Two Intriguing Small-Caps

 | Nov 01, 2013 | 1:00 PM EDT
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Regular readers of my column know that I believe the market is either fully valued or slightly overvalued at these levels. I am finding fewer bargains in equities than at any time over the last couple of years. I also believe it is going to be a stock picker's market for the foreseeable future.

I am looking increasingly at underfollowed small-capitalization stocks to find values that might have been overlooked by most analysts and investors. I am going to devote my Friday columns to highlighting these promising plays that lurk in the background. Here are two small-cap stocks I find intriguing at these levels.

FelCor Lodging Trust (FCH) is a real estate investment trust that invests in hotels, with a focus on the ownership of upper-upscale, full-service properties. The company operates approximately 18,000 rooms throughout the U.S. FelCor almost had a near-death experience during the financial crisis, but it is slowly turning its business around.

The company is more than halfway through a significant transformation. It is selling more than two-thirds of its hotels in non-primary markets as well as half of its airport hotels. This will leave it with it with a portfolio of premium hotels in primary urban markets, upscale resorts and high-traffic airport hotels.

It is investing the proceeds from these non-core sales in debt reduction, renovating existing portfolio assets and making selective acquisitions in core markets. Once this transformation is complete, the company's portfolio should have a higher overall revenue per room rate (RevPAR), improved operational efficiency, as well as lower overall interest costs.

FelCor has successfully restructured its balance sheet and just announced it is initiating a small dividend payout for the first time since the financial crisis. As the company continues executing its strategy and increases its cash flow, I would look for significant dividend increases over the next few years.

Earnings look like they will jump by more than half this year and the consensus is for a similar jump in 2014. Given recent results, FCH is too cheap at just under 12x forward earnings. The stock sells for less than $7 after trading north of $25 per share before the financial crisis. It is a good buy for patient value investors.

Swift Energy (SFY) is a small exploration-and-production company. It focuses on oil and natural gas reserves in Texas and Louisiana. Like FelCor, the company has seen better days. The stock currently sells at just under $14 per share after touching $35 in 2012. Swift, which historically gets the majority of its revenue from natural gas, has been hurt by low natural gas prices.

The company is making significant progress in growing the amount of overall production that comes from oil and liquids, however. Eighty percent of its capital budget is geared to growing this type of production from its Eagle Ford acreage. It grew oil-and-liquid production at better than a 30% compound annual growth rate for 2011 and 2012 and continues to make progress in this area.

The company has done a good job operating its wells more efficiently, and new well costs have dropped more than 10% per well this year. Swift just reported quarterly earnings that beat top- and bottom-line consensus. It was the fourth straight quarter the company easily beat bottom-line expectations.

Insiders seem to believe in the company's strategy as they have been frequent buyers of the stock throughout 2013. Enterprise value is roughly 5x operating cash flow and the stock sells for less than 60% of book value.

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