5 Undervalued Picks By A Top Ranked, Outperforming Large-Cap Value Dividend Fund

Includes: GCI, GME, KRO, NOC, WU
by: Dividendinvestr

By Serkan Unal

Based on the ratings of leading fund industry researchers, SunAmerica Focused Dividend Strategy Portfolio, a multiclass income-focused mutual fund, is ranked fifth out of 329 large-cap value funds tracked by the U.S. News & World Report's "Best Mutual Funds." This actively-managed fund consists of 30 holdings from among the traditional Dogs of the Dow, including 10 highest-yielding DJIA stocks, and top 20 ranking stocks from the Russell 1000 (excluding Financials and Utilities) based on valuation, profitability, and dividend yield. The fund has been a notable outperformer, with its trailing 10-year returns in the top 2% of Morningstar's large-cap value category, according to U.S. News. The fund's 3-year alpha, relative to the S&P 500 index, is high at 3.94%.

Following a contrarian approach, the fund invests in the stocks of fundamentally-strong and undervalued companies, with a "potential for superior relative performance." Stock selection is based on a quantitative, rules-based value strategy that focuses on "overlooked" stocks of companies with solid financial strength and low P/Es. Given the fund's strategy, the fund's following five stocks represent a good combination of income and appreciation potential so as to produce solid total returns.

Kronos Worldwide, Inc. (NYSE:KRO) is the fund's top holding. The company supplies titanium dioxide (TiO2). It has a dividend yield of 3.3% and a payout ratio of 53% of the current-year EPS estimate. Kronos Worldwide's dividend has been unchanged at 15 cents per share since June 2011. The firm has seen a robust insider buying activity from two corporate insiders (its Chairman of the Board and a director). The two purchased in total some 140,000 shares since November 2012. Ninety six percent of that number of shares was purchased over the past two months. Last month, we wrote about the noted insider buying activity in Kronos Worldwide. As regards the company's outlook, while the TiO2 market remains weak, its outlook will improve with the rebound in the overall economic growth. Some indicators already reflecting better market conditions for TiO2 include the company's recent increases in TiO2 prices across the various regional markets. KRO is great value, trading at 1.8 times book value, well below the industry's price-to-book of 3.3 and the company's own five-year average ratio of 2.3. KRO's forward P/E of 17.7x is on par with the specialty chemicals industry's forward earnings multiple. Last quarter, Joel Greenblatt reduced his small KRO stake by 44%.

GameStop Corp. (NYSE:GME), a video games retailer, is another undervalued, high-yielding holding in the fund's portfolio. The company has a dividend yield of 4.4% and a payout ratio of 35% of the current-year EPS estimate. GME started paying its quarterly dividend a year ago, and since has raised its payout twice, with a cumulative increase of 83.3%. The company is mired in an industry-wide sales slump, with the industry sales down 9.0% in 2012, according to NPD Group, and GameStop Corp.'s same-store sales estimated to have fallen between 7.5% and 9.0%. In December 2012, physical video game sales plummeted 22.0% year-over-year. According to NPD Group, the pace of the declines is moderating, as January 2013 sales are down 19% year-over-year, once the irregular five-week reporting period for January 2013 is translated into a typical four-week period. The shift toward digital content is pronounced, with digital video game sales booming. GameStop Corp. hopes that new product launches in 2013 will help lift the video game sales. Analysts see the company's long-term EPS CAGR at a robust 12.0%. With some $488 million remaining under the company's $500 million share repurchase authorization, share buybacks will help buttress the EPS growth. However, some see this support as masking the general weakness in the underlying EPS expansion. In fact, the market looks pessimistic about the company's outlook, as 33% of GME's float is held short. The stock has a price-to-book of 1.4 versus its industry's 4.9. GME's forward P/E is merely 7.4x, but some are concerned the stock could be a value trap. Last quarter, Chuck Royce trimmed his GME stake, while Phill Gross (Adage Capital) doubled his GME holding.

The Western Union Co. (NYSE:WU), a money-transfer company, has a dividend yield of 3.5%, payout ratio of 35%, and five-year annualized dividend growth of nearly 77.0%. The company recently reported its fourth-quarter and full-year 2012 results, beating analysts' estimates on both top and bottom lines. However, based on a forecast of a "low single digit" revenue decline, WU sees 2013 EPS at between $1.33 and $1.43, below the analyst-expected EPS of $1.48. The company is likely to see a faster transaction growth in its core and electronic channel money transfers. In the next couple of years, WU's revenues are likely to recover and margins are expected to expand. The company plans to spend $700 million in dividends and share buybacks in 2013, which represents a 70% combined payout ratio, compared to 83% in 2012. The stock has a high price-to-book ratio of 7.2 versus 1.7 for its peer group. However, that ratio has been declining since 2009. As regards its forward P/E, WU is trading at only 9.8x, compared to the consumer finance industry's multiple of 16.5x. Last quarter, the stock was popular with hedge fund manager John Shapiro (Chieftain Capital).

Gannett Co. Inc. (NYSE:GCI), a publisher of some 82 U.S. newspapers including USA TODAY, has a dividend yield of 4.0% and a payout ratio of 36% of the current-year consensus EPS estimate. The company's quarterly dividend was slashed in 2009, but since has recovered fivefold to 20 cents per share. One of Warren Buffett's holdings, Gannett Co. has had several positive factors working for it, including return to revenue growth-last quarter, the company posted the first revenue jump since 2006-positive newspaper circulation revenue growth, strong TV revenues (with strong political advertising boosting TV revenue growth by 46% last quarter), and robust growth in sales of its digital content. However, revenues and earnings in the coming quarters are likely to be hurt by the absence of political advertising and Olympics, with the overall TV revenues forecast to rise between 10% and 12% in the current quarter. The company plans to boost its digital subscriptions for local newspapers radically-from 46,000 digital-only subscribers in 2012 to between 250,000 and 300,000 by the end of 2013. The stock is a great value play, with a price-to-book of 1.9 versus 2.7 for its industry on average. GCI's forward P/E of 9.2x is a nearly-50% discount to rivals The New York Times (NYSE:NYT) and The Washington Post Co. (WPO). Last quarter, John Rogers (Ariel Investments) trimmed his position in GCI by 15% to $159 million, while Cliff Asness (AQR Capital) hiked his stake by 30% to almost $33 million.

Northrop Grumman Corp. (NYSE:NOC), the world's third largest defense contractor, has a dividend yield of 3.4%, payout ratio of 31% of the current-year EPS estimate, and five-year annualized dividend growth of 5.0%. The company is one of the fund's three defense sector holdings, also including Lockheed Martin Corporation (NYSE:LMT) and Raytheon Co. (NYSE:RTN). With the defense budget cuts, the company is expected to see its EPS CAGR at about 1% for the next five years. However, analysts have been revising upward their 2013 and 2014 EPS estimates. Over the past three months, the full-year 2013 estimate was upped by 1.0% and the 2014 estimate was increased by about 2.0%. The company recently gave estimates-beating earnings guidance for 2013. Northrop Grumman now sees a full-year profit from continuing operations of between $6.85 and $7.15 per share, on revenues of about $24 billion. That compares with analysts' profit estimate of $6.97 per share, on revenues of $24.4 billion. These estimates are based on an assumption that the sequestration will not take place. The stock also represents good value, based on a price-to-book of 1.6 versus its industry's 3.1. NOC's forward P/E of 9.3x is below the defense industry's multiple of 10.4x. First Eagle Investment Management (see its top picks) held almost $424 million in NOC at the end of last quarter.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: Dividendinvestr is a team of analysts. This article was written by Serkan Unal, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.