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2 Small-Cap Stocks With Big-Cap Potential

By Taylor Carmichael – May 5, 2020 at 9:30AM

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Here's why Park Hotels & Resorts and Virgin Galactic are strong buys right now.

The stock market crash in March created some intriguing opportunities for long-term investors. The COVID-19 health crisis (and the lockdown it necessitated) sent the stock for plenty of companies down to new 52-week lows. 

For instance, shares of space tourism company Virgin Galactic (SPCE -0.59%), dropped from a high around $42 in February all the way to $10 a share in mid-March. In another example, the investors in Park Hotels & Resorts (PK -1.40%) thought they were owners of a safe, boring investment that paid nice dividends, until this staid hotel stock dropped from a high of around $26 a share in January, all the way down to $4 a share in mid-March. 

If you bought either stock at these new lows, go ahead and cheer. Over the last six weeks or so, Virgin Galactic shares have jumped from $10 a share up to $16. Park Hotels has more than doubled, from $4 to almost $9 a share.

But this climb back up might be just the beginning for these two small-cap companies with big-cap potential. 

dollar folded into up arrow

Image source: Getty Images.

When will the hotel industry reopen?

Park Hotels & Resorts was spun off of Hilton Worldwide in 2017. It's a real estate investment trust, or REIT, which means that 90% of its taxable income has to be distributed to shareholders. In ordinary times, this is a relatively safe investment. You're buying shares in 60 upscale hotels around the world. It's not a high-flying growth stock -- most investors are buying it for the predictable dividend income.   

But COVID-19 has turned the hotel industry -- along with a bunch of other mature industries -- into speculative stocks. With many hotels either closed or operating at very reduced levels, there isn't much income being generated lately. In mid-March, the company announced it would likely suspend its dividend over this uncertainty and the need for operational cash. 

In January, when Park Hotels was trading at $26 a share, nobody expected the company's 60 hotels to be largely shut down because of a worldwide health scare. Of course, the same goes for restaurants, movie theaters, airlines, cruise ships, and many other consumer businesses. The sharp drop to $4 a share priced all of this macro bad news in. 

The quick rise off the bottom from $4 to $9 a share may be related to the market anticipating that states will soon allow businesses to re-open, perhaps as early as May. Right now this hotel stock, like many others, is kind of a barometer for our COVID-19 fears, and how optimistic investors are about a recovery.

Park Hotels & Resorts has $1.3 billion in cash. That's enough to carry the company through this short-term health crisis until the hotels are allowed to reopen again. Like many companies, Park has yanked its guidance for the year. But we don't need guidance to understand the future business will be a lot stronger than it is right now. While the company's revenue in 2020 will almost certainly be awful, what will 2021 be like? Obviously, when we are comparing open hotels to closed hotels, the comps should be fantastic.

The missing revenue of the here-and-now makes this mature and stable business seem like a fast-growing start-up company. (Certainly, it was trading like one last week.) The lockdown has crashed the business and the stock for now. But over the next year or two, as sales again return to historical norms, the stock price should zoom along with it.

How's the space race coming along?

Last year our family bought a few shares of Virgin Galactic with our "mad money." It was looked at as a high-risk investment on a classic rule-breaker with a huge potential upside. We bought before Morgan Stanley made its iconic forecast of an $800 billion space travel industry. We had rather fortunate timing for our purchase, as the stock ran up into the stratosphere in early 2020.

We bought in at $9 and change per share. In a few months the stock ran up to $42 a share. And then COVID-19 hit, yanking the stock back down to earth.

Perhaps surprisingly, however, Virgin Galactic is in a much stronger position than a lot of businesses that were closed down by this health scare. For one thing, Virgin Galactic has been declared an "essential business," so there is no mandate from the government that it halt operations. But an even stronger argument for buying this stock is that the company has 20 times more cash ($480 million) than debt ($24 million). 

Yes, the initial tourism-focused space flights will likely be delayed because of COVID-19, perhaps pushed into 2021. But the long-term opportunity for this aviation disruptor remains massive. And its moat is still impressive. This is rocket science, after all, and only two companies are serious competitors in space (Blue Origin and SpaceX, both private).

Space travel allows these companies to create far faster flight paths. It takes United Airlines and American Airlines 11 hours to fly people from Los Angeles to Tokyo. Virgin Galactic will do it in two.

My expectation is that airline stocks will bounce back over the next couple of years, for the same reasons the hotels will recover. Over the long term, however, I predict that Virgin Galactic will be a superior investment, as the company takes market share from existing airlines, while it simultaneously opens up completely new business opportunities in space travel.    

Taylor Carmichael owns shares of Virgin Galactic Holdings Inc. The Motley Fool owns shares of Virgin Galactic Holdings Inc. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Park Hotels & Resorts Inc. Stock Quote
Park Hotels & Resorts Inc.
$11.94 (-1.40%) $0.17
Virgin Galactic Holdings Inc Stock Quote
Virgin Galactic Holdings Inc
$5.08 (-0.59%) $0.03
Morgan Stanley Stock Quote
Morgan Stanley
$81.31 (-2.17%) $-1.80
United Airlines Holdings Stock Quote
United Airlines Holdings
$34.96 (-1.30%) $0.46
American Airlines Group Stock Quote
American Airlines Group
$12.73 (-1.09%) $0.14
Hilton Worldwide Holdings Stock Quote
Hilton Worldwide Holdings
$123.35 (-2.04%) $-2.57

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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