These Oversold Stocks Are Now Too Cheap To Ignore

Includes: MEA, NBR
by: Trade In Mexico

With markets trading at or near record highs, it is getting harder to find bargains. Because of this, patient value investors might want to focus more on out of favor stocks that could be poised to surprise to the upside. Late last year, Hewlett-Packard (NYSE:HPQ) shares were out of favor and even hit new 52-week lows at about $11. However, that was a huge buying opportunity to pick up a bargain from investors who had given up on the company. Hewlett-Packard has more than doubled in the past few months, and it has become one of the best performing stocks for 2013. This and numerous other examples show how it can pay to buy out of favor stocks while many investors are giving up hope.

Furthermore, both of the stocks below could rally if commodities rebound since one of the companies is exposed to the price of natural gas and the other is exposed to the price of industrial and other "commodity" metals. Analysts at JP Morgan believe a bottom is in for this sector now and just upgraded commodities. A recent article states that JP Morgan gives ten reasons why investors should go "overweight" into commodities. The article details the very bullish outlook, which states:

For the first time since September 2010, the firm is making an overweight call on commodities.

JPMorgan analysts led by Colin Fenton say seasonal forces are reversing, supply channels are thinly stocked and sentiment is universally bearish.

"In a number of commodities, prices have fallen far enough for long enough to force involuntary cuts in production and to spur fresh demand," the analysts said.

With this in mind, below are a couple of out of favor stocks with commodity exposure, which also appear cheap. Both of these stocks trade well below book value, could be bottoming out, and are possibly poised for significant longer-term upside:

Nabors Industries, Ltd. (NYSE:NBR) is an industry leader that provides drilling, engineering, fracking and other services to some of the world's largest oil and natural gas companies. It has a large fleet of about 500 drilling rigs. While the long-term outlook seems solid for this industry, there appears to be a soft patch right now.

Nabors recently warned (after the market closed on July 9), that second quarter results would come in below expectations and that sent the stock significantly lower. The company blamed weather, competitive pressures and weak demand for rig services for the shortfall. While analysts had expected $111.8 million in operating income for the quarter, the company now expects to report $88 million to $91 million in operating income for the second quarter. The company will report financial results on July 23.

While this is a short-term setback that has caused a sharp decline in the stock, investors might want to take a contrarian approach and consider buying a little into the pullback. Nabors shares have a 200-day moving average of $15.37, so the stock might find support right around the $15 level. It can take several days for a stock to find a bottom after an earnings or guidance miss, and there could also be analyst downgrades in the coming days which could exacerbate the selloff. Because of this it usually pays to average into the stock after it has stabilized a bit.

Consensus estimates are at 98 cents for 2013, although that might be high with the latest earnings warning. However, analysts see profits rebounding to $1.40 in 2014 and that would give the stock a below market PE ratio of just about 10.5 times earnings. This stock also looks undervalued based on the fact that it trades below book value which is $20.28 per share.

Finally, this stock has been the subject of takeover speculation in the past and that could give these shares interesting upside potential in the future. A Morgan Stanley report has listed Nabors as a top takeover pick. Nabors has adopted a shareholder rights plan in order to protect it in the event of a hostile takeover. It's also worth noting that there is also an activist investor named Pamplona Capital Management LLP., involved and it has already bought a 9.3% stake in the company and could buy more in the future. A deal between Nabors and Pamplona has allowed for the mutually agreed upon appointment of independent directors, a press release states:

Alex Knaster, Chairman of Pamplona Capital Management, said, "We believe that the agreement reached will provide new independent voices and perspectives to Nabors' Board and will improve the focus on maximizing shareholder value. We are pleased with the Board's commitment to conduct a strategic review and look forward to continued constructive interaction with Nabors."

Nabors has significant exposure the natural gas business in North America and this could be a downside risk if natural gas prices were to decline significantly. While an economic recession, or major drop in energy prices could create additional downside risks for Nabors, it seems that plenty of bad news is already priced into the stock. It trades well below book value, and for just about 10.5 times earnings estimates for 2014, which gives the appearance of a bargain. Plus with takeover potential and an activist investor owning a major stake in the company, there seems to be a buying opportunity at hand.

Metalico, Inc. (NYSEMKT:MEA) shares have taken an undeserved beating in the past few weeks and this is providing investors with what could be an exceptional one time buying opportunity. Metalico is a leading recycler of a wide variety of metals which includes aluminum, molybdenum, lead, tungsten and others. It also processes precious metals from automotive catalytic converters and other products.

Due to portfolio allocation changes, Metalico was removed from the Russell 2000 and the Russell 3000 Index on June 30, 2013. This led to a sharp drop in the share price leading up to June 30, as funds and ETFs that track the Russell Indexes needed to sell this stock in order to make room and buy stocks that were added to those indexes. It is clear to see that this event caused selling to reach a peak on the last trading day of the month which was June 28. On that day, volume surged to 3,494,500 shares and the stock hit a new 52-week low on that very day. This shows that Metalico shares were the unfortunate victim of portfolio model reallocations, and the sell-off clearly does not seem warranted nor is it based on fair value, or any news or fundamentals from the company.

On the positive side, the shares have already stabilized from the sell-off and even started to rebound a bit. However, there appears to be plenty of rebound potential left in this oversold stock, and it could be poised to gap up as more investors regain confidence and see the long-term value in these shares. Now that we are past the June 30th date, and since trading volumes are returning to more normal levels, it is clear to see that the sell-off from this event is over. What is left is a cheap stock that could be driven higher by fundamentals, bargain hunters and shorts who jumped onboard due to the Russell Index portfolio changes.

In early January of this year and again in March, this stock went up to about $2.20 per share, so it is volatile and capable of big moves both up and down. With the shares at nearly half that level now around $1.34, the stock appears way too cheap. The Russell Index induced sell-off has taken this stock to just a fraction of book value which is $3.75 per share. Metalico posted revenues of about $547 million in the past year, so it is a significant player in the industry. While the recycling industry has been facing challenges due to a slow economy, investors who take a longer-term view could be positioned for big gains.

Back in May, I wrote about Metalico in another Seeking Alpha article which pointed out downside risks and challenges as well as the fact that the CEO, Carlos E. Aguero owns a significant stake of over 5.5 million shares in Metalico. The article also noted that he hinted (during the last conference call) at a potentially large new contract which could boost financial results, he stated:

"Yeah, it happened to… Just sort of briefly, it happened to coincide with a previously scheduled meeting that for a large job that is coming up which we feel confident that we are in line to secure. We've been given indication that we will in fact get it, and we're now just waiting for confirmations and permits. But that's really… Because of competitive reasons, I really don't want to go into it any further, but I will say that it was a successful visit and that we expect to get results from it."

Based on those statements the CEO seems fairly confident that this "large job" will happen. This could lead to the continuation of a recent trend of improving financial results. For the first quarter of 2013, Metalico reported $611,000 in operating income before deducting interests and taxes, which created nearly break-even results on a per share basis. This compares favorably to a $1.7 million operating loss when adjusted for impairment charges which was reported in the fourth quarter of 2012.

With the company operating at near break-even results in the past quarter, and with a potentially large contract coming in, any additional downside risks could be minimal at current levels. It's worth noting that the company has been reducing payroll, benefits and other operating expenses which could also lead to even better results in the future. If higher revenues from the large contract come in, if expense reductions improve profit margins and if industrial metal prices improve along with the economy, this stock could have very significant upside potential. When commodity prices were surging a few years ago, this stock was trading for just over $17 per share in June, 2008, and for over $6 per share in 2011. That shows the potential upside for long-term investors, if commodity prices do rebound over time.

Data is sourced from Yahoo Finance. No guarantees or representations are made. Please consult a financial advisor before making investments.

Disclosure: I am long NBR, MEA. 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.