5 Turnaround Stories to Bet On

Includes: AIG, AVP, CLD, CSCO, USG
by: Investment Underground

We have taken a look at heavily discounted stocks that represent opportunities in a market still supported by the Fed. We think each of these undervalued names could become great turnaround stories over the next 24 months:

AIG (NYSE:AIG) Battered during the financial crisis, AIG has reached up into the 60s in the last year before falling sharply and settling at a 52-week low. The former insurance stalwart currently has a market cap of $53B. With the help of the government, AIG has healed from the beatings it took during the financial crisis, although it is way below its pre-crisis strength. It is ready to put the crisis behind it and remains one of the largest insurers around. The U.S. Treasury is still working to unload its shares in AIG, with a secondary offering coming in the near future. Investing guru Bruce Berkowitz, who is a major AIG shareholder, expects the offering to be in the $27-29 range. This offering barely dents the Treasury’s holdings, and the government is committed to selling its AIG shares completely over time, so there will certainly be more for sale in the near future.

The crisis and government offerings make this a tough evaluation. On one hand, we think the shares are very cheap: A price/book of 0.65 and a P/E below 3 signify dirt-cheap value, as the company remains a giant insurer, and 2010 profits were positive for the first year since the crisis. The operating margin is strong and the company appears to be back on its feet. On the other hand, we remain worried about the stock value due to the new offerings. Shares are currently trading above Berkowitz’s expected offering range, and with more offerings to come, it is hard to see a huge appreciation in the short-term. In the end, we think AIG provides great value for investors who are willing to wait for long-term results, but new stock offerings give us doubts about short-term performance.

US Gypsum (NYSE:USG): USG just reported earnings on April 20, in line with expectations of weakness. Average prices increased mildly while quantity sold dropped 14% on a y-o-y comparison due to the $8,000 tax credit expiration. In the highly cyclical carpetry products industry, this wallboard maker should benefit from a housing revival over the next several years. Household formation rates are above new construction numbers, and therefore, it is only a matter of time before supply and demand begin to stimulate the housing sector. Berkshire Hathaway (BRK.B, BRK.A) and Fairfax (OTCPK:FRFHF) are major shareholders. We think the latest drop in share price is a buying opportunity.

The company has made some progress on the product front lately, with its introduction of new lightweight wallboard in its most popular widths: 3/8", 1/2" and 5/8". USG should benefit from news that Chinese wallboard makers created toxic products. Now that the news has been out for some time, USG will benefit from wallboard replacements. Going forward, builders will be wary of using foreign building products. USG wallboard is all manufactured in North America.

Cisco (CSCO): While we agree that Cisco might be past its prime, we still think it presents good value to investors. The company remains the dominant player in its sector, and while growth may not be ideal, the firm will remain steady. Revenue has continued growing recently, and FCF remains strong. Its operating margin and ROE are both near the top of the industry, and the balance sheet is safe. Finally, the valuation is attractive, largely due to its recent decline. Its P/E of 11.17 is lower than the industry average, and CSCO also offers a 1.6% dividend. In short, Cisco may no longer be a high-growth tech company, but much like Intel (INTC), it is still a major player that should see moderate growth in the future. At a reduced valuation like the current one, we think it is a good buy.

We think CEO John Chambers has a good shot at turning around the company and getting Cisco's growth engine revving again. Shares have been weak as of late, but a return to its core focus should permit CSCO shares to approach $30 by year's end. Citibank recently forecast a return to IT growth rates to 1.5-2xs GDP growth. Cisco should be pleased as the world’s largest purveyor of data networking equipment. It is trading relatively low at $17/share, while analysts are forecasting fair value nearer to $30.

Its forward P/E of 9.8 also suggests it is currently attractive for investors. With a coordinated effort to stabilize Japan and the world’s currently meek-voiced economic momentum, it is reassuring for the analysts at Citi as much as it is for those who decided to lever their portfolios to this trend through Cisco.

Avon Products (AVP): AVP has increased its dividend for 22 straight years and can become a “dividend champion” in just three more. This New York-based firm has a notable Fortune 500 female CEO and an apparently sustainable 54% payout ratio. Perhaps a slight concern would be the decreasing dividend growth rate, nearing a 6% average over the last five years. Still, any growth on the current yield is icing for this strong niche company.

Given AVP’s positioning in the personal products industry, Avon could be a prime takeover candidate for competitors such as The Estee Lauder Company (EL) or French conglomerate L'Oreal SA (OTCPK:LRLCY) looking to expand their reach into the direct sales portion of the personal products market. Because AVP currently has one of the lowest operating margins in the sector (11.50%), competitors such as EL could view AVP as an attractive investment in hopes of increasing profitability.

Cloud Peak Energy (CLD): Coal is still king, and CLD is the most undervalued coal producer out there, even factoring its somewhat poor price hedging decisions. On the heels of Alpha (ANR) bidding for Massey (MEE), Cloud Peak looks ripe for a buyout. We think shares could fetch $30 apiece and, independent of a buy-out, CLD's earnings multiple has plenty of room to expand.

Cloud Peak generated $1.37 billion in revenues in 2010, which was a decrease of 1.96%, after rising 12.78% in 2009. The EBT margins in 2010 and 2009 were 15.46% and 18.2%, respectively. The respective ROEs were 8.6% and 150.9%. The 30-day put/call ratio is 0.5. Cloud Peak Energy is the third-largest U.S. coal producer and the only pure-play Powder River Basin coal company.

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