Investors should pay careful attention to undervalued stocks during earnings season because earnings releases can provide some of the best catalysts opportunities for an investor because of the structured forum for the management to discuss important issues. Last week we had grocer SUPERVALU in our article, 7 Cheap Companies Report Earnings Next Week. We wrote, "the company is worth a closer investigation. Based on the current distress, the company could be leveraged for upside on any better than expected news." Following their better than expected earnings, the company jumped 17%.
Here are some cheap companies with earnings next week that investors should watch:
CAPITAL ONE FINANCIAL (COF)
Forward P/E: 9.15
ROA (ttm): 1.66%
The company appears to be a hidden gem. Net interest income jumped 62% from the previous 2009 highs. Total revenue increased 11% from the previous highs in 2007. These increases are partly the result of increases in returns on assets and partly the result of increased loans held for investment.
Return on assets in 2010 was 1.52%. While this is a solid return, from 2003 to 2007, the return on assets ranged from 1.79% to 3.05%. While the company may have a hard time returning to the high end of that range as consumer retrench and delever their personal balance sheets, a return to 1.79% in 2010 would have translated into a trailing P/E of 6.39 instead of the current 8.33. Capital One seems like a cheap stock that is worth additional investor attention. While growth opportunities should remain strong amid the secular trend toward electronic payments, margins may face pressure from regulatory changes. We find this stock very interesting.
GENERAL ELECTRIC (GE)
Forward P/E: 12.37
ROA (ttm): 1.28%
The Connecticut-based conglomerate has famously had high visibility operations in various segments, including: Energy Infrastructure, Technology Infrastructure, NBC Universal, GE Capital and Home & Business Solutions. Energy and Technology Infrastructure each contributed 25% to GE's revenues, while GE Capital represented 31%, NBC Universal contributed 11% and Home & Business had 6% of total sales.
GE's revenues have not recovered to 2008 peak levels mainly because of GE Capital's roughly 40% decline in revenues from 2007 and 2008 levels.
Going forward, GE offers a good, but not necessarily great investment opportunity for passive minority investors. In the near term, the company offer significant upside through a corporate breakup. With disparate units with few synergies and a fairly low price/sales ratio, this company could become a shareholder activist target. Longer term, the company can growth through international expansion. In 2010, US revenues still represented 70.5% of total sales. While this is an improvement from 2008 levels of 85%, this is still surprisingly below average geographic reach for a company of GE's size and scale.
HONEYWELL INTERNATIONAL (HON)
Forward P/E: 13.10
PEG Ratio: 1.01
ROA (ttm): 5.31%
The conglomerate reports financials according to four segments: Aerospace, Automation and Control Solutions, Specialty Materials and Transportation Systems. Honeywell generated $33.37 billion sales during 2010. Aerospace generated $10.68 million, automation and controls generated $13.749 billion, Specialty Materials contributed $4.73 billion and Transportation Systems contributed $4.21 billion.
The company has suffered along with many other US government defense suppliers, but Honeywell is not a pure play defense name. Honeywell actually has a modest exposure to government spending. In 2010, US government spending amounted to 13% of total sales, of which, 10% were attributed to US Department of Defense. Management states in the recent 10-K:
we do not expect to be significantly affected by any proposed changes in 2011 federal spending due principally to the varied mix of the government programs which impact us (OEM production, engineering development programs, aftermarket spares and repairs and overhaul programs).
The company has not historically been a high ROA company, but they offer an important niche and upside potential if activist shareholders push for a breakup of the company. In the meantime, valuations for passive minority investors are reasonable. We view this stock as a reasonably priced stock with upside.
INTERACTIVE BROKERS GROUP (IBKR)
Forward P/E: 14.14
ROA (ttm): 1.02%
Interactive Brokers operate as a global electronic market making and brokerage firm. The company prides itself on technological supremacy. The problem for this company is very straightforward. Their Timber Hill unit was once a dominant force in the market making business but as spread and opportunities have dried up, their revenues have fallen from $1.34 billion in 2008 to $379 million in 2010. In addition, pre-tax profit margins in the market making division have fallen from 76% to 24% in that same time.
The electronic brokerage unit provides stability for the company. Revenues from brokerage have increased from $505 million in 2008 to $547 million in 2010. In addition, pre-tax profit margins in the brokerage operations increased from 44% to 50%.
Investors should be careful of this stock. Not only is it a distressed company it is also majority-controlled by founder Thomas Peterffy. Still, this company is an intriguing stock that is worth a much closer look. Even if we assume that the company's Timber Hill revenues go to zero, the brokerage business still generated $547 million of sales in 2010. With a market capitalization of $675 million, this represents a conservative price/sales of 1.23 compared to TD Ameritrade's (AMTD) price/sales of 4.88, E*Trade's (ETFC) price/sales of 3.06 and Charles Schwab's (SCHW) price/sales of 5.16.
UNITEDHEALTH GROUP (UNH)
Forward P/E: 10.71
ROA (ttm): 8.23%
Health maintenance organizations (HMOs) like UnitedHealth Group have faced some headwinds because of regulatory healthcare reforms. But because of valuation and growth opportunities, UnitedHealth Group and its peers may turn out to be interesting stocks. One of the most attractive growth drivers lost in the industry tax and profitability caps of healthcare reform is the fact that in 2014, mandated healthcare coverage will drive new memberships and that UnitedHealth Group and its peers will have significant scale to not only grow revenues but also cut costs.
Glenview Capital Management is bullish of this industry. In their shareholder letter, they wrote:
Using an average earnings growth of 15% over the period and a restoration of 12-13x P/E multiples by 2014, we expect the group [HMOs] to generate compound investment returns of approximately 33% annually over the coming three years.
The HMO group appears statistically cheap and as such it is worth further investigation, but with further regulatory headlines down the road, it may be wise for investors to wait for stock weakness.
NEWMONT MINING CORP (NEM)
Forward P/E: 12.61
ROA (ttm): 10.88%
The gold and copper explorer and producer has mines in the US, Australia, Peru, Indonesia, Africa, Canada, New Zealand and Mexico. Management's philosophy is to provide shareholders with leverage to changes in gold and copper prices, and as such, they do not hedge gold and copper sales, though they do hedge input costs, interest rates and foreign currencies.
By the end of 2010, Newmont had 93.5 million ounces of proven and probable gold reserves and 9.42 billion pounds of proven and probable copper reserves. 33.5 million ounces of the gold reserves are located in North America, 11.4 million ounces are located in South America, 31.4 million ounces are located in Asia/Pacific and 17.2 million ounces are located in Africa.
In 2010, the company's average production cost was $617/oz of gold and $1.02/lb of copper. The company is a leveraged investment play in gold and copper. For investors who genuinely believe that gold and copper are great investments, they should take a very close look at Newmont Mining. For investors bearish on gold and copper prices, the stock should be considered more expensive than implied based on valuations.
VERIZON COMMUNICATIONS (VZ)
Forward P/E: 14.39
ROA (ttm): 5.19%
The wireless communications company has developed a reputation for having the best network in the country. With both the iPhone 4 and a pipeline of smart phones that operate on Verizon's 4G network, the company could be on pace for significant upside. The Verizon HTC ThunderBolt is the first 4G phone and it has demonstrated the network's blazing speed. Walt Mossberg said the following about the 4G network in his review of the ThunderBolt:
...the ThunderBolt delivered by far the fastest cellular data speeds I have ever experienced on a wireless phone. In my tests, it blew away not only common 3G phone speeds, but the 4G speeds offered by rival carriers. In fact, it was faster than many home land-line Internet connections.
Mossberg's assessment is not an outlier. These positive reviews validate the nearly $17 billion a year that Verizon has spent on capital expenditures to build out their 4G network. While the availability is still geographically limited, there is enough to warrant optimism for future growth and upside to go along with the company modest valuations.
In addition, the earnings report should also provide clues as to Apple's future growth. Anything short of stellar demand for the Verizon iPhone may signal slowing growth at the iconic retail electronics manufacturer and designer.
We view Verizon as an attractive company. Not only does it trade at reasonable valuations, it also benefits from Apple-related growth as well as from direct exposure to the strong secular growth trends in smartphone adoption. In the future, the company could gain significant upside once it transitions out of unlimited plan pricing.