Three Stocks That Look Cheap Here 25 comments
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It would seem that I made a lot of people mad in previous articles, when I claimed that Apple (AAPL), Google (GOOG) and Qualcomm (QCOM) didn't deserve their current evaluations. Well, I decided to take a different approach this time, and list a few stocks that I thought were trading at a lower evaluation than they were currently worth.
In the case of HD, this one might still require a few more months to start to rebound, but I am recommending getting into it now, as it will rebound so quickly when it does.
Criteria for my choices:
- Stock had to trade on a US-based exchange
- Large Cap stocks only (Minimum Market Cap of $10B)
- Stock must have been publicly traded for at least 5 years
- The stock must have posted Positive Earnings in the latest quarter
- Preference given to those that paid a consistent Dividend
Valero Energy (VLO) – Closing price of $33.41
Most people are aware that Refiners CAN move in sync with Oil prices, however, the general rule is that when the price of Crude moves up quickly, Refiners and Marketers are not able to pass on these rising costs in their entirety to the consumer. Known by the amusing term “Crack Spread” (which is defined as differential between the price of crude oil and petroleum products extracted from it) tends to suffer in environments like we are in now.
However, I believe that Valero has been punished excessively (not that their stock should not have fallen dramatically from its $75+ high, just not down to the level that it is today). Some drop was warranted, due to strong drop in earnings.
There hasn’t been a new refinery built in decades, so it is not likely that there will be an extreme drop in demand for the products that Valero produces. Sure, people are parking their SUVs, and there are more Hybrids on the road, but long-term demand is still going to be strong (this should be a temporary correction). Should Crack Spreads stay down too long, simple supply/demand rules say that Refiners, such as Valero, will have no choice but to reduce output to increase their margins.
This is also a company that shows off tremendous cash flow (over $10/share) and is trading close to its current Book Value.
Using Analyst’s Estimates, Valero is expected to earn at least $4.50 per share in 2009. Based on a relatively conservative 10x 2009 Earnings, this one should easily rebound back into the $40s (which could mean a 25 to 30+% upside in one year, plus a small dividend).
Home Depot (HD) -- $23.83
Am I saying that the Housing crisis is over? Sadly, I think we still have at least a good 12 months before we can say that this Credit Crisis / Subprime fiasco is done. So, it is too early to get into “Home Despot”, as Cramer so nicely calls it?
I don’t think so. Home Depot is still a wonderful franchise, has a dominant market share and it has a decent “Moat” around it (partly due to its strong real estate space….location, location, location!). This company still is a Cash Flow machine (over $3 per share in 2007) and has a strong RoE for a retailer (north of 20%).
The company has become increasingly shareholder friendly in the past few years, now that it has curbed some of its rapid expansion. HD now sports a yield that is close to 4%, and still as a bit of room to raise it (Payout ratio should stay about 50% of 2008 earnings)
This one may be slow over the next few months, but I suspect that it will start its rise closer to the end of the year (most experts think the Sub-prime mess will clear up in about 12 months, and this one will be one of the fast risers when things start looking clear).
Based on a 2009 Earnings Forecast of $2.00 to $2.25 (I think it has potential to beat 2nd half of 2009 Consensus estimates), and a 2009 P/E multiple of 14, this one has a chance to rebound towards $30 within 12 months. Factoring in dividends, this one might return 25-30% by the end of 2009.
Caterpillar (CAT) – closing price of $69.52
In previous downturns, it was quite simple. When the US went into a recession (or smelled like it might), CAT took a significant downturn. While the US makes up a large percentage of its business, CAT is now benefiting from 3 trends that might not have been applicable in the past:
1) Emerging Markets
Everyone is well aware of the explosive growth in the BRIC countries. While this is definitely benefiting CAT, other markets are also adding to its bottom line. Latin America, some parts of Africa and Eastern Europe have seen large growth and Middle Class expansion. This leads to more Buildings, Roads and other large projects, which play into CAT’s favour.
2) Long-term Infrastructure play
Even in developed countries, the need for Infrastructure is ever-increasing. Urban expansion, the push for more Commuter trains / Subways and more importantly, aging existing infrastructure (such as Bridges, which are collapsing at an alarming rate) has lead to Governments dedicating more resources than in the past. While Engineering firms might be a better way to directly benefit from this long-term trend, CAT will nevertheless benefit from this spending, which should be relatively recession proof.
3) Exposure to Resources
In past downturns, demand for resources tended to follow any US downturns. While demand for materials might suffer some drop in demand from the US, the Emerging markets need increased amounts of Copper, Steel, Platinum, etc. than ever before. This has helped to pick up some of the demand, and has kept many mining projects moving forward, when they might have been shut down in the past.
In addition to mining, there is an increasing demand for Oil from more remote places. This helps CAT in two ways. Infrastructure has to be put into to service many of these remote areas, such as Northern Canada. As well, much of the Oil Sands work in places like Canada involve massive vehicles, which CAT has the dominant share, and charges high margin prices for the vehicles, and their servicing.
With a large percentage of their revenue coming from recurring revenue, such as Servicing and parts, CAT looks to be able to weather this storm better than in the past.
Based on an expected earnings in 2009 of $6.50 to $6.75, and a modest Multiple of 13x 2009 earnings, this one should trade back into the mid-$80s range sometime in 2009. This would be close to a 25% upside, when you factor in its modest dividend.
Disclosure: Author is long VLO, no positions in other stocks
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This article has 25 comments:
tipalia
Tipalia -- They are absolutely long-term plays. Also agreed that many things look cheap here. The trick that seems to be to find those who are cheap without justification.
I was going to add Pfizer (PFE) and Gannett (GCI) on the list, but they both seem to be cheap for a good reason (Pfizer with its Lipitor and other patent issues. Gannett seems to have serious challenges to its long-term business model, and is carrying a lot of debt). I wanted to pick those that "were thrown out with the bath water"
Thanks for reading!
On CAT, we should not ignore that emerging markets also have to control inflation, especially if they are strong export based economies. To remain competitive, to ameliorate the condition of the poorer faction of their societies, and to avoid political fall-out/turbulence whether they are democracies (India and Brazil) or not (China, Vietnam). Indeed India has raised interest rates significantly recently while aknowledging that this may have appreciable effect to its growth rates. China also may do so after the olympics to avoid unrest, though the Chinese system has room for manipulating currencies and erecting export/import barriers in certain goods or commodities. I don't wholly buy the argument that in the context of globalization and with all that it entails emerging market economies for the most part will not be subject to some constraints on their growth rates. I agree with the author that the deep modulations that we saw in the past in CAT (and other export based cyclicals) is a thing of the past. But this does not imply that CAT and others will not be affected, but can only have upsides per se.
You both make valid points on VLO
Overcapacity may be a concern in the refining market. Only time will tell. I am wagering that is more than priced into VLO at this stage of the game, though. As for other large players, such as Exxon, these are not new competitors to Valero. Their competition has long been put into the price. While they have strong E&P revenue, in addition to their Marketing/Refining operations, they still get hit by lower margins in Refining. They won't stand for low Crack Spreads for very long either, I would think..
In terms of CAT, there is always a chance that the modernization of Emerging markets does slow down. However, one might need to put it in perspective.....China is growing at 4 to 5 times as fast as most Developed nations in 2008. This is stunning growth that even a small correction would still make it need tons of CAT's products.
Great feedback!
I do like many players in the Oil and Gas space at this stage (Tesoro would be good, I also like Transocean, Noble on the Services and Conoco on the E&P). I just chose Valero, as it was one that I knew well....
Disclosure -- Long on RIG
I'd be reluctant to dip my toes in the US Financial market as of yet. I think that you'll get a good chance to buy later in 2008. However, if you have a long term horizon, you might want to take a partial position soon, though, as I suspect that when they do turn around, they will go up like a rocket.
Home builders might still be too much of a contrarian player for me yet, but might be worth a look if you want to hold them for 3-5 years. I don't follow them that closely, but when you start to see the "Months of Home Inventory" number to drop for 2, maybe 3, consecutive months, I would probably be more likely to jump in.
Great points!
Disclosure -- no position in DE
I don't know either of the ones that you mentioned....
I have another question re the oil game (which I've been following for some time now). When an oil major (Chev, XOM, Shell, et al) sucks a barrel of oil out of the ground/ocean in an OPEC country - how much of the value of that barrel (say, based on $100/bbl) does the company get - and how much does the OPEC member get? Is the OPEC member paid a "royalty" on each barrel? Does anyone know? Percentage-based? Thanks.
The best one that I can speak of is Alberta, Canada, where I live now. The Provincial government will take a very small percentage of revenue for the first while (basically, while the company is recouping the investment that they put in, the Provincial government's royalties are 1% of profit + Corporate Income taxes). Once the initial investment is made back, the royalties will work on a sliding scale (based on the price of Natural Gas or Oil at the time). When you factor in Federal Income tax, it is not unusual to see between 25-40% (or more, in some areas) go to the Government coffers. When you factor in taxes, it becomes more like 50%. Alberta is somewhere in the middle of the road, from what we have heard....
They also "tax" wells or projects that have stabler production at a heavier rate. So, in SE Alberta, there are a lot of Shallow Gas wells. These wells do not take a lot of drilling effort, but tend to be not high producing (so, you need to put a lot of holes in the ground). These wells are taxed at a much lower rate, to the point that if the production falls below a certain amount, there are no royalties at all (only income taxes).
In the case of Deep natural Gas wells or Canadian Oil Sands, the resource will take a lot of initial investment (an Oil Sands operation might cost north of $15B, and an extremely deep Nat Gas well might cost 10's of Millions to drill). However, once you get the initial work done, you can produce many thousands of Barrels per day, at relatively low cost. Trying to encourage this investment, they are given the breaks at first, and the chance to recoup costs.
In many of the OPEC countries, they have Nationalized their production, so they have kicked out the Oil Companies (see Chavez's fight with Exxon). There are few places that are friendly towards Oil Companies anymore....
Hope this helps
Larry
Berkshire does scare me a bit (I am quite long on them, so not that much), in that they do have potential exposure to large scale catastrophes. Doubt that Buffett would allow them to be overexposed, but it does take a bit away from its overall safety. However, at its current price, that fear is more than built into the stock...
No positions in MO or RAI.
Thanks for reading!
Larry
I like them for their Integrated nature, as well as their new Oil Sands play at Fort Hills (which I have seen, as they are one of my customers).
Great, great long term hold....
Disclosure -- minor position in PCA-T
Valero would sit somewhere in the middle in the CapEx world (no low like a Financial company, but not high like a Communications Carrier).
Fortune.com lists a 2007 Free Cash Flow of $11.27/share. Not sure how much lower they will be when they announce 2008 Earnings. Now, it is trading at less than 3x 2007 Cash flow....assuming that this falls by the same rate as their earnings, they would still be trading at 5x 2008 Cash flow.
Cheers
Larry