Christmas Gifts for Bargain Hunters

Dig deeper, look broader, go global, and you can find treasures

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Dec 23, 2016
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The last couple of years have not been the easiest time for the rigorous value investor. Most of the biggest markets are more or less fully priced after several years of soaring prices. Bargain stocks are difficult to find but not impossible.

“If you complain that you cannot find bargain opportunities, then that means you either haven’t looked hard enough or you haven’t read broadly enough,” said Irving Kahn many years ago.

I have picked up some candidates to consider from different markets and from different areas of value investing. If Santa Claus would bring in his gift bag of stocks, I would like them to be like the following.

First are my general undervalued companies and turnaround candidates:

Nokia

Ex-mobile phone superstar from Finland Nokia (NOK, Financial) (OHEL:NOKIA, Financial) has changed significantly over the past few years. After selling its mobile phone business to Microsoft (MSFT, Financial) and HERE mapping business to a consortium of German carmakers, the company acquired Siemens’ (BSE:SIE, Financial) stake in Nokia Siemens Networks in 2013 and Alcatel-Lucent (XPAR:ALUNV, Financial) from France. Nokia and Alcatel-Lucent's joint operations synergies are very important for Nokia’s future. Nokia’s goal is the synergy benefits of 1.2 billion euros ($1.246 billion). Anyway these acquisitions have made Nokia one of the top three vendors of wireless infrastructure with Ericsson (ERIC, Financial) and Huawei.

After the Alcatel-Lucent merger Nokia’s price collapsed about 45%. There’s a lot of negative sentiment baked into the price. The company's capital structure is well organized to support the enterprise's ongoing business. Nokia’s cash balance is relatively large and strong. It is generating sufficient cash to continue paying increasing stock dividends and still make some acquisitions if needed.

Development in the networks industry supposedly continues to be weak. Even though the market remains weak, Nokia will be able to increase its income through its own actions. Instead the technologies segment will be promising. Nokia has the opportunity to negotiate better agreements with phone manufacturers like Apple (AAPL, Financial) and hopefully some others from China. They would have a direct impact on the company’s income. Nokia also has a patent/technology licensing business that has generated close to 1 billion euros per year in high-margin revenue. All this taken into account it should be realistic to earn at least 0.10 euros quarterly; although over 20 price-earnings (P/E) level is probably not sustainable the stock seems to be undervalued.

Novo Nordisk

Novo Nordisk (NVO) (OCSE:NOVO B) is a health care company that is engaged in the discovery, development, manufacturing and marketing of pharmaceutical products. The company has two business segments: diabetes care and biopharmaceuticals. Denmark-based Novo Nordisk is the leading provider of diabetes care products in the world. The company has about 28% market share of the $45 billion global insulin market.

Novo also has a biopharmaceutical segment (about 20% of revenue). The biopharmaceutical group is more profitable and grows faster than the diabetes franchise. A strong pipeline is the lifeblood of pharmaceutical companies, and Novo Nordisk is no exception. The company spent more than $2 billion yearly on its research and development.

Investors severely punished the company after lowering its guidance for sales growth estimates in 2016, and the stock price has declined 45% year to date. Novo is still highly profitable and growing fast. Gross margins are over 80%, and ROE is astonishing at 88% (average over 60%). Novo has grown its revenues at a compound annual growth rate of 15% during the past five and 10 years. If you are looking for companies that can generate lots of free cash flow, Novo is a real cash machine. That's cash the company can use to grow or return to shareholders with dividends and stock buybacks. Of course, no matter how great the business is, we never want to overpay for a stock.

Now the P/E of Novo Nordisk is 16.5 and during the last five years it has been continually well over 20. Earnings per share TTM is now 14.74, and the expectation is that it will be in the 15.50 to 16.50Â range. Even though over 20 P/E level would not be sustainable in the future, a stock price over 300 Danish krone ($41.93) is probable and realistic.

Also EV/EBIT 14.5 is under the long-time average of 17. Don’t forget that Novo’s current dividend yield is 3.8%, and payout ratio is about 50%. Since the company has no long-term debt, it has plenty of room for future dividend increases. In addition, return on retained earnings during the last five years has been excellent (25%). Long-term total returns on common shares (share price appreciation plus dividends) are expected to be strong double-digit numbers going forward, and Novo Nordisk is a health care company that can produce outstanding long-term results.

Resolute Forest Products

Resolute Forest Products (RFP) owns and operates pulp and paper mills and wood products facilities in the U.S., Canada and South Korea and power generation assets in Canada. The company is a global leader in the forest products industry with a diverse range of products.

A cyclical downturn in global commodities including the forest products industry hit all four of Resolute Forest Products’ business segments. When a company manufactures commodities, it has very little control over selling prices. In this case management has concentrated on lowering the cost of every segment, but the biggest problem has been the company’s product mix. Newsprint and mechanical papers make up over half of Resolute Forest Products' sales mix, and these products are experiencing long-term and permanent decline. The company has started to shift its product mix toward lumber production and tissue but probably too slowly in both cases, missing the best business opportunities. Also Resolute Forest Products' recent acquisition of Atlas Paper has not yet generated the desired result.

But things are not so bad. Resolute Forest is still a global leader in the forest product industry and will improve once the downturn clears. The company will maximize its competitiveness particularly in specialty papers and market pulp. Resolute Forest Products' third-quarter results are more promising; the earnings per share result has turned positive. Gross margin has remained constantly above the 20% level during the difficult period, which points to successful cost reduction.

Also operational cash flow has been at least satisfactory. The debt level is under control (debt-equity of 0.38). Although permanent turnaround can take longer than some would wish, it’s hard to believe that Resolute Forest Products has been trading as low as a little over $4 per share for a long time.

Gilead Sciences

Gilead Sciences (GILD) is a big player in the biotechnology field. The company manufactures pharmaceutical products to treat two major therapeutic areas: human immunodeficiency virus (HIV) and liver diseases such as chronic hepatitis C virus (HCV).

On a quantitative basis Gilead Sciences looks undervalued. P/E is 7 (long-time median about 18) and EV/EBIT 6 (median about 13), ROE of 92% (ROA of 30%) versus price-book (P/B) of 6 and price-sales (P/S) of 3.4 versus net margin 48% and dividend yield of 2.5% with payout ratio under 0.20. Earnings per share are quite a stable at $10 per year. The company has kept quarterly earnings firmly at the level of $2.50 despite the business difficulties. In addition to this cash flow is steady and strong. Numbers can be placed in any direction, and the end result is always the same: undervalued company.

So what’s wrong with Gilead Sciences? Gilead’s stock price has performed poorly over the past year because investors doubt its growth potential. The company’s HCV business has been under pressure. There has been increasing competition in this area due to its high margins. Innovations and product pipeline are critical for any biotechnology company. I’m not a pharmacy expert qualified to assess how it is going to succeed in this, but its large cash reserve made it possible to increase the company’s R&D spending 35% this year. Most likely it has had a positive impact on its product development.

Gilead’s tremendous free cash flow also gives the company the ability to make different choices. You can make acquisitions (Gilead Sciences surely will make some acquisitions, but it prefers a slow and steady approach – which is wise), you can repurchase shares (good solution when you have extra money and your share price is down), and you can pay increasing dividends.

Generally the stock market hates uncertainty. This is an issue in Gilead Sciences' case. The share price will advance along with a general recovery in the biotech sector.

Mylan

Mylan (MYL) together with its subsidiaries is a pharmaceutical company that develops, licenses, manufactures, markets and distributes generic, branded generic and specialty pharmaceuticals. Generics segment is more important, contributing 87% of the company’s sales. Specialty segments' contribution is about 13%.

The Justice Department has been investigating the company’s pricing of EpiPens. Mylan’s costs and expenses have increased notably in relation to litigation settlements. Litigation cost seems to be at least $465 million. During the last couple of years Mylan has acquired Abbott’s (ABT) non-U.S. developed markets specialty and branded generics business and Famy Care Ltd., a female health care business. Because of the recent acquisitions the company’s debt level is a bit up (debt-equity is 1.34). Acquisitions are now closed, and they are expected to contribute meaningfully to the company's cash flow stream going forward.

Recently drug companies have been accused of price gouging. Even though Mylan has raised the price of EpiPens, it has many hundreds of domestic drugs – most of which are generics that Mylan is able to sell because it actually posts a lower price on these compared to brand names. Other pharmaceutical companies have been under pressure because there are several types of risks to watch out for  like only a few products. Mylan has over 600 products in the U.S. and 2,000 products internationally. While EpiPen remains the most important product in Mylan's wide product portfolio, it gives it a significant amount of diversification safety.

Mylan’s own full-year 2016 EPS guidance range is $4.70 to $4.90, and its adjusted EPS target in 2018 is $6 with targeted growth in the low teens in both 2017 and 2018. I would not be quite that optimistic. Yet the quality of the cash flow stream going forward is a clear positive signal and will also affect the growth of earnings in the near future. Mylan is the victim of publicly critical statements and a bad public reputation for the whole biotech and pharmaceutical industry. Right now may be the best time to purchase this misunderstood company before its price begins to rise in the range of $50 to $70.

The second will be my deep asset value companies:

Support.com

Everyone knows that the U.S. market at the moment is, to put it mildly, at least full priced. It’s challenging to find a lot of bargain issues, especially candidates to net current asset value investing. Support.com (SPRT) could be an exception. It provides cloud-based services and software to resolve connected technology issues quickly.

Some important background information. What makes support.com interesting is that the activists took control of the company last June. Activist investor VIEX Capital Advisors (plus its affiliates) are support.com's largest shareholder, owning about 15% of the company, and it won five of the six board seats. This led to the resignation of the old CEO, and the company announced that it named Rick Bloom interim president and CEO.

This is an important catalyst because the old management company burned its asset value, ongoing business declined and worst of all leaders just protected themselves. New owners are reducing costs and trying to bring the firm back to profitability. Incumbent management is running the business, emphasizing taking care of shareholder value. A lot of work is still ahead, but the direction is correct.

Valuation

  • Market cap: $37.88 million (small net-net which is good).
  • Price: 68 cents (net cash 83 cents, net-net working capital 96 cents, net current Aasset $1.03).
  • Price/NCAV: 66% (just inside Graham’s two-thirds NCAV price principle).
  • F-Score: 3.
  • Debt to equity: 0.0 (no fear of rapid bankruptcy).
  • EV/EBIT: 0.44.

Although support has burned its assets and NCAV is declining, it provides enough margin of safety. The company is cash rich (net cash value bigger than market price) and without debt.

Any good information will affect immediately the share price. Support.com is a very promising turnaround candidate – and even more.

The rest of my deep bargains are picked up from a previously less well-known market, Singapore. As seen through the eyes of Western citizens, Singapore is very modern and elaborated. Singapore has one of the lowest crime rates in the world. Corruption is not an issue. Enforcement can be too strict. Do not eat chewing gum and throw it in the street there, or you can be in trouble!

Anyway few Western countries are comparable in terms of Singapore's legal and regulatory transparency. In Singapore society is business positive and effective. But be careful; you can encounter shareholder-unfriendly management or power struggles inside the company where you really don’t want to participate. After I had successfully invested in Nam Lee (SGX:G0I), I have been enthusiastic to find other deep value opportunities from Singapore – and here they are.

S i2i Ltd.

S i2i Ltd. (SGX:BAI) operates under two segments: mobility and technology. The main activities of the mobility business are procurement, distribution and sale of mobile handsets. The technology segment consists of VoIP, information technology and managed services.

  • Market cap: 23.59 million Singapore dollars ($16.3 million).
  • Price: 1.73 Singapore dollars (net cash 0.47 Singapore dollars, net-net working capital 1.47 Singapore dollars, net current asset 3.26 Singapore dollars).
  • Price/NCAV: 53%.
  • F-Score: 7.
  • Debt to equity: 0.04.
  • EV/EBIT: 0.07.

The company is strongly controlled by the billionaire Modis family. Even though the business isn’t very profitable – if you look at margins or return on capital – and thus undervalued, it is a low-risk investment. Any sign of growth and increasing earnings could push the price much higher than net current asset value.

Sing Holdings

Sing Holdings (SGX:5IC) operates as a property developer in Singapore. The company's activities include developing and leasing of residential and commercial properties.

  • Market cap: 124.31 million Singapore dollars.
  • Price: 0.31 Singapore dollars (net cash -0.63 Singapore dollars, net-net working capital -0.48 Singapore dollars, net current asset 0.62 Singapore dollars).
  • Price/NCAV: 50%.
  • F-Score: 9.
  • Debt to equity: 0.01.
  • Dividend yield: 3.2%.
  • EV/EBIT: 1.08.

After Sing Holdings’ latest purchase of the residential site at Fernvale Road, it is realistic to expect growing earnings in the long run. Also a newly acquired hotel business can work as a near-term catalyst for the company.

SP Corp.

SP Corp. (SGX:AWE) is an investment holding company. It is engaged in commodities trading including coal, rubber, chemicals, oil and metals. It also markets and distributes tires and auto products and retreads tires.

  • Market cap: 16.85 million Singapore dollars.
  • Price: 0.48 Singapore dollars (net cash 0.03 Singapore dollars, net-net working capital 0.04 Singapore dollars, net current asset 1.42 Singapore dollars).
  • Price/NCAV: 34%.
  • F-Score: 7.
  • Debt to equity: 0.0.
  • EV/EBIT: -1.01.

SP is dirt cheap. The company is profitable and debt free, and its net current asset value is growing steadily.

Brook Crompton Holdings

Brook Crompton Holdings (SGX:AWC) through its subsidiaries is engaged in manufacturing and distributing electric motors for both standard and specialized motors covering industries in Asia Pacific, United Kingdom and North America.

  • Market cap: 11.35 million Singapore dollars.
  • Price: 0.32 Singapore dollars (net cash -0.12 Singapore dollars, net-net working capital 0.09 Singapore dollars, net current asset 0.66 Singapore dollars).
  • Price/NCAV: 48%.
  • F-Score: 5.
  • Debt to equity: 0.07.
  • EV/EBIT: 0.93.

Brook Crompton is profitable and able to generate operational cash flow. Earnings power value of the company is high. The annual NCAV is rising. Major shareholders of Brook Crompton are ATB Group Austria and Wolong Electric Group Co. Ltd. (SHSE:600580), both reputable manufacturers of electric motors.

Disclosure: The author has positions in Nokia, support.com and S i2i Ltd. This is neither a recommendation to buy or sell any securities. All information provided is believed to be reliable and presented for information purposes only.

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