The following is a list of six stocks which are available at attractive valuations after their significant underperformance in 2011.
Bank of America
Bank of America is trading at just 30% of its book value and 45% of its tangible book value. I believe the market is completely neglecting some of the important steps taken by the bank to improve liquidity. Over the past couple of months, BofA has executed on several asset sales that are consistent with management's efforts to strengthen the balance sheet and improve the company's overall capital position. For example:
- BofA recently announced an agreement to sell most of its remaining stake in China Construction Bank. At September 30, BofA held 12.1 billion shares (~5%) of CCB with a carrying value of $7.2 billion, and a fair value of $7.7 billion. Out of this Bank of America will sell approximately 10.4 billion common shares through private transactions with a group of investors. Earlier also, on August 29, BofA sold 13.1 billion shares of CCB reducing its risk-weighted assets by $7.3 billion under Basel I. Together with some further realization of the deferred tax asset, the sale of the 10.4 billion CCB shares should generate about $2.9 billion of Tier 1 common capital boosting that ratio by 24bps.
- BofA recently sold its stake in the Pizza Hut franchisee, for $755 million.
- BofA's previously announced sale of the Canadian card business is expected to close in 4Q11. It will free-up approximately $8 billion of RWA and as such will add another 7bps to the Tier 1 common capital ratio.
In addition to these transactions, Bank of America is also taking advantage of current market conditions, which are putting downward pressure on the market values of BofA's debt and preferred stock issues, some of which are now trading below par. Management is issuing up to 400 million shares of common stock (3.9% of outstandings) and $3 billion in new senior notes to effectively replace roughly $6 billion of higher-cost preferred stock and/or trust preferred capital debt securities.
Once the eurozone stabilizes, the market will take a notice of these confidence-building measures, which will be a positive catalyst for the stock.
Citigroup is pretty much a similar story, trading at 0.6x tangible book value. However, it has the icing on the cake in the form of its emerging market exposure. Ongoing liquidation of Citi Holdings is also a positive for the company, as it will help in reducing the earnings and ROE drag from Holdings. Citi will see better than average loan growth in the longer-term when runoff balances at Holdings decline and its emerging market loan growth becomes increasingly visible. In the near term, Citi is all set to benefit from reduced competition in emerging markets as European peers retrench.
Embraer is a manufacturer and supplier of commercial and defense aircraft. I like Embraer from both short and medium term perspective. In the short term Embraer's operating margins are likely to benefit from depreciation of the real vs.U.S. dollar. The majority of ERJ's sales are in USD while 30% of ERJ's COGS and 40% of SG&A are dominated in the real. Thus, strengthening USD is a near term positive for Embraer's operating margins. In the medium to long term Embraer is well set to benefit from growth in production in commercial OE markets for next several years. ERJ has a dominant position in the 70-110 seat market and is the first business jet manufacturer with emerging market economics. Both markets are beginning to recover and ERJ is likely to see total sales growth at 10% CAGR and EPS growth at 20% CAGR through 2014. At 10.39x forward earnings Embraer is available at a discount to its U.S. peers and I believe it is a good value buy at current levels.
InterOil Corporation is an integrated energy company operating in Papua New Guinea and its surrounding Southwest Pacific region. The Company operates in four business segments: upstream, midstream, downstream and corporate. InterOil's shares are currently pricing in just $0.40/Mcf for its gas reserves. This is a significant undervaluation and usually, gas resources transactions in Asia-Pacific have been done at $2.00/Mcf plus valuations. Given this disparity between intrinsic value and what the market is pricing in, I am bullish on the stock.
Mosaic Co. is a leading fertilizer company and I am bullish on it despite of the broader macro concerns as I don't think a 2008-like correction in fertilizer stocks is in the cards.
During the last downturn in 2008, excess inventory in the supply chain coupled with anticipation of declines in fertilizer prices by farmers caused fertilizer producers and retailers to take a hit. However, the current situation is different. Due to the hit fertilizer retailers took in 2008, they were cautious this time and have not overstocked fertilizer inventories. Thus, supply chain remains very tight.
Further, grain prices corrected very sharply along with other commodities during the last downturn. Thus, farmers anticipated that fertilizer prices will come down as well. I don't see a similar commodity correction this time given the excess amount of money supply that has entered the system thanks to bailouts, quantitative easing and stimulus. In particular, when we talk of food grains where demand is inelastic, the trend is likely headed up in the mid-long term, even if we consider a prolonged recession scenario.
Fertilizer prices are usually correlated with food prices, and I believe fertilizer companies are the best bet in the long term to hedge one's portfolio against inflation in these recessionary times.
Yandex is Russia's Baidu (BIDU). It is Russia's largest internet search company and has 65% traffic share and 70% revenue share. The company has an established track record of profitable expansion. I don't think the stock is expensive at 24x forward earnings when its EPS is expected to grow at 40% YoY next year. Russia is 5-8 years behind US when we compare total online advertising spend to GDP.
Thus, there is a secular tailwind which will benefit Yandex as the normalization occurs even if we do not assume any macro growth. Yandex is likely to continue posting high EPS growth for next several years and it makes a good sense to grab it at current cheap valuations.
One stock which I believe will continue its 2011 underperformance in 2012 is Dow Chemical (DOW). Dow is the second-largest global chemical company providing chemical, plastic and agricultural products and services to diverse markets. In the short term, I am worried about Dow's major commodity exposure - the olefins chain - which is getting adversely affected by lower prices due to sluggish demand and inventory destocking. In addition, tighter-than-expected ethane markets leading to higher-priced feedstocks are adversely impacting the margins. In the medium term Dow's high operating and financial leverage makes the stock very susceptible to the downside in case we enter a recession.