Finding the pockets of value in today's stock market is like finding a needle in a haystack. With the Shiller Cyclically Adjusted P/E ratio for the entire S&P 500 approaching 90s dot-com bubble territory, the chance of coming across a stock on sale is becoming rarer by the day. Every once in a while, though, the market forgets about a few stocks that have a lot of value in them, even in the most overvalued markets. Three companies that look to be selling for a decent discount today are Cooper Tire & Rubber (NYSE: CTB), HCP (NYSE: HCP), and Total SA (NYSE: TOT). Here's a look at why the market may be wrong about these stocks.
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How many China bets come at this low of a price?
Considering how much China has been the growth engine for the global economy over the past couple of decades, it seems appropriate that companies with a significant catalyst in China merit a premium valuation. Strangely, though, Cooper Tire & Rubber doesn't seem to get as much of a premium for its exposure to China. At just 4.2 times earnings before interest, taxes, depreciation, and amortization (EBITDA), it seems like the market is pricing in a pretty significant decline.
To be honest, Cooper has never really garnered much of a market premium. Its current valuation is in line with its 10-year historical average. After all, manufacturing tires is a business that is sensitive to material cost volatility, which can sting earnings from time to time.
If you look at the recent sales trends for Cooper, though, it looks like there is a reason to believe the market is underpricing its potential. In North America, Cooper only sells aftermarket (replacement) tires, so it isn't subject to the overall automotive market. Also, aftermarket tires tend to generate higher margin than those sold directly to manufacturers for new vehicles. This gives Cooper a strong foundation from which it can grow sales in emerging markets, such as Latin America and China. Last quarter, sales in Latin America and its international unit -- mostly China -- grew 16% and 31%, respectively. As more and more people in these regions enter the middle class and demand higher-quality products, Cooper should be able to command better prices and improve margin.
Selling aftermarket tires isn't what you would consider a growth stock, but its opportunities in foreign markets, coupled with its bargain-basement valuation, make for a rather compelling investment thesis.
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An improved outlook, but a lower valuation
Last year, HCP spun off some of its higher-risk real estate assets, such as nursing homes and post-acute care facilities. The deal gave HCP a large injection of cash that it used to deleverage the business in order to focus on private-pay facilities that have proven to be more stable investments. Overall, it was a good move to make over the long term.
Wall Street hasn't been too keen on the idea, though, as the spinoff also resulted in a (sort of) reduction in its dividend payment. As a result, HCP's shares currently trade at an enterprise value-to-EBITDA ratio of 14.6. That valuation is well below its 10-year average valuation and is awfully close to the lowest valuation since the Great Recession.
Today, HCP's business looks well positioned for growth. The recent deleveraging should give it some extra firepower when it wants to make some acquisitions or develop its own properties if the capitalization rate is right. In fact, the company currently has $834 million committed to ground-up developments that could pull in higher capitalization rates than acquisitions. As the baby boomer generation ages, a greater percentage of the U.S. population will be over 75, which will lead to huge investments in healthcare services.
When you add together the long-term demographic trends working in HCP's favor, the improved balance sheet, and the abnormally low valuation, it seems like today is an opportune time to invest in this healthcare real estate investment trust.
Best-in-class returns at worst-in-class price
I think it's fair to say that a company producing the best returns on equity in its industry should deserve the highest valuation among its peers. You could even argue that a middle-of-the-road valuation would be OK. But to have the best returns in the business and the lowest valuation? That doesn't seem right. Yet that is exactly where shares of Total stand today.
Total has arguably done the best job of handling the oil crash, compared to its integrated oil and gas peers. Management was much faster to react to the decline in prices and started to cut capital spending and wring out every cost possible from its operating expenses -- so much so that last quarter, Total generated just as much free cash flow as it did back in 2013 when oil was north of $100 a barrel. That increase in earnings and cash flow has allowed the company to pay down debt and position itself for the next phase of growth that will likely come over the next few years.
Wall Street still treats the entire energy industry with kid gloves, but that broad-stroke approach makes for some great long-term investing opportunities. Total is one of those companies right now, and its low enterprise value/EBITDA is evidence of that.
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