These Companies Are Ready To Start Moving Up

Includes: BFR, CMLP, FTR, MAR, PT, TOL
by: FAF Research

When I analyze a stock, I like companies that can grow in the future without requiring equity financing. If a company is only able to grow by issuing equity or increasing its debt levels, the larger number of shares outstanding or the higher leverage will cancel out any benefit that equity holders might realize from a company's growth. It is essential to find companies with high profit margins because they are better able to generate returns internally. In addition, companies that are able to maintain adequate cost controls over its fixed assets and working capital are able to manage its cash needs and avoid equity financing.

In the article, I will describe some stocks I found interesting to research and explain some positives about each company. It is important to evaluate not only each company's fundamentals and the whole "story," but the quality of the management. An above average management is determined to develop new products and services that will continue to spur sales growth long after current products or services are largely exploited.

BBVA Banco Frances (NYSE:BFR)

A full-service banker for large corporations, middle market businesses and individuals, Banco Frances Del Rio de la Plata S.A., operates approximately 74 branches in Argentina, 8 branches in Uruguay and a subsidiary bank in the Cayman Islands.

As regards Valuation Ratios, BFR´s Current Net Profit Margin is 25.41%, currently higher than its 2009 margin of 12.88%. I like companies that increase profit margins in comparison to other years. Current Return on Equity for BFR is 35.91%. That is higher than the +20% standard I look for in companies I invest and also higher than its 2009 average ROE of 28.73%.

In terms of income and revenue growth, BFR has a 3 year average revenue growth of 13.37% and a 3 year Net Income average growth of 72.10 %. Its Current Revenue Year over Year growth is 17.80%, higher than its 2010 Revenue growth of 10.53%. The fact that revenue increased from last year shows me that the business is performing well. I look for companies that increase both profits and revenues.

In terms of Valuation Ratios, BFR is trading at a Price/Book of 1.4x, a Price/Sales of 0.9x and a Price/Cash Flow of 1.0x in comparison to its Industry Averages of 1.9x Book, 2.3x Sales and 19.6x Cash Flow. It is essential to analyze the current valuation of BFR and check how is trading in relation to its peer group.

The Argentine economy has been exposed to high levels of volatility, and for more than one hundred years, Banco Frances has survived and prospered. During periods of economic slumps, BFR has grabbed the opportunity to buy its distressed competitors and grow its market share. During periods of economic prosperity, BFR has built up its balance sheet ready for another acquisition, making its balance sheet stronger.

BFR has plenty of cash, zero debt, has proven itself over 125 years, is currently paying a high dividend yield (but that could be unstable because of government policies), and is trading at book value. The upside potential vs downside risk for BFR is very attractive, and many investors will see good value at current prices

Portugal Telecom (NYSE:PT)

Portugal Telecom Group, the largest telecommunications and multimedia company in Portugal, offers a package of products and services complying with the market's needs, in which the most important factors are quality, diversification and innovation. Nationally, the company offers the local, long distance and international telephone service, as well as circuit rental. In areas of free competition, the services include cellular phones, paging, cable TV, data communication, value added and broadcasting.

When analyzing this company for investing, I found that, in Brazil, PT has sold its stake in Vivo, the largest wireless operator, to its partner Telefonica TEF for EUR 7.5 billion ($9.6 billion). It used roughly half the proceeds to buy 25% of Tele Norte Leste TNE, known as Oi. Oi is the largest fixed-line telephone company in Brazil, and the fourth-largest wireless corporation. These transactions conclude PT's bitter relationship with Telefonica, but still provide the firm with access to the large Brazilian market. I think Oi is not as well-positioned as Vivo, but I also think the growth opportunity left in Brazil is not as great as either firm think. I believe PT received a great price for Vivo and selling the asset was the correct decision.

The other international operations PT has performed are interesting and have positive growth potential, particularly those in Africa; but PT only has a minority position in most, and they are generally quite small. However, with the speed of growth they show, these operations should become more significant over time. This was one of the reasons why I think it could be interesting to research Portugal Telecom. It has a growing presence in emerging markets.

In terms of income and revenue growth, PT has a 3 year average revenue growth of -15.22% and a 3 year Net Income average growth of 97.08 %. Its Current Revenue Year over Year growth is 0.24%, higher than its 2009 Revenue growth of -44.45%.

In terms of Valuation Ratios, PT is trading at a Price/Book of 1.1x, a Price/Sales of 0.7x and a Price/Cash Flow of 2.8x in comparison to its Industry Averages of 1.6x Book, 1.0x Sales and 4.1x Cash Flow. It is essential to analyze the current valuation of PT and check how is trading in relation to its peer group. PT is trading cheaply in comparison to its peers because it has a high exposure to a difficult Portugal economy.

Regarding Financial Health, Net debt of PT decreased to EUR 6.5 billion with the recent receipt of the final EUR 2 billion payment from Telefonica TEF for Brasilcel. While this is 3.8 times trailing annual EBITDA, the company isn't levered enough. PT didn't consolidate Oi's EBITDA until 2011's third quarter, so the trailing annual EBITDA only has one quarter of Oi's EBITDA, but the entire proportion of its debt. Annualizing the third quarter's EBITDA of EUR 654.2 million lowers debt/EBITDA to 2.5 times. Nonetheless, this is still higher than the European average of about 2.

Frontier Communications Corporation (NYSE:FTR)

As a communications company providing services to rural areas and small and medium-sized towns and cities, Frontier Communications Corporation, provides voice, high-speed Internet, satellite video, wireless Internet data access, data security solutions, bundled offerings, specialized bundles for small businesses and home offices, and advanced business communications access solutions for medium and large businesses in 27 states and with approximately 14,900 employees. The company also offers television services, which comprise access to various digital television channels featuring movies, sports, news, music, and high-definition TV programming; and wireless data services. In July 2008, it changed its name from Citizens Communications Company to Frontier Communications Corporation.

Why do I think this company is an attractive investment? Because Frontier continues to implement several growth initiatives, including new products and services, to produce higher revenues. The company aims at wireline and wireless high speed Internet, satellite video products, Internet advertising and the Frontier Peace of Mind product suite, which is focused on providing different bundles of services (including hard-disk backup, unlimited information storage and PC security). The fact that Frontier is experiencing encouraging market response for this suite of products as reflected by increased revenue and subscriber penetration is attractive to invest. Frontier will also have access to various marketing practices including the sale of voice, data and video services as bundled packages and the use of promotions and incentives, including gifts such as personal computers, digital cameras and gift cards, to drive market share. These marketing strategies are believed to present an important opportunity to increase revenue per customer, as well as strengthen customer relationships and improve customer retention.

Furthermore, Frontier is strengthening its balance sheet and centering on the sustainability of the 12-month dividend to its shareholders, which Simons understood as positive for his investment decision. The company´s leverage (net debt to adjusted operating cash flow), at the end of June 30, 2011, stood at 3.08 times. This company is also trying to reduce its leverage to 2.5 times through a combination of EBITDA improvements and debt reductions. Frontier paid a total of $373.2 million as dividends that equated to a payout of 77% of free cash flow, in the first half of 2011. The company expects the payout ratio to increase in the future when network improvement and IT conversions are fully completed. Frontier currently pays a 12-month dividend of $0.75 per share, representing a 25% decline in its annual dividend from the first half of 2010. In spite of the decline, Frontier´s dividend is the highest in the telecom sector.

As regards Valuation Ratios, FTR´s Current Net Profit Margin is 2.85%, currently lower than its 2010 margin of 4.02%. I do not like it when companies have lower profit margins than the past. Current Return on Equity for FTR is 3.10%. That is lower than the +20% standard I look for in companies I invest in, and also lower than 2010 average ROE of 5.53%.

In terms of income and revenue growth, FTR has a 3 year average revenue growth of 32.83% and a 3 year Net Income average growth of -6.44 %. Its Current Revenue Year over Year growth is 38.06%, lower than its 2010 Revenue growth of 79.31%.The current Net income year growth is -2.00%, lower than its 2010 Net Income y/y growth of 26.40%.

FTR is trading at a Price/Book of 0.9x, a Price/Sales of 0.8x and a Price/Cash Flow of 2.6x in comparison to its Industry Averages of 1.6x Book, 1.0x Sales and 4.1x Cash Flow. It looks undervalued over its peers.

I believe Verizon's wireline operations continue to enhance broadband deployment and high-speed Internet connections in rural areas that would lead to higher profits and free cash flow. I stay positive on the revenue generation, as Frontier is offering various promotion initiatives, marketing practices and aggressive bundled services to improve customer relationship. Nevertheless, I remain concerned about Frontier´s highly leveraged balance sheet derived from ongoing expansion efforts primarily related to the broadband network expansion. Intense competition and regulatory pressure will also restrict operating results going forward.

Regarding Financial Health, as revenue is in decline and the firm faces the challenge of turning around the Verizon properties, Frontier carries fairly heavy leverage. Net debt stands at about 3 times operating income, excluding depreciation and amortization.

Inergy, L.P. (NRGY)

Inergy, L.P. owns and runs a fast growing retail and wholesale propane marketing and distribution business. Their retail business includes the retail marketing, sale and distribution of propane to residential, commercial, industrial and agricultural customers.

John Sherman, President and CEO of Inergy, said they faced a challenging operating environment in the quarter particularly impacting their propane operations, and that they significantly completed the IPO of Inergy Midstream, which provided them the ability to finance more efficiently the expansion of their growing midstream business. This for sure attracted Simons to invest in this company. Sherman also said their management team is deeply involved in repositioning the partnership for the future on behalf of their investors.

The Company Reported Q2 (NYSE:MAR) earnings of $0.31 while revenues fell 8.1% year/year to $662.4 mln vs the $677.7 mln consensus.Management explained:

Our results for the quarter reflect the impact of unprecedented weather on our propane operations. In the midst of a challenging year in the propane business, we have worked to reposition Inergy for the future... The recent IPO of our northeast midstream business followed by the announced strategic contribution of our retail propane operations to Suburban Propane will accelerate the evolution of Inergy into a pure play midstream energy co. As we look forward, we expect to enhance our midstream growth strategy and deliver value to our unit holders.

Recently, NRGY was upgraded to Neutral from Underperform at Robert W. Baird; the target was raised to $21 from $15. The Robert Baird analyst raised the outlook based on co's propane unit sale, with a $4.50/share credit in their valuation from the distribution of 0.104 SPH units for each unit held expected in CY3Q12. In addition to exiting the poor retail propane business to focus on the more attractive midstream business, the transaction delevers co from 55% debt/capital to 25% debt/capital which will strenghten its balance sheet considerably.

In terms of income and revenue growth, NRGY has a 3 year average revenue growth of 4.66% and a 3 year Net Income average growth of -35.34 %. Its Current Revenue Year over Year growth is 20.59%, higher than its 2010 Revenue growth of 13.71%. The fact that revenue increased from last year shows me that the business is performing well. The current Net income year over year growth is -71.52%, lower than its 2010 Net Income y/y growth of -39.05%. I do not like when current net income growth is less than the past year. I look for companies that increase both profits and revenues.

In terms of Valuation Ratios, NRGY is trading at a Price/Book of 1.8x, a Price/Sales of 0.9x and a Price/Cash Flow of 17.3x in comparison to its Industry Averages of 1.8x Book, 1.0x Sales and 6.9x Cash Flow. It is essential to analyze the current valuation of NRGY and check how is trading in relation to its peer group.

Toll Brothers (NYSE:TOL)

Toll Brothers design, build, market and arrange financing for single-family detached and attached homes in luxury residential communities. Toll Brothers is also involved, directly and through joint ventures, in projects where we the company is building, or converting existing rental apartment buildings into, high, mid and low-rise luxury homes. TOL caters to move-up, empty-nester, active-adult, age-qualified and second-home buyers in 21 states of the United States.

TOL recently gave a solid presentation at Wells Fargo Industrial and Construction conference. The Company says they still see fear in the market, but this year, they have done well, and they see growth into 2013. The Company notes that urban market has been a fabulous part of their business, that they are the only national that has invested in urban the way they have. They also noted they have 5 buildings for sale in New York, and the market is strong. I liked it when management said they has started a company call Gibraltar that is looking to buying up bundled underperforming loans, and working out those loans and trying to make a profit. TOL has about $130 mln invested in Gibraltar right now, and that segment will grow.

Boutique research firm MKM view that the housing market is in a bottoming process. The recovery will be gradual and somewhat choppy especially in the early months. MKM analyst remain generally somewhat cautious on the space after the recent run, but recommends to buy TOL on days of market weakness. On April 19, Deutshce Bank also upgraded TOL to Buy from Hold.

I like TOL because they doesn't build basic, first home buyer dwellings. Instead they are leaders in the the luxury residential community market for wealthy older clients. It acquires and develops land in prime locations and is currently working in 19 states.

I think the time to invest in TOL is now. The company projects that many of its markets have bottomed, after six years of declining consumer confidence, softening of demand and over supply of housing. Pent-up demand may be gradually starting to release, and the company has available for sale over 15,000 home sites in communities currently being developed, and more than 20,000 home sites in 'future communities'. The company is also growing in the urban market and has a growing presence in New York, a really strong real estate market.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in (TOL) over the next 72 hours.