Disclaimer: The distributor of this research note, Gould Partners, is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence. We are an investor relations consultant to Andrews and have received 100,000 euros worth of guaranteed equity compensation from the company for our services. We have sold 300 shares in the past and reserve the right to sell or buy at any time.
Investors are cautioned to perform their own due diligence as information contained within this report has been derived from public sources & management and cannot be guaranteed by us to be fully accurate. Always discuss investments with a licensed professional before making any financial decision. Statements made herein are often "forward-looking statements" as defined under Section 27A of the Securities Act of 1933, Section 21E of the Securities Act of 1934, and the Private Securities Litigation Reform Act of 1995. Since these statements are uncertain, actual results may be materially different from those expected.
Despite strong fundamentals that have delivered over the long haul, financials are still heavily undervalued. I find that this sector is discounted in nearly every industry -- a thesis that holds true ranging from companies that have origins dating back to two centuries ago to those that have recently went public. In this article, I will review four financials with vastly different histories and backgrounds: a recent real estate holding company, a consumer financial, a money center bank, and a life insurer. All are undervalued with compelling risks/rewards.
Andrews Development International (GXG:ANDI)
Andrews Development, a financial real estate firm, recently went public on the Danish GXG exchange. The company earns its main business from helping companies go public and grow through financing. The profit that it earns in this line is then reinvested in real estate, particularly multifamily properties.
On the risk side, Andrews Development lacks many of the downside factors that are typically common in newly public companies. Management has proven transparent by releasing operating projections; market volatility is a non-issue in light of the GXG Market's more direct transactions; and debt is not concerning given cash and sales guidance.
On the reward side, Andrews Development has plenty of room for appreciation. The firm is currently valued at ~50 million euros and, at a 4 times price-to-sales multiple on five-year guidance, the target price would be ~80 million euros when discounting by 12%. This figure actually understates Andrews Development's worth in light of the low P/S multiple and aggressive discount rate. Indeed, the price target would rise to more than double the current ~50 million euro price if the future P/S multiple turns out to be 5 times guidance and a 10% discount rate is factored in. In any event, a 1.9 times multiple on five-year guidance is a testament to the favorable risk/reward. By contrast, similar firms like Home Properties (HME), Camden Property (CPT), and Equity Residential (EQR) trade at a respective 5.1 times, 8.2 times, and 9.4 times sales.
Fundamentally, the company is well positioned to capitalize on the growing demand for financial intermediaries. By directly assisting emerging companies in their quests for growth and capital, Andrews Development is being buoyed by the global economy's positive secular trends. The financial holds an initial stake in its clients and thus benefits from the rising IPO market. At the same time, real estate has shown signs of improvement and heightened demand.
It's hard to imagine, but this money-center used to be worth ~$550 per share at its height before the financial collapse. It is now worth just ~5% of that peak, but the fundamentals are compelling in light of the 8 times multiple. Risk has been scaled back and the target price is now $40.64, or around a 43% premium to the current value.
The reasons why are clear. Perhaps most revealing, the firm is a free cash machine. It is valued at just 1.6 times FY 2011 free cash flow and is one-half of book value. Aside from the low multiples, performance has been strong. The firm has beaten expectations in four of the last five quarters for an average of 12.5% ahead of consensus. If the company grows EPS annually by 9.1% over the next five years at a 12 times multiple, its future stock value would be $66.44. Discounted backwards by an aggressive discount rate of 12% yields a price target of $37.70, which yields a healthy double-digit margin of safety. For a firm that delivered $40.89 in earnings per share around five years ago, growth has quite a bit to recover.
Discover Financial Services (DFS)
Discover is also cheap at 7.7 times past earnings and a strong pulse on consumer expenditures. Economists have been negative about how slow the recovery has been and, in my view, this has set the bar low for card providers like Discover and Amex (AXP) to outperform. I am particularly optimistic about the launch of a new mortgage business that, like Andrews Development, is well positioned to capitalize on a housing recovery. Specifically, Discover is working in mortgage origination that will provide fixed and variable-rate loans. Fees for such a service are attractive given the increased loan volume and refinancing activity.
Management also remains committed to returning free cash flow to shareholders with a strong $500 million worth of buybacks and dividends in the second quarter. After all, the firm has plenty of cash to hand back to investors that the market has failed to appreciate. Direct banking experienced strong growth, loans were up 9% year over year, and receivables are on an upward trajectory. Even cards, despite being flat across the industry, have seen delinquency rates fall below 2% on 30-day-plus terms and 1% on 90-day-plus terms. These fundamentals are valuable at an attractive price.
MetLife is even cheaper than Discover. It trades at 5.7 times past earnings and offers a reasonable 2.4% dividend yield. The current P/E multiple is actually nearly one-half of the sector's and 39% of the industry's. Free cash flow has been returning to FY 2008 levels and hit $8.8 billion in FY 2011. It's incredible that the firm is only worth 3.7 times this growing figure.
In my view, regulations have unreasonably held back value. The insurer is trying to sell its online banking division by June 30 to limit Fed oversight, but regulations will make it hard for that goal to be met. Fortunately, MetLife has appropriately diversified into emerging markets, and this strategy is already showing dividends. The firm's strongest growth of late has come from Latin America and Asia, and MetLife is rumored to be seeking more acquisitions in these rising markets.
Disclosure: I am long GXG:ANDI and reserve the right to buy or sell at any time.