15 Lowest EV/EBIT Large Caps With Strong Balance Sheets (And With Great Statistical Returns)

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Includes: BRDCF, BRDCY, CEO, DVN, HLPPF, HLPPY, HXSCF, INTC, IPXHF, IPXHY, JAPSY, LUKOY, MU, OGZPY, SGTPY, SGTZY, SSL, SSNLF, SSNNF, VWAGY, WDC, WOPEF, WOPEY
by: Ruerd Heeg

Summary

Low EV/EBIT stocks with strong balance sheets are stocks with great statistical returns.

This list confirms that cheap stocks with good returns are where the future looks darkest: resource companies, memory chip manufacturers and Russia.

Using these stocks as the long leg of a long/short pair can greatly reduce risks.

In my discussion of these stocks I give two suggestions for such pairs.

Stocks of companies earning enough to pay themselves off quickly to potential acquirers are great investments. Such stocks have a low multiple enterprise value/earnings before interest and tax or EV/EBIT. Research has shown that this is one of the best measures for the valuation of stocks. It works even better in combination with strong balance sheets.

Expected returns are should be close to 20%, on a statistical basis, for the following three reasons:

  1. There is research showing that a low P/E strategy combined with strong balance sheets has long-term annualized returns of about 18%. This particular restricted low P/E strategy also performs much better than an all-stocks low P/E strategy.
  2. Other statistical research also has shown that low EV/EBIT strategies perform better than low P/E strategies. This makes sense since many low P/E stocks carry extra risk due to excessive leverage. EV corrects better the many different possibilities of financing next to common equity.

An extra confirmation is that many extremely successful value investors (among others the first value investors Graham, Buffett and Schloss) prefer strong balance sheets. Stocks of companies with levered balance sheets are more volatile than stocks of companies with strong balance sheets. Professional investors often try to minimize the risks connected with high leverage. For example the probability of being diluted after unforeseen events as might happen with Volkswagen (OTCPK:VLKAY). They think as an owner or an acquirer trying to buy the company as cheap as possible. The enterprise value and the EBIT are better measures than the market capitalization and the earnings respectively.

Most of these stocks are unknown small caps but there also are a few large caps with a low EV/EBIT multiple and a strong balance sheet. For those who do not want to invest in unknown but even cheaper small-cap stocks I keep track of very cheap large-cap stocks with low EV/EBIT and strong balance sheets.

So here are the search criteria:

  1. Market cap greater than $10 billion USD
  2. Enterprise value/earnings before interest and tax less than 7
  3. Tangible assets less than twice tangible common equity
  4. Earnings before interest and tax greater than zero

The search criteria are a bit less restrictive than for the list I made two months ago. Two months ago the limit for EV/EBIT was 8 instead of 7. If I would have chosen 8 instead of 7 I would have found 14 stocks. See also my previous large cap list that contains 13 companies. The list below contains 15 companies. When comparing the current list with the previous list I see another difference. EV/EBIT multiples seem to have decreased. Together with the increased number of stocks found this indicates that global stocks became cheaper during the past two months.

Name

Ticker, Piotroski Score

Country, Business

Price

Market cap, Enterprise Value in billion USD

EV/EBIT

Yield (%)

SK Hynix (OTC:HXSCF)

SEO:000660,

8

South Korea, memory (DRAM, NAND)

32,700 KRW

20.3,

19.9

3.9

0.9

Gazprom PAO (OTCPK:OGZPY)

LON:OGZD, US:OGZPY,

4

Russia, state owned, natural gas and oil

3.87 USD

46.1,

71.1

4.4

5.3

Inpex Corp (OTC:IPXHF) (OTCPK:IPXHY)

1605:TYO,

5

Japan, oil and natural gas

1180 JPY

14.3,

16.1

4.5

1.5

Surgutneftegaz (OTCPK:SGTZY) (OTCPK:SGTPY)

LON:SGGD, SGTPY:US,

5

Russia, oil and natural gas

5.1 USD

22.3,

14.2

4.7

24.3

Sasol (NYSE:SSL)

US:SSL,

6

South Africa,

coal, oil, natural gas, chemicals

27.9 USD

18.3,

18.3

5.9

5

Japan Airlines (OTCPK:JAPSY)

TYO:9201,

4

Japan,

airline

4245 JPY

12.7,

10.4

6.1

2.4

Samsung Electronics (OTC:SSNLF) (OTC:SSNNF)

SEO:005930,

6

South Korea,

consumer electronics

1,300,000 KRW

183,

140

6.4

1.6

Micron Technology (NASDAQ:MU)

US:MU,

5

US,

memory (DRAM, NAND)

14.48 USD

15,

19.8

6.6

0

Western Digital Corp (NASDAQ:WDC)

US:WDC,

6

US,

memory (hard-disks, SSDs)

61.3 USD/

14.2

11.3

6.7

3.1

Bridgestone Corp

(OTCPK:BRDCY) (OTC:BRDCF)

TYO:5108

5

Japan, tires and other rubber products

4428 JPY

28.4

28.9

6.8

2.8

Lukoil (OTCPK:LUKOY)

LON:LKOD, US:LUKOY

6

Russia, oil and natural gas

33.3 USD

28.3,

38.5

6.8

6.2

CNOOC (NYSE:CEO)

HKG:0883, US:CEO,

4

China, state owned, oil and natural gas

109 USD

48.5,

54.6

6.9

3.6

Woodside Petroleum (OTCPK:WOPEF), (WOPEY)

ASX:WPL,

2

Australia, oil and natural gas

28.2 AUD

16.8,

21.5

6.9

10.3

Hang Lung Properties (OTCPK:HLPPY) (OTCPK:HLPPF)

HKG:101,

7

Hong Kong and China, real estate

18.2 HKD

10.5,

11.2

7.0

4.2

Hyundai Mobis Company

SEO:012330,

4

South Korea, auto parts

252,500 KRW

21,

17.9

7.1

1.2

The list reflects common knowledge that good returns are available where the future looks darkest: resource companies, memory chips and Russia. Compared to two months ago this list contains less resource companies. And indeed, Russian oil and gas companies are among the cheapest. I think this is because of Putin's politics and weak ownership rights in Russia. I can recommend a small position in Surgutneftegas though. This is a special non-voting stock that has a preferred dividend right attached. The company has a lot of cash on its balance sheet. Even if the current yield will not be sustainable I do think the dividend will remain high. So of the three cheapest resource companies in the list Surgutneftegas is the cheapest.

Surprisingly there is a Japanese resource company about just as cheap as well: Inpex Corporation. As an investment this stock (probably) does not suffer from the disadvantages Russian oil and gas companies suffer from. Though capital allocation with Japanese companies is usually not as efficient as with American companies I think there are less corporate governance issues with Japanese companies.

I cannot find any other rational reason for Inpex's low EV/EBIT multiple than that the reserves of this company are much lower than those of other oil companies. According to the company's website current reserves are 2.4 billion of barrels of oil equivalent, or boe. According to the annual report (March 31, 2015) about half of the reserves consists of oil and LPG and the rest consists of natural gas. This is comparable to Devon Energy's (NYSE:DVN) reserves. However Devon Energy's enterprise value is about 23 billion, so 9 billion more. In addition Devon Energy made a huge operating loss over the last four quarters. This suggests that Inpex Corporation and Devon Energy may be suitable stocks for a pair trade: long Inpex Corporation and short Devon Energy.

A less rational reason for the perceived valuation difference is that relatively few people know Inpex Corporation. Indeed, when looking on Seeking Alpha there are no focus articles on this company. This year there were only two "related" articles. One of them was a similar list I published last October. Yet the market cap of this production and exploration company is over $14 billion.

The list contains three semiconductor companies that were not present in the previous list: SK Hynix, Samsung Electronics and Micron Technology. These stocks suffer from capacity expansions announced by Intel (NASDAQ:INTC), Samsung Electronics and SK Hynix. The only company that has not announced huge investments in new factories is Micron.

Micron's strategy is not buying new factories. Instead Micron tries to buy capacity when business is slow and factory prices are low. And they have done this recently as well. See their announcement of the acquisition of Inotera. As a side effect they often buy lots of cheap intellectual property every time they buy another factory. Usually the extra capacity and patents come with many brilliant researchers as well.

I think each of these three companies will be great investments. Samsung Electronics for its price combined with its diversification, Micron for its disciplined capital allocation, its price and its intellectual property and SK Hynix for its price and maybe even for its intellectual property. People have been talking about China entering the memory chip industry. Looking at these EV/EBIT ratios SK Hynix would be the most attractive company to buy. The buzz around Micron being acquired by Chinese Tsinghua Unigroup indicates that Micron has better intellectual property than SK Hynix.

Companies that haven't been discussed in the previous two lists are Japan Airlines and Western Digital. Japan Airlines might be a good short-term bet. You might consider hedging the oil price risk though. Or, even better, consider a pair trade with a more expensive Asian airline as the short leg.

I cannot recommend Western Digital at all. I think that their main business, hard disks, is going away in less than five years. Western Digital is acquiring SanDisk (NASDAQ:SNDK), a NAND and SSD manufacturer. Unfortunately the company is paying a high price for this acquisition. The numbers above are from my screener and do not reflect the balance sheet changes that this acquisition will trigger. So going forward Western Digital will be much more leveraged than it has been before. Moreover in this industry much depends on intellectual property. And SanDisk's intellectual property might be weak.

Finally consider auto-parts manufacturer Hyundai Mobis. This is the exception that did not get cheaper so unlike many of the other stocks in the list. Its EV/EBIT multiple and market cap surged since I included it in my first low EV/EBIT large-cap article last August. If you believe that the car industry is a growth market and you want exposure to this part of the global economy this stock could still be a great play. The great advantage of Hyundai Mobis is it has much less regulatory risk than car manufacturers such as Volkswagen. Though many people think Volkswagen is cheap after the diesel engine scandal Volkswagen is much more expensive in terms of EV/EBIT than Hyundai Mobis. For Volkswagen the multiple is 11.3 while for Hyundai Mobis the multiple is only 7.1. Not only that, Volkswagen is much more leveraged with a ratio of total tangible assets/net tangible assets of 9. Many investors ignore this but a "9" is really high for any stock and is very often followed by dilutions. For Hyundai Mobis this ratio is less than 2.

In my article on Volkswagen I implicitly said Volkswagen is a good short at around 25 USD per ADR. At around 30 USD per ADR I still think it is although the market does not agree with me yet. With this short the risk is that global car sales will keep growing enough for Volkswagen to earn out of its balance sheet problems. This risk can be offset with a long position in a much cheaper car stock, such as Hyundai Mobis.

I think the differences can at least partly be explained by the fact that, unlike Volkswagen, Hyundai Mobis does not sell that much to ordinary customers like me and you. Also, these products are not so interesting for consumers. We buy great cars from Volkswagen but not great spare parts from Hyundai Mobis. Well we do but not that most of us know or care. Furthermore Hyundai Mobis is one of the few large caps without a US ticker symbol.

Final words

Many know that my investing approach is that of statistical investing. To do that I use many small positions in undervalued stocks based on multiples like EV/EBIT and NCAV/market cap. These stocks do not have always great returns. And just as US stocks these stocks bear lots of risks, especially the Russian energy stocks in this list. But I believe that on average these risks are more than priced in. If you invest in many of these stocks then, over the years, the law of large numbers should start to work for you as well.

This is my last article for this year. I hope you have enjoyed my writings and I wish you a happy 2016. People interested in systematic research on smaller and cheaper low EV/EBIT stocks and on net-nets I recommend joining my premium research service on Seeking Alpha.

Disclosure: I am/we are long MU, LUKOY.

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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.