Focusing on small- to mid-cap companies and stocks that trade in the single digits can offer more risk but also significantly more reward. These types of stocks tend to be more volatile, but investors who look for opportunities in this sector can use that to their advantage, if they buy cheap or just before a meaningful rebound. Investors who focus only on large-cap stocks like Exxon (XOM) run the risk of generating very average returns and might even get bored "watching the paint dry." A few months ago, I was bullish on Genworth (GNW) back when it was trading for about $5, and it has since doubled to trade over $10. This is just one example of how significant the gains can be when investing in these types of stocks.
As I research for cheap stocks that trade in the single digits, I also make note of takeover potential, if there appears to be any. While I never buy a stock solely for this, it can certainly be an added bonus. These stocks below all appear to be undervalued, and also could be attractive takeover targets. Here are the stocks that have strong upside and even takeover potential now:
Hawaiian Holdings, Inc. (HA) is the parent company for Hawaiian Airlines. This company has been offering flights to Hawaii for 81 years and it currently offers non-stop flights from 10 gateway cities in the United States. It also provides service to the Philippines, Australia, American Samoa, Tahiti and more than 150 daily jet flights between the Hawaiian Islands. However, this could be just the tip of the iceberg because the company has growth plans. It will soon be offering flights to Hawaii from Japan, Taiwan, and possibly even China.
This is significant because Japan has set forth monetary and economic policies that have ignited the Japanese stock market, which is up nearly 50%, in just the past few months. A boom in the Japanese stock market and economy could also create a renewed travel boom in Hawaii like the one seen in the 1980s when Japan seemed to be buying real estate all over the world and vacationing frequently in Hawaii. A lot of the money that is being made in the Japanese economy and stock market is likely to make its way into the Hawaiian economy and that will be very good for Hawaiian Airlines. It should see increased bookings for flights between the Hawaiian Islands plus it will benefit in the coming months from the new service routes between Japan, Taiwan, and China,
Hawaiian Airlines has a very good reputation and a record of on-time performance. It was ranked No. 1 nationally for the ninth consecutive year for on-time performance in 2012 and for the month of February 2013 by the U.S. Department of Transportation Air Travel Consumer Report. Consumer surveys by Conde Nast Traveler, Travel + Leisure and Zagat have all ranked Hawaiian the top domestic airline to Hawaii. This solid reputation and financial strength makes the company well-positioned to expand as it implements growth plans. It recently announced turboprop operations for service, which will begin in the summer of 2013 between Honolulu and Moloka'i and Lana'i. It also recently added one new Airbus A330-200 aircraft in February for North American and International service. It has a purchase agreement with Airbus for 16 new A321 aircraft for delivery between 2017 and 2020, with rights for an additional nine aircraft. Revenues and earnings for the company should see a significant increase in 2013-2014 as these new service routes come into play:
- Honolulu to Auckland, New Zealand three-times-weekly service launched in March 2013.
- Announced Honolulu to Sendai, Japan three-times-weekly service beginning in June 2013.
- Announced Honolulu to Taipei, Taiwan three-times-weekly service beginning in July 2013.
- Announced the addition of seasonal frequency flights between Honolulu and three Oceania gateways, Sydney, Brisbane and Auckland in September and October 2013.
- Announced three-times-weekly service between Honolulu and Beijing, China beginning in April 2014 pending government approval.
This stock looks significantly undervalued relative to its peers and the rest of the market. Let's look at a few metrics that show just how cheap this stock is and the upside potential it has. Analysts expect this company to earn 88 cents per share in 2013 on revenues of about $2.18 billion. That puts the current price-to-earnings ratio at just 7 times, while the market average is at 16 times for the S&P 500 Index (SPY). But it gets even better because with all the new service routes coming into play, analysts see revenues rising to $2.44 billion in 2014 and earnings surging by about 40% to $1.26 per share. That puts the PE ratio at just around 4.5 times 2014 estimates. The stock also looks cheap in terms of book value, which is nearly $5 per share. That means this stock is trading for just a slight premium to book value while the average stock in the S&P 500 Index is currently trading for over two times book.
The company has a strong balance sheet with about $438 million in cash and around $649.6 million in debt. This financial strength reduces risks for investors. The main downside risk for this stock seems to be another economic recession as that would curtail travel budgets, however, with signs that the U.S. housing market is coming back strong and with rising stock markets creating a huge "wealth effect" in key markets like the U.S. and Japan, this risk seems very limited at this time. Fuel prices could also be a downside risk, however, the U.S. currently has an abundant oil inventory and production is expected to grow in the coming years. This could push oil prices even lower and boost margins for all airlines.
The balance sheet strength, low price to earnings ratio, solid reputation, and growth plans this company has announced make this stock simply too cheap to ignore considering the upside potential. Plus, this niche airline has attractive routes and gates that could make it an attractive takeover target for a major airline as the sector continues to see consolidation and increased profitability.
Imperial Capital has an outperform rating and a $8 price target on this stock. However, analysts at UBS AG recently raised their price target on shares of Hawaiian Holdings from $10.00 to $11.00 and have a buy rating on the stock. That implies a possible double in the share price from current levels.
Nokia (NOK) was once the king of the mobile phone world, but thanks to rapid changes in technology and consumer preferences, it seems that no company stays on top of this industry for too many years. However, if any company has a chance at climbing back into relevancy, it could be Nokia. This seems possible for a number of reasons, which include a strong balance sheet, a valuable patent portfolio, continued innovation, new products, and a focus on emerging market consumers. Let's take a closer look at these factors below:
Nokia has a very strong balance sheet with about $13.5 billion in cash and around $7.28 billion in debt. The current market capitalization is about $14 billion, but the enterprise value is only around $7.62 billion due to the cash position. This valuation appears way too low for a company with roughly $37 billion in annual revenues and also when you consider that this company has many very valuable patents, which are generating significant revenues.
In a recent Seeking Alpha article, Jacob Steinberg makes a solid case for the value that could be applied to Nokia's patent portfolio. Over the years, this company has invested tens of billions into research and development and many companies use the patents and pay licensing fees to Nokia. Mr. Steinberg's article details why the patents could be worth $8 to $15 billion which is significantly more than the enterprise value of $7.62 billion discussed above, the article states:
Nokia is expected generate between $800 million and $1.5 billion in patent license fees and royalty payments annually. Considering how IDC estimates that the smartphone industry is expected to double in size between now and 2017, this number can grow considerably. If we assign a P/E ratio of 10 to Nokia's patent portfolio, the patents under the mobile devices segment alone will be worth between $8 billion and $15 billion.
In terms of continued innovation and new products, Nokia has both: It recently launched its top-of-the-line Lumia 925 smartphone which is based on Windows 8, and it features a slim design, a number of popular apps like Facebook (FB) and Twitter as well as an 8.7 megapixel camera. It also announced plans to release the "Asha 501" phone into over 90 countries for just $99, (without a contract) starting in June 2013. This phone is likely to do well in emerging market countries due to the affordable price point and the solid reputation that Nokia still has around the world. It makes sense for Nokia to focus on the growth potential that emerging market consumers and countries offer. As an article by "Uncommon Sense" points out, Nokia is planning to "connect the next billion" (smart phone users) and it has one of the most recognized global brands. Most emerging market consumers cannot afford a $500 iPhone, and that leaves a significant market opportunity for Nokia.
In the past, some analysts and investors have suggested that Nokia could be a takeover target due to its low valuation, patents and brand name. Since it has a significant long-time partnership, some believe that Microsoft (MSFT) could be a potential suitor. Microsoft has a massive cash horde of about $74 billion which gives it the ability to buy Nokia a few times over and still have money left over. Microsoft already owns Skype so it is in the communications business and it could expand in that area. In fact, Microsoft might need Nokia more than Nokia needs it. Microsoft might need to make a bold move if it wants to remain relevant in the smartphone space. Without Nokia, who will adopt Windows in the future?
As with any tech stock, there are plenty of downside risks, including obsolescence, which some investors already seem to believe in. While it is easy to point out numerous tech companies that became irrelevant over time, it is also easy to point out others such as Apple (AAPL) that became seemingly irrelevant, and ended up as a single-digit stock just before returning to the top spot. For a time, Apple was the world's most valuable company in terms of market capitalization. Nokia does not need to reclaim the top spot or invent the next iPhone for it to provide investors with major gains and that is why it makes sense to consider the stock while it is still cheap at below $4 per share. Earlier this year, analysts at Argus upgraded Nokia from hold to buy and set a $6 price target. That would give investors gains of over 50% from current levels, but if Nokia does pull off a real turnaround, even $6 might be too conservative.
Zynga, Inc. (ZNGA) has been on a roller coaster ride ever since it went public at $10 per share. At first, the stock traded well above that level, but as other stocks in the social networking sector like Facebook declined, so did Zynga. The shares were trading in the $2 range not that long ago and now trade in the $3 range, but this is still just about half of the 52-week high of $7.34 and just around a third of the IPO valuation. This volatility and pattern of extreme highs and lows tells me that Wall Street really doesn't know how to value this company, and the stock could still be too cheap based on fundamentals and valuations of other recent deals in the social networking and gaming space.
In terms of fundamentals, the stock appears cheap when considering the strength of the balance sheet. It has about $1.27 billion in cash and just around $100 million in debt. The enterprise value is roughly $1.5 billion which seems low when considering that it has annual revenues of around $1.2 billion. Zynga's cash horde reduces risk for investors and it also gives it the financial flexibility to develop new games, to buy back shares, or acquire promising new companies or game titles, and it appears to be doing nearly all of these now. The cash balance and low valuation could also make Zynga an attractive takeover target.
If you never watched the HBO series called "Game of Thrones" you should try it, but be prepared to get completely hooked on it. It appears to be getting more and more popular and that could be great news for Zynga since it recently agreed to publish this game to its 250 million monthly active users. A company called "Disruptor Beam" designed the game and it was launched on February 21, on Facebook. It recently had more than 500,000 users but with Zynga involved it could expand significantly in the coming months. The game allows you to live in the world of "Game of Thrones" and pick your character, develop your assets, make alliances and even get married to other players.
Zynga also continues to make progress on real money gaming and it has a couple of websites in the United Kingdom, "Zynga Plus Poker" and "Zynga Plus Casino." Not long ago, Zynga applied for a gaming license in Nevada. As many states look for increased tax revenues, more are opening up to the idea of legalized gambling and this could open up huge market opportunities for Zynga in the future. The potential for gambling revenues could make Zynga an attractive takeover target according to some industry watchers.
There has been speculation that an online tech company like Yahoo (YHOO) could be a buyer, however, that seems less likely since Yahoo just announced it would buy "Tumblr" for about $1.1 billion. The Tumbler deal makes Zynga look like an absolute steal when you consider that Tumbler reportedly had a mere $13 million in revenues for 2012 and hopes to have about $100 million in revenues for 2013. That is nowhere near what Zynga brings in today. Others believe that Las Vegas Sands (LVS) MGM Resorts International (MGM) or Wynn Resorts (WYNN) could be interested in Zynga due to the potential for real money gaming.
The downside risks seem limited at this point for Zynga shares because it has a very strong balance sheet and also because analysts expect the company to generate near break-even results for the next year or so. That leaves a couple of non-financial risks to consider which include the possibility of more high-level executive departures and management execution issues. Another risk appears to be investor psychology because if it turns overly bearish as it did not long ago, this company could be considered as a "has been" rather than as one with growth potential. However, with new websites for real money gaming and the potential of popular new titles like "Game of Thrones," it looks like Zynga is getting back on track when it comes to investor sentiment.
Data sourced from Yahoo Finance. No guarantees or representations are made. Please consult a financial advisor before making investments.
Additional disclosure: I may buy NOK and ZNGA shares soon.