7 Unloved Stocks Ready to Go Higher

by: Investment Underground

The goal of the value hunter is to identify stocks trading below intrinsic fair value and purchase them with an adequate margin of safety. Below are six stocks we believe all value investors should examine further. These investments fit the Graham-Dodd mold, and we think all of them would be good aquisition candidates for Berkshire Hathaway (NYSE:BRK.A), which we think is still on the hunt with its elephant gun. As always, please use the information below as a starting point for your own due diligence.

Fastenal (FAST): Fastenal has grown its dividend payouts by an average of 45% over each of the last 10 years. OK, so it might be cheating a little bit when you start with a split corrected annualized payout of $.0025. But then again, it also demonstrates the power of Fastenal's ability to grow its dividend. In recent years, the growth rate has slowed a touch, but the 12 years of consecutive payout increases have added stability to the picture.

The current yield is just 1.5%, but if Fastenal can keep up the dividend growth rates, there shouldn’t be too much concern for future yield on cost. A spot-on 1.00 beta and 55% payout ratio leave solid opportunities for the future for covered call sellers to take advantage of decent call premiums. This should create an additional, synthetic dividend. The company has turned selling fasteners into an ultra-profitable business without creating a bloated cost-structure.

Fastenal has remained nimble during this housing recession. If it can navigate these woods as well as it has shown so far, Fastenal is well-placed for some explosive growth over the next decade. We value shares at $80 apiece in 2012 using a 10% cost of equity. Our intrinsic value for the company is nearly double that figure, for 5-6 years out. We think this is a long-term play with excellent long-term potential for capital appreciation.

JDS Uniphase (JDSU) is a provider of communications testing and measurement devices and services. In FY 2010 through June, the company posted a GAAP EPS of - $0.17. In FY 2009 and FY 2008, those figures were - $4.02 and - $0.10, respectively. Gross margin has steadily risen from 28.27% in FY 2006 to 40% in FY 2010 and 42% over the trailing 12 months.

JDSU trades with a price to sales multiple of 2.9. From 2005 to 2007, the multiples were 3.8, 2.6, and 2.0, respectively. The company also has a debt to equity ratio of 0.29.

Demand for optical components, in which JDS Uniphase is a key player, should benefit from the technology cycle up-swing as the U.S. exits this recession. Most of the world has now worked off the excess supply of bandwidth following the 2000 tech bubble. We are now entering a period of renewed bandwidth growth, and
JDS Uniphase should benefit from this. We have some concerns about the commoditized nature of bandwidth in general, and we are aware of the place of government spending in many bandwidth-expansion initiatives.

Options-players would be wise to sell out of the money calls against their shares to create a synthetic dividend. We do think major investment houses will get behind this name over the next year as a beneficiary of a positive economic backdrop, government initiatives, and some visible product differentiation.

Silvercorp Metals (SVM): The company mines at predominantly high-grade silver-related mineral properties in China and Canada. Silvercorp is the largest primary silver producer in China through its operation of four silver, lead, and zinc combination mines at the Ying Mining Camp. These mines aref located in Henan Province, China. The company has applied for a mining permit for its GC silver, lead, and zinc combination mine in the Guangdong Province. Recently, the company announced the acquisition of a 70% interest in the BYP gold, lead, and zinc Comobo mine in Hunan.

In Canada, Silvercorp is in preparing to apply for an SMP, Small Mine Permit, for the Silvertip high grade silver, lead, zinc combo mine project in northern British Columbia. All of these acquisitions and developments should provide Silvercorp a significant platform for growth, and also offer some geographic diversification. All Silvercorp mines have reasonable access to stellar markets in North America and Asia. In particular, demand for gold and silver seems to be insatiable for the new middle class and rapidly growing wealthy class in China.

Revenues are +16.5% in the company’s fiscal 9M11 compared to fiscal 9M10 or $124.9 million versus $107.2 million. Gross margin in fiscal 9M11 was a solid 74.57%. It was 73.97% in FY 2010 through March. GAAP EPS went from - $0.11 in 2009 ending in March to $0.24 in 2010.

We think shares offer significant upside. The company has nearly $250M in cash. There exists significant potential for blowout quarterly numbers on this inadequately followed stock.

Actuant (ATU): is a global manufacturer of a broad range of industrial products and systems with operations mostly in the EU and North America. In fiscal year 2010, ending on August 31, the company made net sales of $1.16 billion with a 10% increase in profits. Return on equity was a lackluster 3.3% at the end of first quarter 2011, or the three months ending November 30, 2010. It was 3.23% at the end of FY 2010, and 1.99% at the end of FY 2009.

Actuant is an awfully cyclical company, but we think the upswing is about to go into full-force. Large debt-loads, still at $500M, have made the company lean and efficient, translating into high return-on-invested-capital. There is significant leverage at the company, which can create outsized returns when its end-markets are performing well. We think shares are a buy given the likely growth in its energy segment. Many Actuant actuation and hydraulic products are used upstream to build the machines used by land-based and deep-water exploration and production companies. High fuel prices bode well for more production.

We find coverage to be light on Actuant, leaving the potential for positive earnings blow-outs throughout 2011 and 2012. We think Actuant offers a much better bet than larger competitors like General Electric (NYSE:GE), which has a cloud hovering above it due to its financial arm's relatively weak operations. Actuant represents a better pure-play opportunity.

Ford (F) CEO Alan Mulally has now turned in seven quarters of profits for shareholders. The company proclaimed 50% sales growth by 2015, which the lion's share of growth coming from China and India. Currently Ford is playing catch-up in those two markets, where rivals General Motors (GM) and Toyota (TM) have a significant head start.

The other piece of good news comes from Ford CFO, Lewis Booth, who said net debt would be cut by $2.6 billion to around $14 billion by the end of June. Ford is no longer in survival mode, as these executives claim; but rather in growth mode. Astonishingly, a whopping 55% of Ford sales will come from small cars by mid-decade. Large SUVs and popular Ford pick-up trucks have dominated Ford sales and profitability for the last decade. Back in 2006, Mulally came into his job with a meeting of 300 of Ford's top executives and famously demonstrated through pie charts that Ford was lacking in the small car department. That appears to be changing quickly.

This spring's market share gains by U.S. automakers, including Ford and General Motors, will leave a lasting mark at the expense of Toyota. Ford is still trading at a very low $14-15 per share, well below where it could trade a year from now. On a discounted cash flow basis, shares will be worth just under $30 apiece in 2012. EPS for 2011 is forecast at 113% with a five-year projection of nearly 13%. Broad trends suggest that Ford is stealthily improving its position in the competitive landscape: A consolidation of brands, a gain in market share over the past year and the shedding of debt.

The big question mark at Ford is the luxury Lincoln brand. Most Ford dealers were combined Lincoln-Mercury outfits, but Mercury was axed by Ford in its effort to refocus on its flagship brand. We think the upside surprise will in fact be Lincoln as it goes head to head with Toyota's Lexus luxury brand. One-third of Lincoln dealers are likely to be cut, with significant investment needed at dealerships to upgrade the Lincoln brand image beyond the Lincoln Town Car. The last big hit out of Lincoln came with the launch of the Navigator in 1999. Sales have slumped steadily since that year.

Morningstar (MORN): The company has a stellar, deep management bench. We believe it is only a matter of time before the company takes over a substantial portion of the lucrative investment information and investment management markets. The company has $365 million in cash and no debt on its books. This opens up numerous possibilities for bolt-on acquisitions as the company grows. We model Morningstar at $80 per share in 2012 on a discounted cash flow basis using a 10% cost of equity.

Morningstar is sparsely covered by analysts, but we think that will change over time. The company rolled out its credit ratings on stocks the company covers, which is likely to be an eventual threat to the S&P McGraw Hill (MHP) and Moody's (MCO) duopoly on credit ratings. The ratings cover the financial health of the rated company and, in particular, the rating for its most-senior bonds. In our review of Morningstar's ratings products, we see these ratings as more accurate than those that come from gold-standard S&P. We think that new credit rating competition from Meredith Whitney and Jules Kroll will only highlight Morningstar's ratings superiority and not hinder it. The company benefits from instant name-recognition from professionals and the investor class. Morningstar also gets free publicity when its analysts or its opinion is quoted.

Morningstar has a lot of room to develop its forums and create a greater online presence. The interactivity of its retail site in particular, leaves many of its subscribers wanting more. Nonetheless, the top-notch team should continue to do well by providing core research services to its customers.

Each quarterly earnings announcement draws attention to the company. As sleepy Morningstar shares are brought into the light, most value investors will find that shares are generally underpriced in this solid business of which they want to own a part.

Exelon Corp. (EXC): Exelon is a utilities holding company that provides electricity and heating through renewable and non-renewable sources, with 5.4 million customers across Illinois and Pennsylvania. The stock manages to pay out a dividend of $2.10 for a heaping annual yield of 5.02%. Its EPS is relatively weak – only $3.75 – but the company has a good cash flow of $4.80 per share, and the stock’s ability to maintain 5.59% annual dividend growth, above-average for the industry, is not bad either.

Exelon is one of the U.S. leaders in operating nuclear power plants and is quickly expanding with modern electrical grids and renewable energy sources. For analysts, the recent worries about nuclear power after the Japanese earthquakes have reflected poorly on Exelon. Expected revenue growth has been cut to 1.4% and earnings growth is almost non-existent at .2%. However, Exelon should generate enough excess cash to ride out this downtrend in sentiment and keep paying the high dividend.

By a P/E ratio comparison and a simple DDM valuation estimate, Exelon is vastly undervalued compared to its peers and still has a lot of potential. The very generous dividend from the company is just the icing on top of the cake. Fears of weak earnings due to low gas prices are overblown, in our opinion. Continued weakness in Exelon is merely a continued buying opportunity. Exelon is a better bet than Southern (NYSE:SO) or First Energy (NYSE:FE) due to its more substantial, low-cost nuclear fleet. We also applaud Exelon's decision to buy out Constellation Energy (NYSE:CEG).

Disclosure: I am long EXC, ATU.