6 Undervalued Stocks With Large Share Repurchases

by: Hedgephone

This weekend we screened for stocks trading for less than 12X free cash flows that had repurchased at least 5% of their outstanding common stock over the past year. Here are six of the stocks that were generated by this screen. I will be posting another article on this screen shortly with additional names to research.

SAIC Inc. (SAI) is a major defense contractor with a PE ratio of around 10X and is likely cheap here because Mayor Bloomberg is demanding a $600MM refund from the company. SAIC's project manager is under indictment for kickbacks, as is another employee at the company, Carl Bell, but we think the selloff related to these indictments and refund demands create a buying opportunity. Contractors are by and large involved in some type of conflicts of interest on a daily basis, so these charges aren't world shaking in our view -- these guys are the private CIA of sorts.

SAIC handles much of the scientific, engineering, technical services, and systems integration work for Homeland Security, the military, Secret Service, U.S. government civil services, state and local governments, etc. SAIC is trading for a price to free cash flow ratio or less than 10X. The company repurchased over half a billion in stock last year on a market cap of around $6 Billion. This stock appears undervalued at current prices. Though the balance sheet does not offer a margin of safety, the company's business is insulated from economic shocks.

I believe the debt ceiling fears will not materialize for this company as much as they will for other U.S. government contractors, because SAIC operates as a de facto government entity in many ways. Growth in both earnings and cash flow makes SAIC a technology leader to watch, with huge potential for growth and replacing competing contractors and expanding the productivity of a smaller, more nimble U.S. military and Homeland Security force. While the stock is cheap, it is clearly cheap for a good reason -- uncertainty over criminal charges, so keep an eye on the news and follow this story. I have added a small starter position, which is around a 0.5% allocation on a nominal basis via short Feb. 2012 $16 puts on today's sell off to $16 a share.

Hewlett-Packard (NYSE:HPQ): Even after the recent 10% run in HPQ, shares are still incredibly cheap on any measure of cash flow or earnings. HP is a stock that is all about misconception -- the name is trading at just 6.5X forward earnings because it is perceived to be a printer company when its laptop and cloud services businesses are actually in growth mode. Many people fear that the tablet computer will eat up the laptop market, but HPQ has now entered the space and I can't see the tablet market growing much faster than laptops; in the end, people need to type. HPQ has repurchased over 10% of its market cap over the past year, which is a clear sign that the board and management think the stock is cheap. At 9.11X trailing earnings, there appears to be significantly lower risk in HP shares than in most of the technology stocks out there, partly because this high tech name is viewed as a printer company.

Best Buy (NYSE:BBY) is a business that is believed to be in long term secular decline -- brick and mortar, big box retail. With rising gas prices and the savings that internet retailers offer versus big box stores like Best Buy via state sales tax exemption, most investors prefer Amazon (NASDAQ:AMZN) at any price over Best Buy at 10X earnings and 3.77X EV/EBITDA. I believe that position is a foolish mistake, because Best Buy operates a large internet business as well, and the company may eventually benefit from the changes taking place on the state tax issue in places like California and New York -- which could eventually slow competition from Amazon and, to a lesser extent, Overstock.com (NASDAQ:OSTK).

Best Buy repurchased over one billion in stock versus the company's $12 billion market cap. While Best Buy faces risks of a consumer/credit driven slowdown, the business has a proven model and is benefiting from the tablet, PC, laptop, and smart phone boom. Many people choose to "touch" a product before buying it, and Best Buy offers a wide selection of electronics and various retail items that shoppers can interact with in a way that online retail simply cannot completely replicate or make entirely irrelevant. Best Buy is trading for just 8.60X forward earnings.

Gilead Sciences (NASDAQ:GILD) is a cheap stock at current levels, given its historical growth rate and longer term outperformance as a business. The stock is up some 40-fold in the past 20 years and leverages new technologies to deliver the best available medicines for a wide assortment of diseases. Gilead is much cheaper than most of its biotech rivals and recently announced a strategic partnership with Johnson and Johnson (NYSE:JNJ) to provide work towards a cure for HIV. Gilead is trading for 12X earnings, and also repurchased around 10% of its market cap last year -- a very bullish sign for investors in the common stock. When undervalued companies buy back shares, this decision helps investors. When overvalued companies buy back shares, this decision hurts investors over the longer term.

Another undervalued tech name that is repurchasing shares in an accretive fashion right now is Cisco (NASDAQ:CSCO). Cisco is trading for 12X trailing earnings and 9X forward earnings. Although the company has posted dismal numbers over the past few quarters, investors following our put sale strategy on the name have either broken even or made money, even after this stock collapsed some 15% or so. CSCO shares are a bargain, but a bottom needs to be put in at some point for the company's core products and growth needs to pick up before paying 12 or even 9 times makes a good deal of investment sense.

Still, the stock is much cheaper than most; with the Nasdaq 100 trading for 23X earnings, I think a long CSCO and short QQQ trade will likely work out quite well in the months ahead. One way to play this is to buy two long-dated QQQ put options and sell three long-dated CSCO put options. This is what I like to call a "pairs spread," which should have a delta neutral position in the short and medium term. For more bullish investors, selling two puts on your long position and buying one QQQ put would make sense. Keep in mind, I am using this strategy over a wide basket of stocks on the long side and the QQQ on the short side. CSCO repurchased 5% of its market cap over the past year.

Intel (NASDAQ:INTC) is a cheap name at 10X earnings and only 4X EV/EBITDA. Intel trades for a very low multiple to operating cash flows as well, which makes this a decent place to hide out for the rest of the year on the long side. While trends in consumer spending may dampen growth this year, I expect the company to drive solid top and bottom line growth in the next few years as the economy has more or less transitioned online. Certainly, the rise of social media and new media in general will fuel the demand for processors over the longer term. With computing developing at an ever faster pace, the R&D that Intel plows back into the company via capital expenditures looks like a wise investment for the company -- even when its stock price looks so cheap that larger buybacks see appropriate. The company continues to defend its core moat by investing back into the business, which I believe is key for any technology company in the current, extremely competitive technology environment.

Disclosure: I am long HPQ, SAI.

Additional disclosure: I may initiate short puts or buy calls on any of these stocks this week.