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I keep a stock watch list filled with hundreds of names which are evaluated in a broad fashion, with a strong bias toward free cash flow generation. Each stock is assessed a rough intrinsic value estimate and monitored weekly. If a stock's price falls near my estimated intrinsic value, it shows up on my radar as a candidate for further, more in-depth analysis. As of May 8th, 39 stocks closed near my fair value estimate, with the following 16 names priced at least 25% below my rough value estimate:

COMPANY Current Price 52 week range PE Estimated Intrinsic Value
CCA Industries Inc (CAW) $5.90 "4.35 - 6.14" N/A $9.00
Ducommun Inc (DCO) $19.39 "16.04 - 26.08" 11.4 $30.00
Dean Foods Co (DF) $10.97 "7.13 - 14.96" 22.6 $25.00
Energysolutions Inc (ES) $5.33 "4.35 - 7.53" N/A $13.00
Frontline Ltd (FRO) $20.91 "20.55 - 36.85" 10.1 $48.00
Frontier Communications Corp (FTR) $8.43 "6.96 - 9.84" 36.4 $17.00
Global Cash Access Holdings Inc (GCA) $3.21 "2.26 - 8.58" 12.4 $11.00
Horizon Lines Inc (HRZ) $1.75 "0.83 - 5.95" N/A $-
Icahn Enterprises LP (IEP) $39.57 "30.12 - 43.00" 16.4 $50.00
L 3 Communications Holdings Inc (LLL) $83.04 "66.11 - 91.00" 10.0 $140.00
New Frontier Media Inc (NOOF.O) $1.69 "1.35 - 2.18" N/A $-
Novatel Wireless Inc (NVTL.O) $5.46 "4.77 - 11.53" N/A $10.00
Regal Entertainment Group (RGC) $13.99 "11.59 - 16.77" 58.7 $20.00
RR Donnelley And Sons Co (RRD.O) $19.25 "14.87 - 20.53" 17.9 $30.00
Telefonica SA (TEF) $24.49 "17.7367 - 27.6067" 7.7 $35.00
Teamstaff $0.75 "0.36 - 0.92" N/A $3.00



Let's take a look at some of these stocks.

Telefonica (TEF) is a current Enlightened American portfolio holding. Based in Spain, Telefonica is one of the largest telecom companies in the world. Historically, the company's dominant position in the Spanish fixed-line and wireless market provided the bulk of its earnings. However, in recent years Telefonica's home market is becoming less vital and is no longer the largest geographical segment by revenue, as the company grows its European and Latin American divisions.

In many ways, TEF has become a stealth play on Latin America. The region is Telefonica's largest segment with the recent acquisition of Vivo in Brazil. While margins and average revenue per user (ARPU) are lower in those markets, the company's leading position there gives it a growth profile not found in other European telecoms like Deutsche Telecom (OTCPK:DTEGF) or France Telecom (FTE).

As with most major telecoms, Telefonica generates outstanding free cash flow (FCF) but must be discounted against the constant need for huge capital expenditures to expand and build out networks. I put TEF fair value at $35 per ADR, with low-to-moderate risk to that assessment. Despite being a stodgy major telecom, Telefonica has historically operated with higher amounts of debt due to an appetite for acquisitions. But management has a good track record of successfully digesting its buyouts, and I expect that to continue.

While its current share price significantly undervalues the stock, I initially opened my position around $18.50 and prefer to leg down-- not up-- into stocks. If shares were to drop below my entry price, I would look to add more.

Energy Solutions (ES) was a position I exited in December. The company is a full-suite nuclear energy services provider operating across commercial and government nuclear sites and offering services in nearly all aspects in the nuclear product life cycle, from managing producing plants to hauling and disposing of contaminated waste. The company conducts business primarily in the U.S. and U.K.

My initial run through the numbers suggested a fair value of $13, and after in-depth study, I put intrinsic value at $10 - $12. Originally, I was attracted to the company's decent, if erratic, FCF returns over the last 5 years as well as the barriers to entry inherent to the field of nuclear waste management. Energy Solutions’s crown jewel asset, its nuclear waste disposal site in Clive, UT, is the largest privately owned low-level radioactive waste (LLRW) disposal site in the country and underpins much of its business strategy as Clive allows ES to leverage its disposal operations to gain other business.

Furthermore, ValueAct Capital, a respected activist investing fund, owns a significant amount of shares and could act as a catalyst if share prices lagged for too long. At the time I bought shares, ES was yielding 2% so we were also being paid to wait.

While the leverage situation was a concern, I thought a complete deterioration of business to be unlikely, perhaps 10% probability at most. Unless ES was locked out of the credit markets for the next 3 years and unable to roll over debt, the biggest risk I saw was the stock price lingering for years with no immediate catalyst to trigger a rise. At $5-$6 per share, a 2% yield and an activist investor lurking, we were getting paid to take that risk.

I sold my position at break-even when the company incurred more debt and discontinued its dividend. Since then, the Japanese earthquake and nuclear disaster suggests a bleaker regulatory landscape for nuclear power going forward. While not a successful investment, my value philosophy allowed me to minimize losses (or in this case, break even) when I was wrong — that is the key to long-term capital growth.

Regency Entertainment Group (RGC) is the country's largest movie theater operator. The company's consistent FCF results, steady business which performed even in a recession, and its fat dividend, all convinced me the shares were worth $20.

The company's major risks are its high debt load and its dependency on external companies (movie studios) to drive its business. But RGC has pushed out all debt maturities to 2016 at the earliest, and the movie studios have basically financed the theaters' conversion to digital cinema from 35MM at a cost of over $600M, which suggests studios are committed to maintaining theatrical revenues. After all, blockbuster status is still derived by big opening-day box office numbers which are followed like sports scores and it is difficult to see digital downloads either replacing those numbers or replicating the theater experience.

All in all, I am confident that Regency's cash flow is sufficient to manage its debt and figured the company had little downside risk around $12 per share, especially with a 6% dividend.

Earlier this year, I sold in-the-money $12.5 naked puts on RGC, hoping to back my way into a position below $12 a share. The stock moved up beyond the strike price at the time of expiration so I had to settle for an 8.4% gain (based on the stock's trading price at the time I sold the options).

Excluding past or current portfolio picks, the most intriguing name is Ducommun (DCO), an aerospace concern which "designs, engineers and manufactures aerostructure and electromechanical components and subassemblies, and provides engineering, technical and program management services principally for the aerospace industry." DCO dropped 15% after a bad earnings report last week, following on an announced bid to buy LaBarge (LB-OLD) for $340M cash, largely to be financed by debt.

I first evaluated DCO at a fair value of $30 per share (current share price around $19). The company exhibited consistently strong free cash flow, averaging $21M over more than 5 years. Ducommun's balance sheet was rock-solid with debt at just 0.7x EBITDA. Add in a decent 1% yield at a sustainable 23% payout ratio, and it was clear DCO was a definitely a candidate for investment at the right price.

The LaBarge transaction scrambles this picture. Will Ducommun be able to successfully integrate this acquisition? If management can bring the combined company's FCF up to its current 6% rate as a percentage of assets, the new Ducommun would generate $33M FCF on combined assets of $550M. Because the transaction is an all-cash affair, DCO's share count would remain near current levels, thus theoretically boosting fair value to $42 per share. But the strategy comes with risk which is most clearly evident in the company's altered financial profile. After the buyout, Ducommun will sport debt levels near 5x EBITDA, assuming a doubling of EBITDA once the deal closes. A once conservative stock prospect turns more speculative as debt reaches those levels, and to underscore the heightened financial risk, Ducommun suspended its dividend last week.

Other interesting names include Novatel (NVTL) which has dropped in light of analyst concerns that new sophisticated smartphone and tablet devices may erode the market for Novatel's MiFi technology. Dean Foods' (DF) share price has lagged as the company struggles to pass high input costs along to consumers.

With these watch list stocks, it is important to remember the broad nature of this analysis, based solely on examining financial results over the last 5 years or so -- a quantitative approach, so to speak. Further, in-depth research is needed to truly assess a stock's investment potential, especially in the case of Ducommun and its buyout of LaBarge.

Readers can also see all 39 watch list stocks in a viewer-friendly spreadsheet format.



Disclosure: I am long TEF.

Source: 16 Potential Opportunities in an Overpriced Market