It's Time To Consider These 3 Undervalued 'Special Situation' Stocks

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Includes: AIG, GNW, MET, SVU
by: Hawkinvest

Summary

The stock market correction of about 10% in the first weeks of 2016, has created an ideal buying opportunity.

Every scare this market has had in the past few years has been a buying opportunity, and not another 2008-style crisis.

Current fears are overblown, stocks are much cheaper now and appear undervalued when you consider the 10-year Treasury Bond yields just 2%.

Stocks with special situations like spin-off potential could be poised to significantly outperform the rest of the market.

It seems like every single time the market has a correction, many investors quickly revert back to memories of the Financial Crisis and start to believe that this could be 2008 all over again. However, even though some investors considered Ebola, SARS, swine flu, Greece or "Grexit", the debt ceiling, and the S&P downgrade of U.S. Treasury debt to be the start of another financial calamity, these concerns faded and in hindsight were ideal buying opportunities. This shows that every major market concern or pullback since the Financial Crisis, has actually rewarded investors who bought while others ran in fear.

For a number of reasons, I think the recent sharp pullback the market has seen is just another buying opportunity. First of all, I acknowledge that the global economy is slow, but it is still growing in spite of the challenges. The global economy has always had challenges, but that has not stopped it from growing over time nor has it stopped stocks from being a strong way to create wealth over many decades. I don't think a 1/4 point increase in rates is going to derail the U.S. economy and I also doubt that the Federal Reserve is going to raise rates again anytime soon. The world's Central Banks still have our backs and are not going to suddenly withdraw. Furthermore, with the 10-year U.S. Treasury bond yielding about 2%, stocks are not expensive. In fact, with a PE ratio of about 15 times, the average stock has an earnings yield of about 6%, which is triple the yield provided by bonds.

The best time to buy stocks is when there is a sale, just as there is now thanks to a market pullback of roughly 10%. Since the market has been in an unforgiving mood lately, it does make sense to be more cautious by averaging into positions and also by focusing on stocks that have "special situations" which could be upside catalysts. Special situation stocks could include ones that have upcoming spin-offs and that is what I have recently been focusing on. With this in mind, let's take a closer look at some undervalued stocks that have recently announced a plan to boost shareholder value through a spin-off:

MetLife (NYSE:MET) is a leading provider of life insurance, annuities, employee benefits and other financial services. This stock was trading at about $52 per share in December, but has since fallen to the low $40's. Financial stocks have been hit hard recently due to concerns that the Federal Reserve won't be able to raise rates too rapidly since the global economy is not experiencing stronger growth. But, this concern seems overblown because these financials did not have a huge rally over expected rate increases and these companies have also been dealing with low rates for nearly a decade. All of these firms are now better off with a 1/4 point rate increase. The other concern is that financial firms have some exposure to losses in the energy sector. However, as the CFO from insurance giant Travelers (NYSE:TRV) recently pointed out, risk from energy junk bonds is "quite manageable".

Analysts expect MetLife to earn $5.88 per share for 2016, and this puts the price to earnings ratio at just around 7 times. This stock also offers a dividend yield of 3.55%. Analysts have recently become more bullish with upgrades and price target increases. On January 19, 2016, analysts at RBC Capital Markets reiterated an outperform rating on MetLife and raised the price target from $61 to $65 per share. On January 22, 2016, analysts at Raymond James upgraded this stock from market perform to strong buy. MetLife just announced it would spin off its U.S. retail business which could reduce regulatory burdens and create shareholder value. Many analysts applauded the move and Thomas Gallagher of Credit Suisse stated:

"Our bottom line on the announcement is that we think it is the right short term and long term direction for the company and is a meaningful positive for the valuation of the stock, especially at the current depressed levels,"

American International Group (NYSE:AIG) seems to have decided to follow in MetLife's footsteps as it just announced it will pursue the spin-off of its mortgage insurance business. That might not go far enough however, because Carl Icahn is pushing AIG to break up into three separate businesses. More details are expected to come soon, but a Marketwatch article states:

"AIG is expected to discuss the future of the mortgage insurance business on Tuesday, when it releases its strategic plan, and the sources said this week the company will pursue a partial spin-off of the asset. This would mean that AIG shareholders would only receive some of the shares of the spun-out company, with the remainder kept by AIG itself."

Analysts expect AIG to earn $5.10 per share in 2016, and that implies a PE ratio of about 11. The dividend yield is around 2% which is lower than what other major insurance companies pay out. With a PE ratio of 11 and a yield of about 2%, I don't think this the biggest bargain in the sector, but it certainly appears undervalued relative to the rest of the market. The potential for the mortgage insurance spin-off or the breakup of the entire company could put a floor under the stock in the short term and longer-term it could create significant shareholder value. There appears to be a trend in the insurance industry for spin-offs, so speaking of mortgage insurance, I believe that Genworth Financial (NYSE:GNW) could be the next company to announce a spin-off later this year. Billionaire and activist investor John Paulson has suggested in the past that Genworth should spin off its mortgage business and the company has said it is considering this option. Analysts at Booth Laird Investment Partnership also see spin-off potential and believe that the company assets or sum-of the-parts value could be over $10 per share. An analyst at BTIG also sees major upside potential and about two weeks ago came out with analysis that suggests a spin-off or breakup of the company and set a $10 price target.

Supervalu (NYSE:SVU) is a supermarket chain with about 3,400 stores and around 35,000 employees. The Save-A-Lot division, which has over 1,000 stores, is a fast growth potential business that competes with dollar stores and companies like Costco (NASDAQ:COST). Save-A-Lot had sales of about $4.6 billion, while Supervalu had total sales of around $17.8 billion in the past year. Supervalu just filed a form 10 with the SEC on January 7, stating that it plans to move forward with a spin-off of Save-A-Lot. Supervalu plans to either spin off this company with about 80% or more going to shareholders or it could sell this business to a private equity company, as a number of firms have expressed interest in buying Save-A-Lot.

This stock has plunged along with the market and also because some investors were disappointed with recent financial results. But this appears to be a major overreaction and I expect this stock to rebound from oversold levels soon. Supervalu reported Q3 earnings of16 cents per share which met analysts' estimates. It also matched revenue estimates of $4.1 billion that were issued by Factset, but missed another analyst estimate of $4.2 billion. This miss off the higher revenue estimates is about a 2.8% difference, but the stock has dropped by about 30%, which is way overdone and creates an ideal buying opportunity.

Analysts expect Supervalu to earn 73 cents per share in 2016, and nearly 80 cents per share in 2017. That means this stock is now trading for just about 6 times earnings which is very undervalued relative to industry peers and the rest of the market. Peter Andersen of Congress Asset Management (which owns Supervalu shares) estimates that the Save-A-Lot division is worth about 10 times EBITDA, which would imply a potential value of about $2.2 billion. After the recent decline in Supervalu shares, the current market capitalization is only around $1.2 billion or nearly half of what Save-A-Lot could be worth after the spin-off. That is another sign the plunge from nearly $7 to below $5 is excessive and an ideal buying opportunity. Just a couple weeks ago, TheStreet.com published an article that suggested Supervalu shares could have significant upside and set a 6 to 12 month price target of $12 per share. On January 14, 2016, (a day after Supervalu reported earnings) an analyst at Pivotal Research Group reiterated a buy rating and set a $10 price target for Supervalu shares. Supervalu management has suggested that the Save-A-Lot spin-off could occur in the next few months, which means investors would not have long to wait before this potentially significant upside catalyst boosts the share price. With this stock being extremely cheap and oversold now, I believe it will rebound soon back towards the $6 level and then rise further as the spin-off deal draws closer.

Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.

Disclosure: I am/we are long GNW, MET, SVU.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.