2 Safe Stocks Trading for Up to 65% Off

David Sterman's picture

Friday, January 28, 2011 - 10:30am

by David Sterman

Bull markets can be broken into several phases. At first, investors seek out large stable companies, tentatively stepping into stocks while still a bit unsure if the rally will last. As a rally builds, investors start to migrate into the tried-and-true growth stocks, such as major Nasdaq technology stocks. Only after a bull market has been well underway do investors start to wade into stocks that, as the British would say, are "cheap and cheerful." After all, stocks that failed to participate in the first stages of the market rally are likely less prone to profit-taking if the bull market suddenly hits a wall.

That makes this a good time to seek out stocks that are cheap in the context of their balance sheets. I went looking for companies that are valued at a point well below the hard assets on their balance sheet. Specifically, I screened for stocks that are trading at less than 80% of tangible book value (which is shareholders' equity minus liabilities and intangible assets, such as goodwill).  I avoided banking, insurance and real estate stocks, because their balance sheet figures may not always accurately reflect current values.

Company (ticker) Market Cap. ($M) Tangible book value ($M) Price/book
Aircastle Ltd. (AYR) $853 $1,291 66%
Delta Petroleum Corp. (DPTR) $214 $689 31%
Dynergy Inc. (DYN) $709 $,,522 28%
Eagle Bulk Shipping Inc. (EGLE) $260 $620 42%
Energy Conversion Devices (ENER) $214 $298 72%
FormFactor Inc. (FORM) $459 $578 79%
Genco Shipping & Trading (GNK) $436 $929 47%
General Maritime (GMR) $264 $335 79%
Globalstar Inc. (GSAT) $365 $587 62%
Hercules Offshore Inc. (HERO) $374 $971 39%
Hornbeck Offshore (HOS) $565 $797 71%
Imation Corp. (IMN) $398 $566 70%
Overseas Shipholding Group (OSG) $989 $1,759 56%
PHI Inc. (PHII) $328 $465 71%
Radian Group Inc. (RDN) $984 $2,005 49%
SkyWest Inc. (SKYW) $878 $1,328 66%
Tecumseh Products Co. (TECUA) $238 $463 51%
USEC Inc. (USU) $643 $1,269 51%
Winn-Dixie Stores Inc. (WINN) $358 $712 50%

Indeed a balance sheet doesn't tell you everything. Eagle Bulk Shipping (Nasdaq: EGLE), Genco Shipping (NYSE: GNK) and Overseas Shipholding (Nasdaq: OSG), for instance, may look quite cheap relative to the value of their dry-bulk shipping fleets. But there is a global glut of such ships, so the current open market value of these vessels is well less than it cost to build them.

A balance sheet can also steadily weaken if a company is losing money. That's why shares of Energy Conversion Devices (Nasdaq: ENER), a manufacturer of photovoltaic products, and FormFactor (Nasdaq: FORM), a semiconductor maker, are not really cheap when you think about what their balance sheets may look like a few years from now.

Yet real values abound. Here are two stocks from the table above that look quite appealing in the context of tangible book value.

1. Aircastle (NYSE: AYR)
Even as global air traffic has rebounded, share prices for the companies that buy (and then lease) planes still remain at a sharp discount. In the case of Aircastle, its fleet of planes is worth almost $1.3 billion, yet the company is valued at just $850 million. Why the disconnect? Because the company typically carries a considerable amount of debt and investors recall that just a few years ago, that debt load could have been lethal when demand for airplanes slumped. Since then, debt has been coming down, and barring a new global economic crisis, any lingering balance sheet concerns are likely to recede.

I wrote about a rebound for this sector back in September and though shares of Aircastle have risen 35% since then, they still look quite cheap. A few weeks ago, Citigroup boosted their target price for the stock up to $17 -- 55% above the current price -- which is roughly the value of what the company's balance sheet is projected to look like at the end of 2011. The fact that shares sport a 3.8% dividend yield is icing on the cake.

2. Hercules Offshore (Nasdaq: HERO)

I noted earlier that dry-bulk shipping stocks shouldn't tempt you because the value of their ships is not likely to rebound considerably thanks to a glut of existing and newly-built ships. At first glance, a similar fate may appear to befall firms like Hornbeck Offshore (NYSE: HOS) or Hercules Offshore. These companies own expensive oil-drilling rigs which have also seen a downturn in value. But there's a key difference: drilling rigs are only temporarily depressed while drilling activity in the Gulf of Mexico remains slow to rebound. All signs point to rising drilling in the Gulf later this year and into 2012 as regulatory barriers are lifted. (The federal government banned drilling in the Gulf of Mexico's deep waters after the April 20, 2010 explosion of the Deepwater Horizon drilling rig, which killed 11 people and became the largest offshore oil spill in U.S. history.)

The lift of the drilling ban would be great news for Hercules Offshore, which has seen its stock fall to less than 40% of tangible book value, thanks to a high debt load and temporarily diminished cash flow to service that debt. As drilling activity picks up, so should Hercules' cash flow, and those debt concerns will recede.

Make no mistake: investors are unlikely to reward shares all the way up to tangible book value of $8.16 a share while debt remains high. But I fully expect some of the price/book gap to narrow, pushing that metric up to 0.60. That would yield a 50% upward move in shares. And you need not be concerned that Hercules is expected to post a loss for each of the next three years. Actual cash flow in each year is likely to exceed $1.00 a share, which could help the company slowly pay down debt.

Action to Take --> Stocks that trade at a sharp discount to tangible book value have often hit rough sledding. In some instances, such as Aircastle, those rough patches appear to be at an end, while for firms like Hercules Offshore, they look set to end in the next 12-18 months. These stocks may be slow to rebound, but they also have a clear floor underneath them -- which is not a bad thing when the market is pushing many stocks up to multi-year highs.

P.S. -- We've just identified six surprising events that could break your portfolio wide open in 2011. Knowing these pivot points in advance lets you focus your investing strategy like a beam of light in the dark... and make a lot of money in a hurry. Get them free by simply watching this video presentation.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.