By David Sterman
What will the U.S. economy look like in 12 months? The crystal ball, as they say, is hazy. The odds seem balanced between a renewed recession and a long-awaited upturn. With such uncertainty, it's wise to focus on stocks with material protection on the downside. This way, if the economy and the market hit the skids, investors will be less likely to unload these stocks and will instead start to sell pricier equities.
You can find this downside protection on the balance sheet. Many companies have shares selling for less than the value of the assets on their balance sheet, or below tangible book value. These "below book" stocks tend to be safe harbors in any market storm.
Know your assets
To profit from this approach, you'll need to figure out whether the balance sheet figures represent real-world values. When I ran a screen of below-book names, a number of dry bulk shipping firms appeared right at the top. Yet as I noted last month, it's not clear what their ships would actually fetch in the re-sale market. So for today's purposes, I've eliminated all of those names from the screened results. I also noted a preponderance of big banks on the list. Many are limping along in a tough economy, waiting for business to pick up. Yet when that happens, shares could move up to 1.5 times book value, more than 50% above current levels, if history is any guide.
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After excluding shippers, insurers and banks, what's left? Well, Audiovox (VOXX), which I wrote about earlier this week, stands out as a deep value play. Here are five other stocks that are surely worth more research.
Ingram Micro (IM): In tough times, this global re-seller of office technology can trade down to 85% or 90% of book value. When the economy improves, that figures moves up to 130% or 140%. And sure enough, shares may languish a bit more as there's no reason to expect great news when quarterly results are released on July 28. In fact, I'm curious to see how the company responds to any short-term weakness that pressures shares anew, as Ingram Micro sports a bullet-proof balance sheet with more than $1 billion in cash. For that matter, the company is sitting on $6.7 billion in receivables and inventory. Meanwhile, the whole company is valued at less than $3 billion.
After a recent pullback, analysts at Sterne Agee upgraded their rating on Ingram Micro from Neutral to Buy with a $24 price target (representing 35% upside), noting that "We believe for IM to remain trading below its book value makes little sense as the company generates strong profits and cash flow and continues to build book value." They add that the company is developing a range of high-margin services to the business mix, which should boost profitability at a reasonably fast clip. Meanwhile, shares trade for about eight times projected 2012 profits.
E.W. Scripps (SSP): It's not easy getting behind a media company these days. Scripps, which owns a collection of TV stations and newspapers, has surely felt the seismic shift in media consumption towards the online world and away from the broadcast and print world. It appears that the transition has run its course, at least for now, as revenues have largely stabilized for Scripps.
Yet a recent transaction will soon turn investor attention towards the balance sheet. In early June, Scripps sold its Iconix Brand division for $175 million. As a result, the company will sport roughly $325 million in cash when second quarter results are released on August 9. That's more than 60% of the company's entire market value. For now, management is using that cash for a stock buyback, and investors may want to listen to the upcoming conference call to hear about other potential uses for all that cash.
Axcelis (ACLS): Back in May, I noted that this semiconductor play was starkly undervalued, based on the recent sale price garnered by a rival. What I failed to mention then is that the company also has a rock-solid balance sheet. A key concern for investors has been a rising bulge of unsold inventory, which stood at $123 million at the end of the last quarter. When Axcelis releases quarterly results on August 4, check to see if inventories are working their way back down. If so, then this stock increasingly looks like a steal.
Global Industries (GLBL): Here's another deep value play to watch for this earnings season. Global Industries, which provides offshore drilling equipment and services, delivered a lousy first quarter, and shares have been in freefall ever since. Yet at the time, management noted that Global picked up several large new contracts, causing backlog to swell more than $100 million from a year earlier to $248 million. If backlog swelled yet higher in the second quarter, then it won't be long before sales start to rebound, and investors start to bottom-fish.
Tuesday Morning (TUES): This operator of "closeout stores" (goods that weren't picked up by other retailers and can be bought at a substantial discount) recently saw its shares slump after the company pre-announced a weak second quarter. Slowing foot traffic means that inventories are building. They stood at $286 million at the end of the prior quarter and now likely top $300 million. Meanwhile, the whole company is valued at just $175 million. The key for this value play is to convert that inventory into cash without resorting to major markdowns. The good news: closeout stores rarely need to resort to that as they are in no hurry to bring in the next season's merchandise, so Tuesday Morning can be patient. Of course the company would like to move the goods sooner rather than later to free up cash and acquire fresher inventory. This is not a "clean" retail story, but the balance sheet strength is quite impressive.
These stocks are well below book value for a good reason. Business has been weak lately. Yet each appears to have found a floor, and once management is able to stabilize operations and reverse recent trends, value investors may flock to them in droves.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.