Seeking Alpha
Larry Meyers, PDL Capital (76 clicks)
Value, special situations, long-term horizon, small-cap
Profile| Send Message| ()  

I like nothing better than finding deeply undervalued stocks that are undiscovered gems. In my experience, great companies don’t stay secret forever. With a little patience, you can find some stocks that will vastly outperform the market. I have three stocks that, based on numerous factors, are so significantly undervalued that I believe they will each triple in price within the next three years or less.

Cash Store Financial Services (CSFS) is the new kid on the block. The company is based in Vancouver and until recently only traded on the Toronto exchange. It's now on the U.S. exchange and I'm thrilled by this move. Cash Store is the latest entry as a public company in the payday loan space and they have many more advantages by having their business located in Canada rather than the U.S.

The U.S. has provided numerous regulatory challenges for payday loan stores. In Canada, however, certainly has entered the regulatory space as the major provinces have all locked in permissible rates. There will be no more questions surrounding the legality or fees on payday loans in Canada. These rates average almost $23 per hundred borrowed, which exceed the average U.S. rate of $16 per hundred. Even better, the average cash advance is close to $500, compared to about $400 in the U.S. That number has been increasing dramatically since 2009 and underwriting is much looser with loans being made up to 50% of a customer's net income compared to about 25% in the U.S. Despite this, loan losses are about equivalent to U.S. stores, which goes to show how serious Canadians are about paying their debts.

Cash Store had been acting as a broker of these loans and a third-party lender had been actually making the loans, similar to the model used by U.S. lenders in Texas. Now, however, Cash Store can begin utilizing its own capital to lend directly to consumers. It's also kicked off a brilliant idea by partnering with a bank to offer unbanked customers a bank account, and since they need a bank account to get a loan, they are able to not only generate revenue by getting them a bank account, but by lending them money. They offer many of the same services U.S. stores do, like check cashing, prepaid debit cards and so on. But they also offer loans against injury settlements, and have more new products in the pipeline to leverage the existing customer base.

The company owns 574 stores in Canada and is the largest chain, by far. It owns 8 stores in the U.K. and 81 in Australia. However, they plan to expand to between 80 and 95 branches in the U.K. by the end of 2012 and 80 new stores annually thereafter. Australian stores are expected to hit 300 branches by 2014. Now you're starting to see why I think this company's stock is going to triple.

Loan growth is exploding, with loan volume having exploded 26% in the TTM leading to June 2011. This followed years of 4%, 15%, and 10% growth, respectively. The company is also entering the cutting-edge field of text-messaging-based lending in the UK, where there are no regulations.

This is a mega-growth story. For the TTM ending in June, the Canadian and UK branches contributed $29 million of EBITDA. The company will essentially double its number of branches by the end of 2014. Operating margin maturity takes 4-6 years on average, so in three years, the market should be discounting that maturity.

Cash Store's TTM net income was about $18 million, or about $1 per share, giving them a P/E of 9, with an expected growth rate of over 25% annually. Its' EV-to-EBITDA ratio is 4.14, below Advance America's (AEA) of 4.74. It is a screamingly undervalued play at these levels.

Even more enticing, it pays a 5.3% yield. When you examine some other blue chip stocks, they are not growing anywhere near as quickly and have smaller yields. AT&T (T) is a no-growth story paying 5%. Microsoft (MSFT) is growing at 11% and pays a 3% dividend. Wal-Mart (WMT) pays 2.6% while only growing at 9.4%. Walt Disney (DIS) has 14% growth while only yielding 1.2%. Previously mentioned Advance America is a slow grower and yielding only 2.8%. Cash Store outgrows and out-dividends all of these, and more.

DGSE Companies (DGSE) is a fascinating gold play I've written about twice before. The company should report Q3 earnings any day now, and I'm expecting some very encouraging numbers after digesting the Southern Bullion Trading acquisition. The company will shortly become a major player in the retail gold trading space, where margins are consistent, and volume is high thanks to record gold prices. Total DGSE 2011 earnings are thus $5.74 million, or 57 cents per share. At a stock price of $8.20, DGSE thus trades at 14 times 2011 earnings. One sector I would use to make comparisons are the gold miners. The Market Vectors Gold Miners ETF (GDX) trades at a P/E of 15, Newmont Mining (NEM) is at 13.9x, Barrick Gold (ABX) is at 13.2x, Kinross Gold (KGC) trades at 18x, Goldcorp (GG) is at 21x, and El Dorado Gold (EGO) trades at 31x. The average of these six securities is a 19 P/E, suggesting DGSE is 27% undervalued.

I stick by my 30% annualized growth rate projections, giving the stock $1.25 per share in earnings in 2014. At a 30x P/E, that gives a $37 three-year price target, or more than a triple from here.

My last choice will surprise you. How on earth could I support the idea that venerable retailer J.C. Penney (JCP) will triple in price over the next three years? There are several reasons. For starters, hedge fund manager Bill Ackman has taken a gigantic position in the company and a seat on the board. He not only sees that Penney is undervalued compared to its peers, but it has hidden value in its real estate assets. The real tale, however, is told by hiring Ron Johnson as the new CEO. Mr. Johnson is the visionary behind the Apple (AAPL) retail store concept and he walked away from $73 million in Apple stock to take $50 million in Penney stock. I believe Mr. Johnson's plan is to completely reinvent the retail shopping experience at J.C. Penney -- and I mean completely reinvent. That is, I can't even conceive of what he's planning, but I think it will be revolutionary. This is going to turbo charge the stock, because when a retailing stock gets hot, it gets white hot. All the big clothing retailers, like Christopher and Banks (CBK), Jos. A Bank Clothiers (JOSB), and Abercrombie and Fitch (ANF) have all experienced multi-bagger behavior. Penney will be next.

Source: These 3 Stocks Will Be 3-Baggers In 3 Years