In search of underperforming value stocks that are on the rebound, I used the GuruFocus All-In-One Screener to search for the following criteria:
- Market Cap: Greater than $500 million
- OTC Stocks: Exclude
- P/E: Between 1 and 18
- EPS Growth Rate (one year): Greater than zero
- 12-Month Price Change (Relative to S&P): Maximum -20%
- 3-Month Price Change (Relative to S&P): Minimum +5%
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The resulting stocks were Transocean Ltd. (RIG), Noble Corp Plc (NE) and Conn's Inc. (CONN). Each one of these stocks has a notable guru owning them. I first searched for stocks that were underperforming the S&P 500 for the past year. All of the resulting stocks had negative returns. For the rebounding aspect, I searched for stocks with strong relative strength compared to the S&P 500 and increasing earnings. The S&P 500 has been up about 3.5 percent for the past three months. Overall there were ten results, but I dug a little deeper to find which companies increased year-over-year earnings for the latest quarter in combination with the screen for full year earnings increases.
Transocean Ltd. (RIG)
Transocean is part of the largely unloved offshore drilling services industry. The stock is down 48 percent for the past five years. Over the past year the stock is down 13 percent, but has outperformed the S&P 500 by 3.4 percent over the past three months. Throughout the past five years, the stock has had very strong support along the $40 mark. It is currently trading at $43.47.
Transocean is a large holding of Carl Icahn's Icahn Enterprises (IEP) owning 6 percent of the shares outstanding. He first started purchasing the stock in the fourth quarter of 2012. Carl Icahn (Trades, Portfolio) looks for undervalued companies that he thinks can benefit shareholders with his activist investing style. For Transocean he pushed for a higher dividend, a smaller board of directors, and spinning off part of the company as a master limited partnership (MLP). So far the company has increased its dividend from $0.56 to $0.75 per share, reduced its board from 14 to 11 members while adding an Icahn representative, and is planning to create an MLP. So far it looks like the MLP will be called Caledonia Offshore Drilling Company and be comprised of eight North Sea midwater rigs.
The company has average ratings for Financial Strength (6/10) and Profitability & Growth (6/10), but it is trading at cheap valuations. It has a low P/E of 10.32 and P/B ratio of 0.89. Those valuations are too low for a company with increasing earnings. Earnings came out of the red last year at $3.87 per share compared to 2012's EPS of $-0.62. The EPS has continued its upward trend by increasing 42 percent year-over-year. With a more conservative 10 percent growth rate, the stock is valued at $57.09 according to the GuruFocus DCF Calculator making it undervalued with a 24 percent margin of safety.
Noble Corp Plc (NE)
Noble is another company in the offshore drilling industry. The stock has gone nowhere over the past five years as it has been mainly trading in a range between $30 and $40. It recently reached $40.06 in November and dropped right back down. It is down 16 percent for the past year, but has outperformed the S&P 500 by 4 percent over the past three months. The stock has held strong support at about $30 per share over the past five years, and is currently trading at $32.85
Donald Smith of Donald Smith (Trades, Portfolio) & Co., Inc. is the notable guru that holds Noble Corp. He purchased 2.7 million shares in the first quarter of 2014, about 1 percent of the outstanding shares. I follow Donald Smith (Trades, Portfolio) because his strategy is a simple concept that works. He generally invests in stocks of out-of-favor companies that sell in the bottom decile of price-to-tangible book value ratios, and that have significant earnings potential over the next two to four years. His average holding period is approximately three years.
Noble Corp has the same Financial Strength (6/10), but a much higher interest coverage ratio of 10.55 compared to Transocean's 3.81. The price-to-tangible book ratio is a low 0.90 and fits Donald Smith (Trades, Portfolio)'s criteria. The stock also has a very low P/E of 8.80 along with increasing earnings. Earnings increased 13.8 percent for the full year of 2013 and 67.8 percent for the most recent quarter. The stock is priced as if earnings are growing at a low rate of 5.06 percent according to the GuruFocus DCF Calculator. Analysts are estimating about 11.5 percent growth over the next five years. At that rate the stock has a fair value of $49.61 with 34 percent margin of safety. In the near future Noble is planning to spin off its older assets and focus on deepwater drilling.
Conn's Inc. (CONN)
Conn's is a specialty retailer that sells electronics, appliances, and furniture. Unlike the two previous stocks, Conn's has had a great run for the past five years being up 223 percent. It had a rough start to the year, though, and is down 45 percent year-to-date. The overall retail sector has also struggled with the S&P Retail Index being down 4 percent year-to-date. The stock has come back lately, and has outperformed the S&P 500 by 29.6 percent over the past three months.
David Einhorn of Greenlight Capital recently purchased 3.3 million shares of Conn's in the first quarter 2014 at an average price of $35.49. His new position represents 9.13 percent of the outstanding shares. Although he is known for being an activist investor, it looks like he is taking the passive approach to his new holding so far. In his first quarter letter to shareholders he explains that Conn's finances 77 percent of customer purchases through its proprietary subprime portfolio. In February, the company announced 33 percent comparable store sales growth in fourth quarter with strong gross margins. However, it also announced increased credit losses and reduced earnings guidance. The market overreacted due to its recent experience with subprime lending and drove the stock down to $32 from $79 per share on the news. Einhorn felt that it was a bargain with 15 to 20 percent unit growth and current double digit comparable store sales growth.
This stock is selling at a deep discount if it can maintain double digit same store sales and accomplish their long-term goal of increasing their store count by 20-25 percent per year. The company currently has 80 stores with potential for 500. Those numbers and their increasing margins will more than make up for its 8.2 percent bad debt provision. With that kind of growth, the stock should be back on its way to $79. To be more conservative, I am using the average estimated growth rate of 17.5 percent from the analysts. At that rate the stock has a fair value of $61.29 giving it a 31 percent margin of safety.This article first appeared on GuruFocus.
- Investment & Company Information
- Transocean Ltd.