I Couldn't Pull the Trigger on These Stocks

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Dozens of discarded near misses (shouldn't the phrase be "near hits"?) litter the path to each stock a good investor ends up picking. When I chat about stocks with fellow Fools, I'm often more interested in the investments they turned down; I believe we can learn even more from the stocks investors pass on than from the ones they eventually decide to buy. In the interest of sharing the knowledge, here are three stocks I recently almost bought -- but on which I couldn't pull the trigger.

No. 1: Regis
Regis
(NYSE: RGS  ) owns or operates (or both) more than 12,000 hair salons, mostly in the United States. Although the company does own the Regis salon concept, those stores make up just a sliver of revenue. Regis also owns Supercuts, Cost Cutters, SmartStyle, and MasterCuts, among others. That's what caught my interest: the Regis-concept stores, which are more expensive, have been suffering in a softer economy; but most of the other concepts I mentioned, which on average charge roughly half what Regis does, have held up well.

I passed because I couldn't get comfortable with the company's growth strategy. The salons have demonstrated a consistent ability to raise prices to pass on higher costs, but growth on a salon-level basis is not forthcoming: There are only so many haircuts you can do in a given space each day. Therefore, the company grows by building new stores and by acquiring new salon concepts, and I don't have the necessary faith that management is wildly good at that. When it comes down to valuation, a single poor acquisition can destroy a lot of value here quickly.

No. 2: Great Lakes Dredge & Dock
Almost 30% of U.S. ports are "constrained," which means that ships can't load up to their full capacity without hitting the bottom on the way in or out. This is a problem, and one that will only get worse when the Panama Canal expansion is completed in 2014, allowing larger (and thus deeper) Pacific Ocean ships to visit Eastern Seaboard ports, which currently aren't deep enough to handle them, for the first time. The bottom line is there is a lot of dredging to be done, and the largest chunk of that work should go to Great Lakes Dredge & Dock (NYSE: GLDD  ) .

This one came down to valuation for me. Dredging is a capital-intensive business, and even though Great Lakes Dredge & Dock is the undisputed alpha dog in the U.S. dredging market, the company's operations generate precious little free cash flow. In fact, over the past five years, the business is net free cash flow negative. This company remains on my radar, but until management demonstrates an ability to sustainably generate more cash, I'll be watching from the sidelines.

No. 3: Willis Lease Finance
Airlines loathe anything that keeps their planes out of the sky, and regular engine maintenance work -- which, besides being crucial to keeping planes flying smoothly, is thankfully also required by law -- is no different. That's why, instead of grounding a plane to work on the engine, airlines simply swap out the engine for another and keep the plane in motion. Rather than keep spare engines sitting around, many airlines choose to lease them, often from Willis Lease Finance (Nasdaq: WLFC  ) .

Founded by Charles Willis IV, who has worked in the airline industry for more than 45 years, Willis Lease Finance's business is simple: The company buys airplane engines and then leases them to airlines. Engines are expensive, so as you might expect, this company is highly levered. With a market cap of just $115 million, Willis carries more than $750 million in debt against just $3 million in cash.

The leverage itself didn't turn me off to the company, but something else did. The company leases three aircraft (not engines, but actual planes) to Island Air, a small airline that happens to be owned by Charles Willis. When Island Air hit a rough patch in 2006, it stopped making its lease payments and, five years later, still owes Willis nearly $3 million. Normally, I would expect Willis to repossess its engines if payments stop coming in, but Island Air still has those planes. These may be legitimate transactions, but since Mr. Willis owns both Island Air and 30% of Willis, another explanation might be that he is pulling levers that benefit insiders more than shareholders.

This article is part of our Rising Star portfolio series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios) here. 

Neither Fool contributor Alex Pape nor The Motley Fool owns shares of any company mentioned. Try any of our Foolish newsletter services free for 30 days. 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. 


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  • Report this Comment On July 06, 2011, at 7:12 PM, TMF42 wrote:

    Have you ever looked at GE?

  • Report this Comment On July 09, 2011, at 12:46 PM, supercuts wrote:

    Really Alex? "There are only so many haircuts you can do in a given space each day" This is an example of an analyst who has no clue what he is talking about..... Many of our salons are not even close to having all the chairs full and are actively trying to hire more stylist and even so with the existing staff can still do many more cuts per day.... As a franchisee my sales are up 8% over last year.....

  • Report this Comment On July 12, 2011, at 3:45 PM, TMFPapester wrote:

    Supercuts,

    Thanks for the comment. I'd love to ask you some follow-up questions on the business. If you are willing, please contact me at apape@fool.com.

    Thanks!

    Alex

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