Like many other investors out there, I keep a watchlist of stocks. While stocks can be on my watchlist for various reasons, the ones that tend to make it into my portfolio the soonest are the ones that appear to be mispriced based on their long-term prospects.
Three stocks on my watchlist that look incredibly cheap and will likely be high up on my next buy list are LGI Homes (NASDAQ: LGIH), U.S. Silica Holdings (NYSE: SLCA), and Transocean (NYSE: RIG). Here's why they look compelling to me now and why Wall Street seems to be assigning them such modest valuations.
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In the sweet spot of the housing market
After years of growth, there are increasing signs that the U.S. housing market is slowing down considerably. While there are certainly several factors that are contributing to that trend, one that continues to pop up recently is affordability. Low inventories of existing homes on the market and housing starts remaining steady has led to much higher prices. According to the Case-Shiller 20-City Composite Home Price Index, homes prices were up 6% compared to the prior year in June, with some metropolitan areas reporting price increases as high as 13%.
At the same time, though, there is still likely pent-up demand for homes. Millennials -- who have largely stayed out of the housing market following the Great Recession -- are now starting to enter the market. As a result, demand from first-time buyers is still relatively high.
This market dynamic plays quite well to homebuilder LGI Homes' business model. The company focuses almost entirely on the first-time buyer, with much lower price point homes than its peers, and actively markets to renters and first-time buyers by advertising mortgage rates comparable to local rental rates. As recently as the second quarter, LGI's average realized home price was in the $225,000-$235,000 range, which is $100,000 less than most of its peers. What's more impressive from an investor point of view is that LGI has some of the highest gross margins in the business. Couple that with LGI's fantastic growth rates over the past few years, and you get one of the best businesses in an otherwise crappy industry.
Thanks to Wall Street's concerns about a slowing housing market, shares of LGI trade at a dirt-cheap price-to-earnings ratio of 8.7. If there is one company that will be able to overcome the issue of affordability in the housing market, LGI is it, and it looks like a compelling buy at these prices.
Not the same company it was, but priced like it is
Fracking sand supplier U.S. Silica is trading like it's 2016 all over again. At the time, U.S. Silica was supplying sand using spot market prices and typically letting customers or oil services companies handle the complicated task of doing the last-mile logistics. So when oil prices started to plunge and producers stopped fracking wells, the business incurred heavy losses and investors that had previously bet big on frack sand fled for the exits.
Since then, though, a lot of things have changed at U.S. Silica and the fracking industry as a whole, making this a much more compelling business. First, producers looking to lower per-barrel costs and improve economics found that adding more sand to the fracturing mix yielded better results. Consequently, the amount of sand used per well has doubled -- and in some basins, tripled -- over the past few years. Also, with domestic oil prices back around $70 a barrel in the U.S., drillers are returning in droves to the oil patch. Production is on the rise and sand demand is expected to reach more than 100 million tons in 2018. (In comparison, total sand demand at the prior peak in 2014 was 63 million tons.)
U.S. Silica's management has significantly reduced commodity price risk several ways. It has built several mines close to demand to reduce transportation costs, signed up producers to long-term supply contracts that ensure sand production facilities run at high rates, invested in last-mile logistics services that drastically improve per-ton margins, and acquired industrial sands and minerals businesses to diversify away from being overly reliant on the oil and gas industry.
Despite all of these positive changes, shares of U.S. Silica trade not that far off the lows we saw when oil prices were less than $30 a barrel, and its current P/E ratio of 10 doesn't seem to do the moves management made justice. Things are looking up for this frack sand producer, and investors could be looking at a steal today.
The catalyst looks to be on its way
Like U.S. Silica, offshore rig company Transocean suffered mightily as oil prices crashed and producers stopped investing in offshore exploration and production. You can pretty easily argue that Transocean and other offshore rig companies have probably had a rougher go at it than frack sand suppliers. An offshore project is much more capital-intensive than shale drilling, and the payoff for an offshore well is measured in years instead of weeks for shale. As a result, companies that did have money to spend on production were more likely to tap their shale prospects than tie up capital in multiyear offshore programs.
Since the offshore crash, Transocean -- also like U.S. Silica -- has taken monumental strides to improve its business. It sold, retired, or scrapped dozens of rigs to focus its fleet on new rigs capable of doing jobs in the most demanding places, such as water depths of more than 10,000 feet and harsh environments like off the coast of Norway. It even used the strength of its balance sheet to acquire other companies' rigs or buy companies outright at steep discounts to their book value.
Those moves look like they are about to pay off. With international oil prices hovering closer to $80 a barrel -- yes, they are that different to domestic prices -- several producers are planning on hitting the high seas again in search of oil and gas. Transocean's management anticipates that there will be 87 offshore projects that will equate to 57 rig-years of work to bid upon in the next 18 months. Having a ready and highly capable fleet will make it easier to win that work.
Transocean hasn't turned a profit in a few years, so the P/E ratio is useless. It does trade for 0.44 times book value, which suggests that Wall Street is highly skeptical of an offshore turnaround. If one does materialize sooner than later, though, then Transocean's stock is a bargain.
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