Over the past few months, I have made several successful calls and have earned an 80%+ return on my simulated portfolio; not to mention, my real life portfolio. Back in March, I began buying into quality REITs that could be had for bargain-basement prices. I have continued to research more companies in the REIT sector, most recently writing about DCT Industrial Trust (DCT) in late July. I recommended buying into Discover Financial Service (DFS) under $7 in late April; it now trades near the $14 mark. I even argued that microcap boat and yacht dealer MarineMax (HZO) could be a great buy under $3.50. HZO now trades over $7.50.
Given the market’s run-up, however, my views have shifted a bit. Once we tipped over Dow 9000, I felt as if we were entering a “change of seasons” and that it was time to start shifting my portfolios a bit. Marine Max might’ve been attractive at $3.50 and Discover might’ve looked good at $7, but at the current prices, I believe risk exceeds reward potential, so they are not great buys any more. The market changes quickly and you have to stay ahead.
With the Dow over 9500, it’s not quite as easy to spot deals as it was back in early ’09. There was a time when three-quarters of the market looked undervalued, but that day has passed. The good news is, there are still some great buys out there for prudent investors. You just have to search a bit more than you did back in March.
1. Ensco International (ESV), under $40
Ensco is an international offshore drilling services company catering to the oil and gas industries. The things that make Ensco particularly enticing are their low debt, great history of profitability, and position in an industry with strong growth potential. You’d think with that profile, the stock would be selling at a sizable premium, but that’s simply not the case.
Net tangible assets are around $33 per share and the stock has been selling in the $35 - $40 range. Now, consider their earnings: $8.11, $6.73, and $5.04 per share for FY ’08, ’07, and ’06 respectively. Based on FY ’08 earnings, the stock could be worth $120+. Given the precipitous drop, you’d think earnings had dived off a cliff, except, they really haven’t. Sure, they’ve been affected by the downturn and drop in oil prices like everyone else in the industry, but they still managed to scrape out earnings of $1.41 per share for Q2 for FY ’09, and $2.97 per share for the first half of ’09.
It's not as if cash flows have been poor either. Operating cash flows have been very impressive, normally exceeding earnings. Free cash flows [FCF] are not quite as plentiful since Ensco continues to expand its operations, but to their credit, ESV has managed to stay FCF-positive throughout most of the past five years.
Maybe the market is still somewhat sour on oil services, but given the high dependence on oil in the US, and increasing dependence in China and India, I still believe offshore oil related services are a winner in the long-term. Ensco looks like a great bargain to me under $40.
2. Lexington Realty Trust (LXP), under $5
Many of the REITs that I have recommended or bought have jumped 30% - 100% over the past few months. Lexington has outperformed the market since I first wrote about them, as well, but not by as much as I would have expected. LXP still looks significantly undervalued to me. After the run-ups on Brandywine (BDN) and Penn REIT (PEI), I’d rate LXP as my number one buy in the sector.
There’s a lot I like about Lexington right now. Lexington’s leverage is moderate for a REIT with a 63% Liability/Value ratio. Their properties tend to be in mid-sized markets, where property values haven’t become as out-of-whack as they have in some of the large-city markets like NYC, DC, LA, and the SF Bay Area/Silicon Valley. Funds from Operations (FFOs) have remained positive, ignoring one-time write-downs. Cash Flows from Operations are also very impressive. All the while, Lexington continues to use their cash to pay down debt (at huge discounts to face value), while selling off some of their properties.
The only frightening thing about Lexington right now is that they are issuing most of their dividend in stock. I’d like to see that practice come to an end, but it’s not enough to scare me away. I’d wager to guess this stock dividend is helping to keep the stock price suppressed. All the same, I believe the LXP is worth at least $12 and maybe even more like $15 - $20. The dilution factor makes it difficult to nail down an absolute price, but once that stops, I believe the price for this stock will start moving back upwards.
3. DCT Industrial Trust (DCT), under $6
My views on DCT have not changed significantly since I did my write-up in late July. Even if we assume their properties are overvalued on the balance sheet and write them down 10%, we still end up with net tangible assets around $4.30. That might be dramatically on the pessimistic side, too. Given the cash flow stream, I believe this is worth at least $8, and probably more in the $10 - $12 range. Potentially, it could even be worth $15+. If you want to read more, see my in-depth analysis.
4. StarBulk Carriers (SBLK), under $4
5. Danaos Corporation (DAC), under $4
6. Paragon Shipping (PRGN), under $4.50
Certainly, there are a lot of issues with dry bulk shippers and it’s a particularly frightening sector. All the same, I think it might be a good idea to do a sector buy and gobble up a few companies. If one or two of them strike out, you can still come out ahead in the end due to the high gains from the winners. These three companies (SBLK, DAC, and PRGN) all have some particular strengths and weaknesses:
StarBulk (SBLK) is not as heavily levered as most of the companies in the industry and is selling well below net asset values [NAV]. However, their operating history is fairly short so they are more difficult to judge than some of the other players in the sector.
Danaos (DAC), unfortunately, is heavily levered, which is the main reason why the stock has been punished so heavily. However they have very strong cash flows. I’d consider DAC a very high-risk stock, but potentially, it could come with some spectacular rewards.
Paragon (PRGN) seems to be the middle ground. They are not as heavily levered as DAC, but more levered than SBLK. They have also had strong historical performance.
There are a large number of other intriguing buys in the sector, as well. Overall, I believe the sector is significantly undervalued, but it’s completely possible that we see a shake-up in the next few years with a number of bankruptcies, so beware of the risks. None of these companies are completely “safe”, but that’s why the rewards could be handsome in the future.
I have mixed opinions on the refiners right now. Almost all of them are selling well below net tangible assets. From a valuation standpoint, most of the refining stocks look very attractive to me. However, there are reasons to believe this entire industry is in contraction. Even more frightening to me is the prospect that Washington, in its effort to pretend it’s tackling environmental issues, seems to have a strategy of targeting “big oil”. Case in point, the Wall Street Journal reports that new legislation could have a disastrous effect on the US refining industry. Believe it or not, I’d consider myself an environmentalist who is highly concerned about energy independence, but this proposal is wrong-headed in every way. It doesn’t solve any of our problems; it merely puts our refiners at a competitive disadvantage while increasing our dependence on foreign oil.
But I digress … my bigger point here is that the refiners look undervalued, but we have Washington looming in the background making them a potentially dangerous buy. Still, I’d keep an eye on them and an oil refiner basket play could work well. Sunoco (SUN), Valero (VLO), Western Refining (WNR), and Tesoro (TSO) are a few of the companies I’ve looked into. All have their risks, but it would appear that the sector as a whole might be undervalued. I just wouldn’t be the bank on it right now due to the risks from Washington. A refiner basket as a 5% - 10% holding in one’s portfolio might still be wise, though.
8. Pennsylvania REIT (PEI), under $7
As you might be able to tell, I still believe the REIT sector, as a whole, is significantly undervalued. There is a lot of garbage in the sector, of course, but if you can find companies with strong assets, low to moderate leverage, and reasonably good FFOs and cash flows at historically cheap prices, I still believe it’s a good idea to gobble them up. Pennsylvania REIT has had a bit of a run-up since my original write-up, but it still looks cheap to me.
While P-REIT has a bit more leverage than I like to see, it’s still a strong company selling well below NAV. Even with further drops in real estate prices, I believe the stock is significantly undervalued and could be worth closer to $30 than the $7 price it’s selling at. Under $8, I believe it’s still a great value. See my article for a more in-depth look at PREIT.
9. Tsakos Energy Navigation (TNP), under $18
10. Nordic American Tankers (NAT), under $32
Like the drybulk shippers, tankers can be scary, as well. Most of them are heavily levered and it’s a volatile industry. Tsakos (TNP) has a great deal of leverage like many of its peers, but it has a strong operating history and it’s selling at a sizable discount to net tangible assets, worth about $24 per share. For a closer analysis, see my pitch at Motley Fool
Nordic American (NAT) is a bit different than Tsakos. NAT still sells above net tangible assets of $22 per share, which creates some risk. On the other hand, it has virtually no debt and has had a consistently good operating history. I don’t think you’re going to blow the world away buying this stock, but it seems like it’s in a win-win situation. If conditions improve, their earnings and cash flows should go back up, which means it will be worth more. If conditions deteriorate, some of their competitors might get wiped out, meaning they can gobble up more market share. I believe it’s probably worth closer to $40 - $45 and it has some good upside potential even despite the lack of leverage. See my pitch at Motley Fool to read more.
11. Constellation Energy Partners (CEP), under $3
This company recently came across my radar. I still need to research it a bit more before I move it up the list, but it looks very promising to me. Even after a $225 million writedown of their PP&E, I still come up with net tangible assets of over $13 per share. Earnings fluctuate wildly, as seems to be typical in the oil & gas industries, but cash flows have actually looked pretty good. They have hedged their bets like crazy, which has helped them through the current crisis.
Of course, there's something wrong or it wouldn't be selling below $3. They recently eliminated their quarterly distribution, which tends to be one of those things people overreact to. Their leverage isn’t too terrible, so even if they went bankrupt, I think there’s a strong possibility it would be worth more than the current price. If CEP survives this crisis, it could potentially go back up to above $15 - $20. This is definitely a high risk/high reward play. Sure, there’s a chance I could lose 100% on it, but there’s a reasonable chance I could gain 1000% on it. If you like going for broke, this might be a company to look into.
12. Ruddick Corporation (RDK), under $26
On the completely opposite end of the risk spectrum from CEP lies Ruddick Corporation (RDK); the parent company of regional up-scale grocer Harris Teeter. Trading at a slight premium to book value, with strong cash flows. I come up with an intrinsic value closer to $40 - $45.
Disclosure: Author is long ESV, FUR, DCT, LXP, and PEI. Author is considering going long on CEP, SBLK, DAC, and PRGN in the near future.