This article is excerpted from New Generation Research’s The Turnaround Letter. George Putnam, III has been sharing market-beating stock recommendations and timely commentary since 1986. One of the longest-running investment newsletters on the market today, Putnam’s Turnaround Letter is also one of the top ranked: The annualized return on Turnaround Letter stock picks over the past 15 years is 11.7%, vs. the S&P 500’s 9.6% (through 11/30/17). Learn more about The Turnaround Letter’s contrarian investing philosophy.
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The growth in bankruptcy activity that we’ve seen over the last few years paused somewhat in 2017. As shown in the table below, the number of publicly traded companies filing for bankruptcy this past year dipped to 70 from 99 in 2016. However, the total assets of public companies going into Chapters 7 and 11 during 2017 actually rose slightly to almost $107 billion from $104 billion the year before. This may have been skewed somewhat by the fact that some of the largest 2017 filers arguably were financial services companies (which we typically exclude from our totals because they show huge assets on their balance sheets), but the numbers nonetheless reflect a continued high level of filings by large companies.
While Chapter 11 activity in the energy and mining sectors remained significant in 2017, it no longer dominated the bankruptcy world the way it did in 2016. This past year there were only four energy or mining companies among the ten largest Chapter 11 filings, compared to eight of the top ten in 2016 (or nine of the top ten if you include a solar energy company).
Interestingly, the largest bankruptcy of 2017 wasn’t by a company, and technically might not even be a “bankruptcy.” When the Commonwealth of Puerto Rico defaulted with a total estimated $73 billion of debt earlier this year, it wasn’t eligible to seek protection under the U.S. Bankruptcy Code because that law doesn’t cover unincorporated territories. Instead, Congress passed a special statute called the Puerto Rico Oversight, Management, and Economic Stability Act (sometimes known as “PROMESA”) to provide judicial oversight for the restructuring of the island’s debt.
Looking ahead, we expect corporate bankruptcy activity to remain at a high level for at least the next few years. Much of the unprecedented amount of debt that has been raised during the exuberant markets since 2009 comes due soon. Roughly $1.5 trillion dollars of lower quality corporate debt (a combination of high yield bonds and so-called “leveraged” bank loans) comes due over the next five years. Even if the debt markets stay strong, some small percentage of that debt will need to be restructured, much of that through Chapter 11. If the debt markets get more selective, a larger percentage of the maturing debt will not be able to be refinanced, leading to even more bankruptcies.
If we are correct and the pace of defaults pick up, this will create a wealth of opportunities for distressed debt investors. Also, the large number of companies, particularly energy companies, emerging from Chapter 11 has created interesting opportunities in post-reorganization stocks.
Finally, Puerto Rico’s debt is beginning to look attractive, as some issues have fallen to 20 or 30 cents on the dollar or below. It is a complicated and risky situation for at least three reasons: 1) there are quite a few different types of Puerto Rican bonds outstanding, many of which have competing claims on the same limited pool of assets; 2) the restructuring is governed by a new and untested law and 3) the island’s economy remains in shambles after being battered by two hurricanes last fall. All that said, our best guess is that at least some of the Puerto Rican debt could provide substantial rewards to investors willing to take on those risks.
Disclosure Note: Accounts managed by an affiliate of the Publisher own certain Puerto Rican bonds.
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This article is excerpted from New Generation Research’s The Turnaround Letter, which is published by George Putnam, III. A graduate of both Harvard Law School and Harvard Business School, George Putnam, III first became involved with distressed securities as a lawyer in the late 1970s. He founded New Generation Research, Inc. in 1986 after seeing how profitable turnaround stocks could be because many investors do not understand them or are afraid of them. Since the first issue of his flagship publication The Turnaround Letter hit the presses back in 1986, Putnam has consistently practiced the same straight-forward and profitable contrarian investment philosophy.
As a distressed investor, Putnam does not follow the crowd. His Turnaround Letter purchase recommendations avoid “blue chips” and “hot” stocks—instead cherry-picking select “troubled” companies poised for a rebound. His strategy is simple: Beaten down stocks with genuine value will prevail regardless of the overall market. The key to profits with turnaround investing lies in skillful analysis and decades of proven experience—separating those companies that will recover and, ultimately, return to favor from those that will not. Like many things in life making this distinction is often easier said than done. Learn more about The Turnaround Letter’s performance returns.