3 Basic Material Plays Worth Considering

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Includes: APC, SDRL, TLM
by: Tactical Investor

Three candidates based on the following criteria, were selected and are examined in detail below. These are not absolute rules, but suggestions to get the novice investor started. The criteria can be adjusted to suit your own specific style of trading. Even though net income took a hit in 2011, Anadarko Petroleum Corp (NYSE:APC) was included on the list because quarterly earnings growth has expanded significantly and net income for the first quarter of 2012 has soared to $2.15 billion.

A lot of key ratios will be used in this article and it would be good for investors to get a handle on some of the more important ones listed below.

The payout ratio tells us what portion of the profit is being returned to investors. A payout ratio over 100% indicates that the company is paying out more money to shareholders than it is making. This situation cannot last forever. In general, if the company has a high operating cash flow and access to capital markets, it can keep this going on for a while. As companies usually only pay the portion of the debt that is coming due and not the whole debt, this technique/trick can technically be employed to maintain the dividend for some time. If the payout ratio continues to increase, the situation warrants close monitoring as this cannot last forever. If your tolerance for risk is low, look for similar companies with the same or higher yields, but with lower payout ratios. Individuals searching for other ideas might find this article to be of interest: Apache: A Great Low Risk Way To Open Up A Second Income stream.

Long-term debt-to-equity ratio is the total long-term debt divided by the total equity. The amount of long-term debt a company carries on its balance sheet is very important for it indicates the amount of money a company owes that it doesn't expect to pay off in the next year. A balance sheet that illustrates that long term debt has been decreasing for a few years is a sign that the company is doing well. When debt levels fall, and cash levels increase, the balance sheet is said to be improving and vice versa. If a company has too much debt on its books, it could end up being overwhelmed with interest payments and risk having too little working capital which could in the worst case scenario lead to bankruptcy.

Operating cash flow is generally a better metric than earnings per share because a company can show positive net earnings and still not be able to properly service its debt. The cash flow is what pays the bills.

Free cash flow yield is obtained by dividing free cash flow per share by the current price of each share. Generally lower ratios are associated with an unattractive investment and vice versa. Free cash flow takes into account capital expenditures and other ongoing costs associated with the day to day to functions of the business. In our view free cash flow yield is a better valuation metric then earnings yield because of the above factors.

Current Ratio is obtained by dividing the current assets by current liabilities. This ratio allows you to see if the company can pay its current debts without potentially jeopardizing future earnings. Ideally, the company should have a ratio of 1 or higher.

Price to free cash flow is obtained by dividing the share price by free cash flow per share. Higher ratios are associated with more expensive companies and vice versa. Lower ratios are generally more attractive. If a company generated $400 million in cash flow and then spent $100 million on capital expenditure, then its free cash flow is $300 million. If the share price is $100 and the free cash flow per share is $5, then the company trades at 20 times-free cash flow. This ratio is also useful because it can be used as a comparison to the average within the industry. This gives you an idea of how the company you are interested in holds up to the other companies within the industry.

Cash ratio is the ratio of the company's total cash and cash equivalents to its current liabilities; this ratio is used as a measure of a company's liquidity. It allows investors to determine how fast the company would be able to pay its short term debts if push came to shove. Higher numbers are better because it makes it easier for a company to ask for new loans, increase in credit lines, etc.

Interest coverage is usually calculated by dividing the earnings before interest and taxes for a period of one year by the interest expenses for the same time period. This ratio informs you of a company's ability to make its interest payments on its outstanding debt. Lower interest coverage ratios indicate that there is a larger debt burden on the company and vice versa. For example, if a company has an interest ratio of 11.8, this means that it covers interest expenses 11.8 times with operating profits.

Price to tangible book is obtained by dividing share price by tangible book value per share. The ratio gives investors some idea of whether they are paying too much for what would be left over if the company were to declare bankruptcy immediately. In general stocks that trade at higher price to tangible book value could leave investors facing a great percentage per share loss than those that trade at lower ratios. The price to tangible book value is theoretically the lowest possible price the stock would trade to.

Retention ratio is the amount of net income that is not paid out as dividends. In other words, it is the money the company retains that can be used to grow the business, etc. It is calculated by subtracting 1 from the dividend ratio.

Levered free cash flow is the amount of cash available to stock holders after interest payments on debt are made. A company with a small amount of debt will only have to spend a modest amount of money on interest payments, which in turn means that there is more money to send to shareholders in the form of dividends and vice versa.

Company: Anadarko Petroleum Corp

Brief Overview

  1. Percentage Held by Insiders = 0.28
  2. Long term debt to equity ratio = 0.76
  3. Operating Margin = 19%
  4. Quarterly Revenue Growth = 5.8%
  5. Quarterly Earnings Growth = 898%
  6. Operating Cash Flow = 3.11 billion
  7. Beta = 2.12
  8. Percentage Held by Institutions = 87.7%
  9. Short Percentage of Float = 1.4%
  10. Cash Flow 5 -year Average = 20.74
  11. Relative Strength 52 weeks = 50
  12. Cash Flow 5 -year Average = 10.67

Growth

  1. Net Income ($mil) 12/2011 = -2649
  2. Net Income ($mil) 12/2010 = 761
  3. Net Income ($mil) 12/2009 = -135
  4. Net Income Reported Quarterly ($mil) = $2150
  5. EBITDA ($mil) 12/2011 = 1245
  6. EBITDA ($mil) 12/2010 = 6210
  7. EBITDA ($mil) 12/2009 = 4126
  8. Cash Flow ($/share) 12/2011 = 11.07
  9. Cash Flow ($/share) 12/2010 = 9.32
  10. Cash Flow ($/share) 12/2009 = 6.25
  11. Sales ($mil) 12/2011 = 13967
  12. Sales ($mil) 12/2010 = 10984
  13. Sales ($mil) 12/2009 = 9000
  14. Annual EPS before NRI 12/2007 = 8.34
  15. Annual EPS before NRI 12/2008 = 6.92
  16. Annual EPS before NRI 12/2009 = -0.96
  17. Annual EPS before NRI 12/2010 = 1.81
  18. Annual EPS before NRI 12/2011 = 3.38

Click to enlarge

Dividend history

  1. Dividend Yield = 0.6
  2. Dividend Yield 5 Year Average = 0.6
  3. Forward Yield = 0.5

Dividend sustainability

  1. Payout Ratio = 0.11
  2. Payout Ratio 5 Year Average = 0.2

Performance

  1. Next 3-5 Year Estimate EPS Growth rate = 27.15
  2. ROE 5 Year Average = 6.93
  3. Return on Investment = 4.94
  4. Current Ratio = 1.42
  5. Current Ratio 5 Year Average = 1.25
  6. Quick Ratio = 1.42
  7. Cash Ratio = 0.75
  8. Retention rate= 89%
  9. Interest Coverage Quarterly = N/A

Company: Seadrill Ltd (NYSE:SDRL)

Levered Free Cash Flow = -722M

Brief Overview

  1. Profit Margin = 23%
  2. Operating Margin = 44%
  3. Quarterly Revenue Growth = -5.2%
  4. Quarterly Earnings Growth = - 52%
  5. Operating Cash Flow = 1.76 billion
  6. Beta = 1.99
  7. Percentage Held by Institutions = N/A
  8. Short Percentage of Float = 2.00

Growth

  1. Net Income ($mil) 12/2011 = 1482
  2. Net Income ($mil) 12/2010 = 1172
  3. Net Income ($mil) 12/2009 = 1261
  4. Net Income Reported Quarterly ($mil) = 439
  5. EBITDA ($mil) 12/2011 = 2310
  6. EBITDA ($mil) 12/2010 = 2054
  7. Cash Flow ($/share) 12/2011 = 4.22
  8. Cash Flow ($/share) 12/2010 = 3.95
  9. Sales ($mil) 12/2011 = 4192
  10. Sales ($mil) 12/2010 = 4041
  11. Sales ($mil) 12/2009 = 3254
  12. Annual EPS before NRI 12/2009 = 2.6
  13. Annual EPS before NRI 12/2010 = 2.69
  14. Annual EPS before NRI 12/2011 = 2.9

Dividend history

  1. Dividend Yield = 9.90

Dividend sustainability

  1. Payout Ratio = 1.55

Performance

  1. Next 3-5 Year Estimate EPS Growth rate = 48.32
  2. Return on Investment = 8.75
  3. Current Ratio = 0.70
  4. Quick Ratio = 0.5
  5. Interest Coverage = 4.90

Company: Talisman Energy (NYSE:TLM)

Levered Free Cash Flow = -$2.71B

Brief Overview

  1. Percentage Held by Insiders = 6.01%
  2. Long term debt to equity ratio = 0.73
  3. Profit Margin = 16%
  4. Operating Margin = 21%
  5. Quarterly Revenue Growth = 5.8%
  6. Operating Cash Flow = 103M
  7. Beta = 1.60
  8. Percentage Held by Institutions = 72%
  9. Short ratio = 1.3%

Growth

  1. Net Income ($mil) 12/2011 = 776
  2. Net Income ($mil) 12/2010 = 629
  3. Net Income ($mil) 12/2009 = 385
  4. EBITDA ($mil) 12/2011 = 4569
  5. EBITDA ($mil) 12/2010 = 3521
  6. EBITDA ($mil) 12/2009 = -329
  7. Cash Flow ($/share) 12/2011 = 2.94
  8. Cash Flow ($/share) 12/2010 = 2.19
  9. Cash Flow ($/share) 12/2009 = 0.17
  10. Sales ($mil) 12/2011 = 8272
  11. Sales ($mil) 12/2010 = 6712
  12. Sales ($mil) 12/2009 = 7028
  13. Annual EPS before NRI 12/2007 = 0.93
  14. Annual EPS before NRI 12/2008 = 1.91
  15. Annual EPS before NRI 12/2009 = 0.17
  16. Annual EPS before NRI 12/2010 = 0.13
  17. Annual EPS before NRI 12/2011 = 0.51

Dividend history

  1. Dividend Yield = 2.5
  2. Dividend Yield 5 Year Average =1.4%
  3. Dividend 5 year Growth = 14.7%

Dividend sustainability

  1. Payout Ratio = 0.31
  2. Payout Ratio 5 Year Average = 0.4

Performance

  1. Next 3-5 Year Estimate EPS Growth rate = 8.5
  2. ROE 5 Year Average = 11.46
  3. Return on Investment = 5.48
  4. Debt/Total Cap 5 Year Average = 29.37
  5. Current Ratio = 0.65
  6. Current Ratio 5 Year Average = 0.95
  7. Quick Ratio = 0.6
  8. Cash Ratio = 0.16
  9. Interest Coverage Quarterly = 18.66
  10. Retention rate = 69%

Conclusion

In general, a great way to get into a stock at a price of your choosing is to sell puts at strikes you would not mind owning the stock at. Investors looking for other ideas might find this article to be of interest: Duke Energy: 2 Extra Income Streams In Addition To the dividend.

Note: EPS and Price Vs industry charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This list of stocks is meant to serve as a starting point. Please do not treat this as a buying list. It is imperative that you do your due diligence and then determine if any of the above plays meet with your risk tolerance levels. The Latin maxim caveat emptor applies - let the buyer beware.