4 Undervalued Stocks Primed For Double-Digit Gains
In this special report Chris Mayer, a regular contributor to The Daily Reckoning and editor of Capital & Crisis explores 4 stocks primed for double-digit gains in 2008. Often referred to as one of the nation’s premier up-and-coming investment advisers, Mayer has been featured on globally syndicated networks such as Fox News and CNBC. Chris Mayer is also the editor of a special bonus report on How to Get Cash Back Every Time You Trade.
Hutchison Telecommunications Intl. Ltd. (HTX:NYSE)
China’s stock market has been sizzling, more than doubling this year. The whole market trades at a price-earnings ratio of about 50 times next year’s earnings estimate. The Chinese market is now home to 4 of the world’s 10 most valuable companies. It boasts the biggest bank, airline, insurer and telecom carrier. Soon, it may nab the top energy spot too, with less than $50 billion separating the market caps of ExxonMobil and PetroChina.
As hot as China’s stock market has been, I’ve found a China stock that’s trading for a 27% discount to net asset value and with plenty of excess cash. It trades for only 13 times next year’s earnings guess, after backing out that cash. It could hand us a quick gain of nearly 40%, at a minimum. And finally, it gives us a bag of cheap options on cool emerging markets – including Vietnam and Indonesia.
Hutchison Telecommunications Intl. Ltd. (HTX:NYSE) calls Hong Kong home, but it also lists on the NYSE. It’s a subsidiary of Hutchison Whampoa, the huge Asian conglomerate, which owns 50.1% of HTX. The so-called Sam Zell of the East and Asia’s richest man, Li Kashing, controls Whampoa. So we’re in good company here. A big shareholder with brains is good to have in any deal.
Flush with cash, management again showed its prudence. It paid down some debt. It also handed shareholders a big special dividend (which explains the big drop in share price from $30 in July). Hutchison still sits on a cash hoard of $5.2 billion, against only $1.7 billion in debt.
To start, we get $3.4 billion in net cash. The entire market cap of Hutchison works out to about $6.8 billion. So we’re halfway to covering our investment in HTX with just the cash it has in the bank. When you add up the rest of the businesses, you get well over $6.8 billion – as you’ll soon see.
Let’s look at Hutchison’s remaining businesses… It’s easiest to think of them in three buckets – Hong Kong, Israel and the rest. Its biggest operations are in Hong Kong and Macau. The latter is an old Portuguese colony at the mouth of the Pearl River. Once a trading port for silks, tea, spices and opium,
Macau has become the Las Vegas of the East! It’s the only place in China where gambling is legal. It’s booming and American casino operators are all scrambling to get a piece of the action. The Hong Kong business is solid. Revenues rose 18% in the first half. Profit margins were healthy.
The second bucket is Israel, which is also growing nicely – first-half revenue and profits up more than 18% from a year ago. Hutchison conducts this business through Partner Communications, of which it owns the majority. Partner trades on the NASDAQ under the symbol PTNR. Valuing Hutchison’s stake is, therefore, simple as pie. Hutchison’s 52% interest comes out to about $1.5 billion.
The last bucket is a grab bag of emerging market properties in Thailand, Sri Lanka, Vietnam, Indonesia and Ghana. These are all uncertain and unproven properties. But they hold much promise. Vietnam and Indonesia are two of the fastest-growing telecom markets in the world. Sri Lanka is doing well. Thailand and Ghana less so. These are young start-up operations. A commonly used benchmark would be to value the business on a per subscriber basis.
Emerging market cellular customers are in hot demand. South African subscribers go for $600-plus a pop. In Turkey, you’ll pay at least $550 per subscriber. Hutchison has over 3 million subscribers across its grab bag of emerging markets. If we just take a base of $500 per subscriber, then Hutchison’s emerging market properties weigh in at $1.6 billion. That’s reasonably conservative, since its best market Indonesia could go for over $500 per and there are over 1 million subscribers there. All told, Hutchison’s net asset value comes in at $30 per share – that’s a 27% discount from the earlier price of $22.
I think Hutchison is a good bet here. It’s a simple value play as well as an interesting entrée into some fast-growing emerging markets. Recommendation: Buy Hutchison Telecommunications International (HTX:NYSE) up to $25 per share.
Deltic Timber (DEL:NYSE)
If you’ve been involved in the stock markets, you already know that financial panics have a way of unsettling the nerves. As a result, you seek refuge in things you can trust. Assets you can see and watch over. And sometimes those assets hold their own secrets, which are unveiled only after the passage of a century.
And so it was that one C.H. Murphy Sr. found refuge in the loblolly pines of central and southern Arkansas after the Panic of 1907. Murphy bought up thousands of acres of timberland. Timberland is one of those old-world assets that never go out of style. Trees grow by the grace of nature’s bounties – sun, rain and warm weather. They hold their value by the grace of a marketplace that needs timber to make things.
If we fast-forward a century, we find that Murphy’s old timberland is now in the hands of Deltic Timber (DEL:NYSE). The Murphy family still owns 26% of the stock. Deltic is actually a spinoff of Murphy Oil, having achieved independence back in 1996.
I’ll tell you a little about Deltic Timber, which is a fine investment on its own. But the reason I’m excited about Deltic has little to do with trees. It’s more about what lies beneath. Deltic Timber Corp. is a natural resources company. Deltic owns 437,700 acres of timberland!
Deltic owns lots of timberland and also owns a couple of sawmills. Management maintains these facilities are state-of-the-art. These mills crank out all the sorts of things you’d expect a mill to produce: lumber, boards, timbers, decking, finger-jointed studs, etc.
In Deltic, the sum-of-the-parts value of the company’s timberland assets, real estate projects and mills covers your investment, which limits your downside. But what’s really exciting – and what provides the upside — is the potential for the mineral rights of Deltic’s land. Namely, I’m talking about the potential for natural gas under its trees. Secondly, the potential value of its lands’ water rights.
Let’s start with the natural gas. Deltic owns 55,000 surface acres within an area known as the Fayetteville Shale Play. Southwestern is the leading energy company operating in this region. Its Web site defines the Fayetteville Shale Play:
Natural gas aficionados will recognize the equivalents, in particular Barnett Shale – which some speculate may be the largest onshore gas field in the U.S. As for Arkoma, some call it Barnett’s cousin. That leaves Fayetteville in good company. Fayetteville is a large area – some 2,000 square miles.
Timberland at only $1,000 per acre – which is 20% less than what large tracts of forest have sold for lately – gives you $437 million right way, or about $36 per share. Then you add in the real estate developments, land and mills – and you can tack on another $30 per share. That gets you to $66. Take out the debt and you get about $60 per share in a conservative – and growing – net asset value.That doesn’t even include any estimate for gas or water rights.
You have a proven operator anyway, even if none of this pans out — Deltic Timber itself is a wealth-creating business. It has many of the things we look for – chiefly, lots of tangible assets supporting your investment and a strong financial condition. In addition, we’ve got strong insider ownership. But best of all, we’ve got a cheap backdoor play into a promising natural gas and water play. Recommendation: Buy Deltic Timber (DEL:NYSE) up to $60 per share.
Buy Loews Corp. (LTR:NYSE)
This leads me to my next recommendation, Loews Corp. (LTR: NYSE). Not the home building supply retailer, but the conglomerate controlled by the Tisch family. Loews is in great shape to take advantage of market turmoil. And thanks to a recent pullback in the stock price, you can pick it up for a discount from its net asset value.
Essentially, you get the brains of the serially successful Tisch family to work for you for free. Jim Tisch, the current CEO, is the son of Larry Tisch — a great old value investor. Jim has followed in the footsteps of his old man. He is a no-nonsense sort of guy and a proven investor.
The basic playbook at Loews is to buy cheap assets and pick up out-of-favor businesses. Today, Loews owns a hodgepodge of different assets. Let’s take a quick look at them: CNA Financial, Lorillard Inc., Boardwalk Pipeline and Diamond Offshore.
Beyond these publicly traded businesses, Loews also owns about 18 hotels and resorts in the U.S. and Canada. It also owns Bulova, the watch company. The company also has a massive pile of cash — about $3.4 billion in net excess cash. That’s a plus, especially when you have someone like Tisch at the helm.
Some of that cash will go toward the recent purchase of Dominion’s natural gas properties. HighMount Exploration and Production is the spiffy new name for the newest Loews subsidiary. The acquisition is another plus, because Loews picked up these assets at a healthy discount — maybe as much as 25%.
In the past, Loews used much of its excess cash to buy back its own stock. Since 1992, the company retired over one-third of its shares. Since the average price on these buy backs has been about $13 over time — and Loews stock trades for $46 today — it’s been a great investment. Loews’ shares are still cheap today. The company’s net asset value is at least 25% higher than today’s share price.
The good thing about this net asset value is that much of it depends on publicly traded stocks, such CNA and Diamond Offshore. So there is not as much mystery trying to figure out what it’s worth. Plus, I think I’m being conservative by using market multiples on the publicly traded assets. You can make a good case that CNA is cheap or that Diamond Offshore’s stock price should be trading for much higher.
As is, Loews trades for only 11 times trailing earnings and only 9 times next year’s estimate. There are plenty of levers to pull to create value over time — more buy backs or the sale of a subsidiary for a big premium, both things it’s done regularly in the past.
As far as risks go — I see a couple of things to watch. One is the potential for any surprise litigation stemming from its cigarette business. The second is any surprise in its insurance company requiring Loews to infuse it with cash. Based on what I’ve read, I believe these risks are worth taking. The tobacco litigation has turned favorable to the industry in recent years, and CNA is in the best shape it’s ever been in.
The market got worried recently about CNA’s subprime exposure, but CNA has minimal subprime exposure — something like 2% of its invested assets. The market overreacted and it helped knock down Loews’ share price a bit. Stocks like these can anchor your portfolio. Owning them is like owning a share in a mutual fund or having your own private equity firm. Recommendation: Buy Loews Corp. (LTR:NYSE) up to $55.
National Fuel Gas Co. (NFG:NYSE)
And last but not least… I’m going to tell you about a century-old land holding — suddenly worth a fortune… I like old things. Old things endure. I also like it when an old thing becomes extremely valuable in a way not expected.
The investment idea I have for you today is a company that has been around for a long time. It has proven itself as a wealth creator by delivering good gains for its shareholders. It has done so in a relatively mundane business.
But what makes this business particularly interesting are its vast land holdings — about 770,000 acres – that for more than 70 years lay fallow in the sleepy Appalachian Basin in Pennsylvania. Picked up for a song during the Great Depression, these lands now could hold great treasures that once were out of reach. These lands sit on Devonian shale, which could hold a large amount of natural gas once thought unreachable.
National Fuel Gas Co. (NFG:NYSE), incorporated in 1902, though its predecessor companies are much older, is an integrated gas utility. This means it is involved in every aspect of natural gas, from the bottom of the well to the burner tip.
NFG has its own exploration and development company, with oil and gas reserves across many states (45% of production is oil). It has a regulated utility serving 727,000 customers in New York and Pennsylvania. It owns nearly 3,000 miles of pipeline, along with 32 storage fields. NFG also owns over 100,000 acres of black cherry hardwood in Pennsylvania. Finally, NFG has a small energy broker business with some 25,000 customers.
Now for the good stuff: NFG’s Devonian shale asset. Drilling for natural gas in Devonian shale used to be unprofitable. That explains those long years of inactivity. Things are different now. NFG’s CEO Phil Ackerman writes in the 2006 annual report: “Given continued robust gas pricing and the evolution of relevant technology, it is possible to envision thousands of additional wells being drilled on our acreage.” In his first-quarter conference call, Ackerman tantalizingly laid out the opportunity in front of NFG.
National Fuel has operated gas wells in northwestern Pennsylvania for more than 100 years, and during that time, various combinations of discoveries, new technologies and rising prices have spawned a series of booms, which have created large fortunes, starting, of course, with John D. Rockefeller. We may very possibly be at the early stages of another of those eras… Ackerman and his team own 5% of the stock. Not a huge amount, but enough to keep everybody interested.
So what might the shale asset be worth? First, here is a sum-of-the-parts valuation on the integrated utility business, excluding the shale (in millions of dollars):
Essentially, you are paying for an integrated gas utility business — which, as far as I can tell, is fairly valued in the market today. The kicker is that you’re getting any upside from the Devonian shale asset for free. So what’s the shale worth?
Range Resources is one company that is aggressively buying Devonian shale acreage, right around where NFG’s is. The investment bank Morgan Stanley put the value of Range’s shale acreage at $5,500 per acre – and that was using some conservative assumptions. If you apply that $5,500 figure to NFG’s 770,000 acres, you get $49 per share of additional value.
Take that $49 and add it to the $49 and you get a $98 stock price — 117% above today’s price. That’s a nice margin of safety, in any event. Lots could go wrong or the estimate of value could be off and you could still come out ahead.
This is a company loaded with tangible assets, in good financial shape and with a hidden asset to boot. There are always risks, but in NFG there are lots of good things that can happen, with limited downside risk. Recommendation: Buy National Fuel Gas Co. (NFG:NYSE) up to $55.
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