest downward revision reflects the lower earnings ability of the company for the year and that Bon-Ton will be able to meet or beat analyst estimates. Even if the company doesn't beat estimates, it's still drastically undervalued but the "quotation risk" factor increases.

Bon-Ton Stores is a very interesting value stock, although interested investors would have to purchase it against momentum as a falling knife. The company's slowing growth has been enough to send the stock falling nearly 40% in the last few months -- a move that I believe has pushed the stock far into undervalued territory when comparing it with its peers.

Tags: Bon-Ton Stores, BONT, Deltec Asset Management, Falling knife, Soros, Value investment