Turnaround opportunities

Photo of Nick Radge, The Chartist By Nick Radge, The Chartist

min read

What the share-price charts say about Woolworths, Origin, Qantas and Fairfax.

When a company is in crisis, investors tend to sell first and ask questions later – and that creates opportunity. Thus, the lure of a corporate turnaround opportunity is strong and a popular investment strategy among fund managers.

The stock that once traded at $15 and now trades at $4 can be appealing, especially in the age of Buffettology: finding beaten-down companies with real value and hoping they turn around. Add to that our emotional makeup, driven by anchoring bias, which contends that a stock that was once $15 and now $4 can probably go back to $15.

Fundamentally speaking, turnaround opportunities require well-known companies with solid core businesses, good brand or franchise exposure, low debt, reasonable cash flow and appealing dividends.

However, one of the drawbacks of investing in turnarounds is the opportunity cost of waiting for the price to recover (granted that dividends can alleviate some angst). The turnaround can take many months and sometimes years.

So, is it possible to use charts to better time the entry and improve the opportunity cost? I believe so.

Two turnaround scenarios

In terms of pure price action, there are two turnaround scenarios: the “V” formation and the “accumulation” formation.

The “V” formation occurs when a stock slides swiftly, reverses on a dime, then rallies straight back to where it came from. Usually the slide occurs due to an unforseen event – such as Sirtex in early 2015, which fell about 50 per cent in a few weeks then within months had fully recovered.

The “V” formation is very difficult to predict and trade – usually because the move is extremely swift, bearish momentum is potent and negative rhetoric is heightened. It takes a strong mind to step in front of that bus.

However, the “accumulation” formation does provide an opportunity. The pattern takes time to develop – usually many months or even years. Investors have had time to assess the fallout and the company itself may have taken the time to adjust its direction in a more sustainable way.

The “accumulation” formation evolves in three stages. Stage one is the initial decline that tends to end in a mass exodus or capitulation. The second, the most important stage, is a sideways meander lasting many months or sometimes years.

This is the stage where long-term holders who did not sell during the decline finally get bored and exit – each time the stock bounces they take the opportunity to sell out and it is this action that creates the sideways meander. Once these sellers have been exhausted the stock is ready to rise again, which is stage three.

(Editor's note: Do not read the following ideas as stock recommendations. Do further research of your own or talk to a financial adviser before acting on themes in this article)

The weekly chart of Woolworths below shows the significant decline investors have been dealt over the past few years. On this weekly timeframe, the low could be deemed a “V” formation. However, if we zoom into the daily timeframe (refer inset) there is a 12-month period of sideways meander with a defined upper boundary sitting at $26.00.

This is accumulation taking place. Any breach of that boundary line suggests the accumulation has completed, supply has been exhausted and prices have started to recover. Waiting for the breach before entering can help in the better deployment of capital.

Source: Premium Data
Origin Energy has been undergoing a balance sheet repair phase after its share price slid from $14 to under $4 in early 2016. During this time the company has simplified its corporate structure by divesting its conventional gas assets and ensuring they can weather a decline in oil prices.

Like the Woolworths chart, the larger weekly timeframe highlights the major price decline and what appears to be the “V” formation. Zooming into the daily chart we can clearly see that prices meander sideways below the $6 boundary for nearly 12-months. Importantly, trading volume during this period declines considerably.

During the last legs of the decline in late 2015 the average daily volume swelled to approximately 11 million shares, almost four times the average. This was clearly a signal of capitulation and the initial stages of the accumulation phase.

As the share price wallowed during 2016 the volume declined, some days trading down to less than 3 million shares, signalling that sellers were becoming exhausted and that phase two was underway – eventually allowing the share price to rise again.

In late November 2016, the price finally breached the upper boundary and has since advanced 25 per cent without pause. If the corporate restructure plays out as expected, Origin Energy may have plenty of upside yet.

Source: Premium Data
Qantas Airways took a sharp step backward in early 2016 following a great trend higher through 2015. The balance of 2016 was one of consolidation, with $3.50 a solid barrier to the upside. Analysts are expecting the stock to be re-rated with a compelling valuation, improved trading conditions and a low in domestic revenue behind it.

While technically not a deep turnaround scenario, the recent 38 per cent decline certainly showed investor nerves. Volume dramatically increased on down days, signalling a high level of panic selling – very typical in the first phase. For the balance of 2016 the share price traded in quite a wide range below a $3.50 barrier.

I have added the volume to this chart to show the slow decline through the year as the consolidation, or accumulation, took shape. A move back through recent highs is possible in the coming months.

Source: Premium Data

Fairfax Media also looks interesting, with the accumulation phase quite evident on the larger weekly timeframe. The joint-venture SVoD service, Stan, has been significantly better than expected, attaining the number two position in the market with 600,000 subscribers. The company has also committed to reducing its print exposure during 2017 in what could be a turnaround year.

The share price is off its major low point set back in 2012, but upside progress compared to its historical high has been extremely slow. Since 2014 the price has been held back by a resistance barrier at $1.10 that has been tested on three occasions. It also appears the stock is well supported on the lower side, creating a tight range-bound market.

One positive is that these low-volatility, range-bound scenarios tend to be followed by explosive price action, so any penetration of the upper boundary could be a trigger for a more sustainable trend higher.

Source: Premium Data

About the author

Nick Radge is head of trading and research at The Chartist. He has more than 27 years’ experience in financial markets, from the trading floor of the Sydney Futures Exchange to international dealing desks in London, Singapore and Sydney. He has written several books on trading and investing, including his bestseller, Unholy Grails - A New Road to Wealth. Contact him on Twitter @thechartist.

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