3 turnaround plays that could climb higher in 2016

Credit: Joits

Even though stock prices change minute by minute, it is fairly clear to investors that the prospects of a business do not change materially on a day-to-day basis.

However, with that said, reporting season, also known as confession season by some, is a time when companies are able to give clear indications about the state of their business, and prepare investors for the likely outcomes for the year ahead.

In my opinion, these three companies have benefitted more than most from clearing the air around the issues that may have been clouding their outlook in recent months.

Qantas Airways Limited (ASX: QAN) has been an undoubted beneficiary of an oil price that has fallen far beyond what almost every “expert” could have predicted this time last year. However the earnings update that Qantas recently provided the market showed that the business is in good shape, even if you take out the benefits of the oil price falls.

For the domestic operations of Qantas, the end of the so-called “capacity wars” on domestic routes has meant that the company can charge more rational prices on the seats it has on its planes, rather than having lower revenue per passenger due to larger numbers of vacant seats brought on by flying more planes at lower capacity.

The company also made it clear to the market that Qantas got its aviation price fuel hedging contracts right, which has seen it benefit more than most of its competitors. This factor has also seen the airline more than offset the effects of a weaker Australian dollar when purchasing aviation fuel.

In addition, Qantas is profitable in all of its four divisions, including international travel, which was a laggard for many years, and has grown the strength of its frequent flyer program. The frequent flyer program has significant value for Qantas as a going concern if it ever considered selling the division to a third party.

It was always uncertain just how much of Qantas’ fortunes were due to the fuel price, but the recent results have shown that there is far more than that working in favour of the company, and the benefits should continue.

For many years, Australia and New Zealand Banking Group (ASX: ANZ) was able to hold itself out as the bank best positioned to take advantage of the “Asian Century”. Former CEO, Mike Smith, laid out an ambitious plan to make ANZ a super-regional bank with outposts across south east Asia.

However, going in as a small, new bank against established competitors with more resources and established histories proved a hard slog, and earnings were consistently lower than expected. New CEO Shayne Elliot has hit reverse on the Asia strategy, which is timely as there are indications that credit quality and non-performing loans are starting to tick up in the region.

While overdue, the new ANZ strategy will be to focus on growing its share of the Australian banking market, where it has arguably under-invested for years. For example, it has the lowest exposure of any of the Big 4 banks to the Australian housing market. With more efficient allocation of capital and management focus on getting it right in Australia, ANZ has a far clearer strategy than it did six months ago.

Vitaco Holdings Ltd (ASX: VIT) is certainly the smallest stock on this list, but arguably has the most potential for outsized earnings in the future. This is despite the share price having taken a severe hit on the announcement of its results. However, looking at the detail shows a fairly attractive story. The statutory loss was largely due to IPO expenses and the acquisition of Musashi, which management has already stated is performing ahead of expectations.

The company is actively targeting the giant e-commerce market in China, which is estimated to grow to over $1.5 billion US dollars in 2018. That figure will account for close to 30% of all retail spending in the Middle Kingdom.

Vitaco is a beneficiary of the beachhead that has been established by high quality Australian companies selling food and value added products like infant formula in China. In that sense, it benefits from the “halo effect” that is attached to Australian food and vitamin products in the country.

The vitamins and supplements division recorded EBIT of over 75% higher than the previous comparable period, while sales in China through official channels also impressed, rising by 233%. The distinction about sales through official channels is important, as there is a risk that the tightening of regulations around parallel importing could affect sales of imported products in China.

Vitaco could also benefit from being a consolidator of smaller Australian vitamins, supplements and health foods brands, with the ability to take them to much larger markets and grow earnings that way.

Foolish takeaway

Picking turnarounds is fiendishly difficult, but it is less of a challenge to follow good businesses that have some uncertainty facing them, and wait for that uncertainty to be cleared up. Qantas, ANZ and Vitaco have all addressed their respective uncertainties, with ANZ looking like it is the most oversold, while Vitaco is worth keeping a very close eye on going forward.

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Motley Fool contributor Ry Padarath has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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