Three Pullback Buys To Consider

I believe that Steven Madden (SHOO), Valero (VLO), and New Frontier Media (NOOF) are currently solid buys given their low valuations.

While I don’t know anything about women’s fashion, I do think I know something about reading financials, and it is from that perspective that I look at SHOO. SHOO is a pullback buy I was a few days late in discovering. Shares are down 15% in the last two weeks, and now trade for 10.5x free cash flow and under 6x EBITDA.

With the recent sharp decline in the price of SHOO, the company’s cash rich balance sheet now offers nearly 15% of the share price in cash. Much of that money will be used to buyback shares, and with the stock at a 52-week low, I’d look for management to start using some of that authorized money and create a floor under the stock - after all, a $59 million repurchase program is over 11% of the float, and with another 10% of the float short (over 7 average trading days worth of volume to cover), those two factors could create a short squeeze and a pop themselves.

I’m willing to bet that this strong brand with margins far in excess of its peers and consistent double-digit returns on equity will rebound, as I think the share price tumble was unwarranted and investors could see 20% upside as the market slowly realizes the fundamental strength.

Valero (VLO), America’s largest refiner, has come down more than 15% off of its 52-week high, and the swiftness of the pullback in the face of no real fundamental changes makes me see this as more of a buying opportunity on sector rotation weakness than anything else. People are still using refined petroleum, no new refineries are going to be built, and Valero’s heavy and sour crude processing capabilities put it at an advantage to other refiners that are limited to more costly light, sweet grades.

With $3.5 billion in free cash flow over the last year and a commitment to selling off underperforming assets and returning the money to shareholders through buybacks, I like the financial moves management has been making. Shares trade at 2x book value, even though the premium being placed on refining capacity coupled with the low carrying cost of Valero’s refineries means that the value of those assets is understated, and at 7x trailing earnings it is difficult to argue with how cheap the stock is.

I don’t use charts, but those of you who do should note that the last time VLO came into the $65 area, the stock held just below here and proceeded to run to over $75. I see more reasons why that should happen than the selling continues, although I would be willing to scale in and buy this stock down.

The last stock is New Frontier Media (NOOF), which is a distributor of adult videos through cable, satellite, and pay-per-view services. NOOF is just above 52-week lows and offers a whopping dividend yield of 6.01%, more than 100 basis points better than even the 30-year Treasury.

Yes, the payout ratio is quite high at 85% of free cash flow, but for a business with essentially no capital expenditures and 20% profit margins, I don’t see a liquidity squeeze anywhere in New Frontier’s future. Additionally, the company has a debt-free balance sheet loaded with more than $25 million in cash, not bad for a company with a market cap of just $200 million.

This is a cheap stock with the added benefit of a historically large dividend backed by real cash flow, and thus further downside seems rather limited.

Disclosure: Author does not have a position in stocks mentioned

Comments

[Andrew Hor...:]

SHOO? Where is Steve Madden now?
VLO, maybe
NOOF - Podcasts and broadband going to have effect on this??? HELL!

Why these three? WHY?

2007 Aug 03 02:28 PM

[James Cullen:]

Andrew,
The general "why these" comes down to the quant model I use to narrow down picks. Some of my comments were edited down here, but my basic reliance on the model comes from the ranking logic making sense... and about half of the top 25 list Jim Simon's Renaissance Technologies as a top holder. I just confirmed that gem the other day.
For the particular "whys":
I'm not sure where Steve Madden is, as I wouldn't be able to pick the guy out of a lineup. I do know, however, that the informal survey of a few girls did reveal that they are completely willing to buy hundreds of dollars on products bearing his name. If Steve is really dead, maybe thats a good thing - revenues did grow about 25% YoY in 2006 v. 2005, and earnings were up about 150%. What am I missing?
Obviously broadband could hurt NOOF, but they did turn in another impressive performance YoY on the top line, which makes me question the real impact it is going to have. If I was going long NOOF, I would heavily consider a short on Playboy (PLA) to turn it into a more hedged pair trade; if you look at the ratios on PLA and compare them to NOOF I believe the discrepancy is startling. PLA is almost 4x more expensive on an EV/EBITDA basis, operating margins are 1/9th of those for NOOF, etc. etc.

I'll be checking here the next day or two looking for a reply, but after that I'd prefer to be contacted at my email - research@"my site name".com

2007 Aug 04 07:38 AM