Companies that trade at a discount to tangible book value typically either offer strong downside protection due to the value of the underlying assets, or offer little downside protection due to a highly leveraged balance sheet.
While investors should strongly prefer the former types of companies, sometimes leverage may be acceptable if other factors make it likely that equity value will not be impaired. For example, companies with large insider ownership are more likely to fight for the preservation of shareholder value in a distressed situation, than are companies with disinterested management.
Similarly, sometimes ownership of the equity by well-informed investors (e.g., John Fredriksen's ownership of TORM) can signal that equity value may not be impaired in the long term, despite the current state of distress (e.g., David Einhorn's ownership of Republic Airways (RJET)).
The following list includes both companies that have little financial leverage, as well as those that have substantial leverage. The common thread is an equity valuation below one times tangible book value and our judgment that large equity upside potential exists in the long term if equity value is preserved in the short term.
We have looked for businesses that are not only cheap on book value, but also have substantial normalized earning power. Ideally, a company will have lots of value on the balance sheet but also one or more businesses that are not capital-intensive, adding going-concern value above and beyond the assets on the balance sheet. Here are ten companies that are cheap on tangible book and appear to have material stock price upside:
Republic Airways ($4.60 per share; MV $222 million; EV $2.5 billion), based in Indianapolis, IN, operates two business models: a fixed-fee code-share model with predictable operating margins (key partners are American (AMR), Continental (UAL), Delta (DAL), United (UAUA), and US Airways (LCC)), and a branded airline model via Denver-based subsidiary Frontier (FRNT).
The operational fleet of airplanes declined 5% from 290 at the end of 2009 to 275 at yearend 2010. Analysts expect Republic to lose $0.13 per share in 2011, followed by EPS of $0.47 (10x P/E) and $1.10 (4x) in subsequent years. The company trades at 0.5x tangible book value of $449 million.
Republic has been a long-time holding of superinvestor David Einhorn. While some holders of Republic were hoping the company would buy back shares at some point, the company did the opposite in November when it issued 12 million shares at $7.80 per share. While the equity raise suggested that Republic's financial situation was a bit more tenuous than some longs had believed, the equity raise was accretive in hindsight (due to Republic's recent trading price well below $7.80 per share).
Panasonic (PC) ($12 per share; MV $28 billion; EV $36 billion) is one of the world’s biggest makers of consumer electronics, selling a wide range of products under the Panasonic and, since January 2010, under the Sanyo brands. Sales in the Digital AVC Networks segment, which includes audio and video as well as information and communications equipment, decreased 3% from ¥3,410 billion in the fiscal year ended March 31, 2010 to ¥3,304 billion in FY11, while total revenue rose 17% to $108 billion in the same period. Analysts expect Panasonic to earn $0.54 per share in FY11 (21x P/E), followed by $0.07 (>99x) and $0.92 (13x) in subsequent years. The company trades at 0.9x tangible book value of $32 billion. While Panasonic added significant intangible asset to the balance sheet with the Sanyo acquisition, the company remains undervalued based on tangible assets, including large holdings of Japanese real estate.
Beazer Homes (BZH) ($3.30 per share; MV $248 million; EV $1.2 billion), based in Atlanta, GA, is a top ten U.S. single family home builder with operations in 16 states. The company has delivered 120,000+ homes over the past decade. The number of home sales closed increased 8% from 4,196 in the fiscal year ended September 30, 2009, to 4,513 in FY10, while total revenue remained roughly flat at $1.0 billion in the period.
The sell side expects Beazer to lose $2.17 per share in FY11. The company trades at 0.8x tangible book value of $296 million. Management expects U.S. national single family home starts to be flat in 2011, with Beazer's new home orders also expected to be flat. Guidance for new home prices is for flat to down 3%, implying margin pressure and the need for continued cost rationalization. While Beazer is quite leveraged (net debt to total cap of 49%), the company is not facing any significant debt maturities until 2015 (see latest investor presentation).
GenOn Energy (GEN) ($3.80 per share; MV $2.9 billion; EV $4.7 billion), based in Houston, TX, was formed as a result of a merger between wholesale electricity producers Mirant and RRI Energy in December 2010, resulting in a business with 24,000 MW of net electric generating capacity around the U.S. Power generation volume, measured in gigawatt hours, rose 18% from 17K in 2009, to 20K in 2010, while revenue decreased 2% in the period.
The sell side expects GenOn to lose $0.24 per share in 2011. The company trades at 0.5x tangible book value of $5.4 billion. GenOn derives a large portion of generating capacity from coal-fired plants, a risk given increasing environmental concerns. In addition, as electricity prices correlate with natural gas prices, Mirant's unhedged sales of electricity have failed to generate an acceptable margin.
Crimson Exploration (CXPO) ($3.50 per share; MV $156 million; EV $324 million), based in Houston, TX, is a natural gas and oil E&P company historically focused on the onshore U.S. Gulf Coast and South Texas regions. Proved reserves were 166 Bcfe at year end 2010, consisting of 135 Bcf of natural gas and 5.1 MMBbl of crude oil and liquids, with a PV-10 of $240 million.
81% of proved reserves were natural gas, 48% were proved developed and 89% were attributed to wells and properties operated by the company. Proved reserves (in Bcfe) surged 71% from 98 at the end of 2009 to 167 at yearend 2010. Analysts expect Crimson to lose $0.18 per share in 2011. The company trades at 0.9x tangible book value of $175 million. The company's largest shareholder is Howard Marks' respected value investment firm Oaktree Capital, which owns 34% of Crimson.
Arbor Realty Trust (ABR) ($4.40 per share; MV $111 million; EV $1.4 billion), based in Uniondale, NY, is a REIT that invests primarily in real estate-related bridge and mezzanine loans, including junior participating interests in first mortgages, preferred and direct equity, and in limited cases, discounted mortgage notes and other real estate-related assets.
To a lesser extent, the company also invests in mortgage-related securities and real estate property. Book value per share jumped 117% from $3.81 at the end of 2009 to $8.25 at year end 2010. Analysts expect Arbor to lose $1.07 per share in 2011. The company trades at 0.5x tangible book value of $218 million. As of March 31, Arbor's GAAP book value was $8.55 per share while adjusted book value was $12.54 per share (adjustments are comprised of deferred revenue minus the prepaid management fee on a transaction at 450 West 33rd Street, plus an unrealized loss on derivatives).
Arbor's loan portfolio consists of 33% fixed-rate and 67% variable-rate loans, suggesting that the REIT might benefit in a rising interest rate environment. The company authorized the repurchase of 1.5 million shares on June 14th following a sharp stock price drop on June 13th on no news. Also on June 13th, Leon Cooperman bought stock in Arbor, apparently for his personal account, bringing his stake to 5.2%. Clearly, those close to the company believe strongly that it is undervalued at recent trading levels.
Thomas Properties (TPGI) ($3.30 per share; MV $121 million; EV $382 million), based in Los Angeles, CA, is a real estate company that owns, acquires, develops and manages primarily office properties in the U.S. Property operations comprise the primary source of cash flow and generate revenue through rental operations, property management, asset management, leasing and other fee income.
The properties are located primarily in Sacramento and Southern California, Philadelphia, Northern Virginia, Houston and Austin. Rental revenue decreased 2% from $29.8 million in 2009 to $29.2 million in 2010, while total revenue declined 14% to $98 million in the same period. The company trades at 0.8x tangible book value of $145 million. Thomas seems to be somewhat misunderstood in the market, as investors may underappreciate the company's capital-light businesses in investment advisory, management, leasing and development.
Those businesses generate high-margin service fee net revenue of roughly $15 million annually. In addition, Thomas's development pipeline may be worth $100+ million. For details, see slide 21 in the company's latest investment presentation. Finally, we note that CEO James Thomas is heavily incentivized, as he owns 8% of the common stock, 31% of the operating partnership units, and 100% of the limited voting stock.
Callaway Golf (ELY) ($6.30 per share; MV $405 million; EV $379 million), based in Carlsbad, CA, makes golf clubs, golf balls and golf accessories under the Callaway Golf, Odyssey, Top-Flite, Ben Hogan, and uPro brands. Sales of drivers, fairway woods and irons have accounted for roughly one-half of total sales in recent years. Sales outside the U.S. increased 6% from $475 million in 2009 to $503 million in 2010, while total revenue increased 2% to $968 million during the same period. The sell side expects Callaway to earn $0.02 per share in 2011 and $0.36 in 2012 (17x P/E). The company has $26 million of net cash and $546 million of tangible book value.
Coldwater Creek (CWTR) ($1.30 per share; MV $124 million; EV $112 million), based in Sandpoint, ID, is a specialty retailer of women's apparel, accessories, jewelry and gifts. The firm was founded in 1984 as a catalog company and has grown into a multi-channel retailer (it was flying high only a few years ago on rapid store expansion and same-store-sales growth, but the company has been retrenching since the financial crisis). Coldwater Creek's premium retail stores average 5,900 square feet in size, with 42% located in traditional malls, 53% in lifestyle centers, and 5% in street locations.
The premium retail store count increased 5% from 356 at the end of the fiscal year ended January 30, 2010, to 373 at year end FY11. Wall Street expects Coldwater Creek to lose $0.96 per share in FY12. The company has $12 million of net cash and $163 million of tangible book value. With a strong balance sheet and a heavily incentivized CEO (Dennis Pence owns 14%), we believe the company is here to stay, but the big question is whether it can resume same-store-sales growth and improve profitability.
Torm (TRMD) ($4.00 per share; MV $295 million; EV $2.1 billion), based in Hellerup, Denmark, is a Danish shipping company founded in 1889. It owns and operates primarily product tankers, with the owned fleet recently numbering 70 vessels transporting refined oil products such as gasoline and jet fuel.
The company also charters vessels, including dry bulk carriers (see 20-F for detail). Time-charter equivalent earnings declined 11% from $633 million in 2009 to $561 million in 2010, while revenue remained roughly flat at $856 million in the period. The Street expects Torm to lose $1.33 per share in 2011. The company trades at 0.3x tangible book value of $984 million. Torm's large financial leverage has put it in the distressed equity category, but it seems likely that the company will survive due to an established market position and long operating history. Famed shipping entrepreneur, Frontline's John Fredriksen, is reported to have bought a 5% stake in TORM this year. Also, in May of last year, TORM CEO, Jacob Meldgaard purchased 100,000 shares for roughly $800,000, paying almost twice the recent market price.