SVB Financial Group (SIVB) targets the strongest verticals in the U.S. economy, growing in the double digits in recent years, and its Silicon Valley Bank is positioned to soar profits if domestic interest rates being to move higher after the current extended period of low interest rates, says Aaron James Deer, Managing Director and Equity Research Analyst at Sandler O’Neill + Partners, L.P.
“[Silicon Valley Bank] has seen 20% to 30% growth over the past couple of years, and it still has a terrific outlook. SVB focuses on technology companies, life sciences, venture capital, private equity — areas that have been very strong in our economy — and SVB has been a beneficiary of that,” Deer said.
Although Deer doesn’t currently have a “buy” rating on the stock, but he says any pullback in the stock price may present a good opportunity to get in the name. The bank is part of the larger Western banks regional group, a banking group that has managed to maintain profitability by controlling operating expenses and funding costs.
“[SVB Silicon Valley Bank] profitability is pretty good, but this is another bank where, if we ever see interest rates move higher, its profitability should really soar, so that’s one to keep a close eye on. Right now I think the stock is a little expensive, but on any sort of pullback, that would be one to look at,” Deer said.
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Apollo Group (APOL) is expected to overcome weak enrollment trends and diminished earnings due to investments in technology and marketing, generating significant savings and alleviating near-term fines the University of Phoenix accreditation may incur from the Higher Learning Commission, says Daniel G. Lysik, Founder & Managing Director at Pratt Capital, LLC.
“We think Apollo’s cost-reduction program, eliminating redundant physical facilities and excess infrastructure costs, will generate significant savings starting in 2013 and continue through 2014. The company still generates a very attractive return on equity of more than 20%. With capital expenditures, only 3% of revenues, Apollo’s annual free cash generation is significant,” Lysik said.
Lysik says APOL has developed a way to make the online education space even more portable by combining multiple applications to provide services through mobile devices, and the company remains a well-known technology leader in its industry, with roughly 1,000 technology employees, a third of them in the Bay Area.
“The company has a pristine balance sheet with $9 per share of net cash and long-term investments. We believe if you look out a couple of years, as expenses come down, Apollo’s earnings should recover from $2-$2.50 range to normalized level closer to $4 per share. Apollo’s current market price, ex-cash, is currently only two times normalized earnings and has a normalized free cash flow yield greater than 40%,” Lysik said.
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Corning Incorporated (GLW) takes advantage of the global growth of touch-screen technology in mobile devices, benefiting from its manufacturing advantage over peers and seeing increased free cash flow generation which may result in more dividends and share repurchases, even as it trades below liquidation value, says Daniel G. Lysik, Founder and Managing Director of Pratt Capital, LLC.
“In our opinion, the market is missing a couple important things with Corning. First, the company has a pristine balance sheet, more than $5 per share of net cash and long-term investments, 40% of the current market price. Market participants are overly concerned with near-term margins compression as the stock price is also currently trading below liquidation value. Third, investors are missing the company’s manufacturing advantage over their competition,” Lysik said.
Corning manufactures new products at current facilities, providing the company with significant incremental profits. The current ample capacity GLW enjoys will allow capital expenditures to fall by 30% in the next year or two, providing Corning with free cash flow that can be used to return capital to shareholders via share repurchases and dividend payments.
“Over the next couple of years, Corning should see margins improve, revenue growth re-accelerate, and we believe the company’s share price will move overtime towards its intrinsic value, which is north of $20. With the current share price near $12, we believe Corning is a great value investment with a significant margin of safety,” Lysik said.
Bank of America Corp (BAC) and Citigroup (C) benefit from tailwinds in the financial sector and are expected to continue showing operating efficiency improvement, all while currently trading at below tangible book value, says Daniel G. Lysik, Founder and Managing Director of Pratt Capital, LLC.
“I think some of the leading companies in the financial sector provide great long-term investment opportunities,” said Lysik. “Capital levels have been restored, asset quality trends continue to improve, loan growth is accelerating, net interest margins are starting to stabilize and companies are aggressively adjusting their cost structures to match the lower-revenue environment.”
Lysik says that while it may take some time for the market to fully understand Bank of America and Citigroup‘s earnings power, both franchises will continue to further book value growth and can still generate normalized return on equity of at least 10% as they right-size their cost structures.
“As of the latest earnings report, Bank of America’s tangible book is $13, their book value is greater than $20 and we believe their normalized earnings over the next couple of years is greater than $2 per share. Citigroup’s tangible book is $51, their book value is greater than $60 and we calculate their normalized earnings potential as greater than $7,” Lysik said.
CapitalSource (CSE) posts above-average performance and seems to be on the path to return capital to shareholders, benefiting from low capital requirements now that CSE is close to finish its transformation into a bank, a commercial bank charter and a bank holding company, says Aaron James Deer, Managing Director and Equity Research Analyst at Sandler O’Neill + Partners, L.P.
“I expect CapitalSource to benefit from lower capital requirements. This is an institution that has just a huge amount of excess capital, and it has been doing massive share repurchases, and I expect we’ll see more of that as well as rising or even special dividends. The company is seeing very strong loan growth,” Deer said.
Deer says CSE’s business loans should see less competition due to the nature of the niches it serves, and the capital the bank holds should benefit shareholders as its balance sheet becomes lighter.
“[CSE] has an above-average margin. It tends to operate in some pretty interesting niches where there is less competitive pricing pressure, so the profitability is strong, with an ROA around 1.30%, and its ROE should improve as it bleeds down more of its excess capital,” Deer said.
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Molson Coors Brewing Company (TAP) expands internationally and into the craft beer segment, and this leading beverage company recently traded down to 10 to 11 times 2013 earnings in the last quarter of 2012, leading J. Jeffrey Auxier, President and CEO at Auxier Asset Management, LLC, to include it in his value investment portfolio of misunderstood businesses.
“Right now, many of their markets are suffering from recession. [TAP‘s] customers are out of work, there was a difficult National Hockey League strike. But five years from now, if the business can achieve just a 15 times multiple, this seemingly dull company could provide exciting returns,” Auxier said.
Auxier buys during periods of turmoil, when many investors are selling rather than buying. He previously studied the investment practices of well-known investors Warren Buffett and Carlos Slim, and he says he will buy and wait for his stocks to appreciate rather than chase momentum.
“We want to take advantage of the market when it’s offering compelling bargains. We typically come alive when the market is pessimistic. Most people are worried during a recession, but we turn it upside down and say, ‘time to shop,’” Auxier said. “We would rather get in early for the double or triple play.”
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Starz (STRZA) was spun off in unique way from Liberty Media Corp. (LMCA), in a way that won’t cause it to necessarily have a tax liability if it merges with another company, leading Jonathan S. Vyorst, Senior Vice President at Paradigm Capital Management to invest in Starz and include it in its special-situations portfolio.
“[Starz] was spun out from Liberty Media, and what was interesting about the way it was done from a legal perspective is that Liberty Media didn’t spin out Starz — Starz actually spun out all of the other assets of Liberty Media. That’s significant because spinning off a company is a tax-free endeavor,” Vyorst said.
Vyorst says the tax concerns may be at the center of why LMCA chose to handle the spin-off in this way, making Starz a more attractive buyout target candidate. Vyorst says special situations are an old and important part of value investment, and he says corporate transformations such as mergers, acquisitions or a restructuring are other situations which may present opportunities.
“If the spun-off company is bought within two years, then you have a tax liability. On the other hand, if the original company merges with another company, there is not necessarily a taxable event. So it seems that Liberty Media’s intention was to sell Starz in a tax-efficient manner, and that’s why it effected the spin-off the way it did,” Vyorst said.
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Analysts describe a potentially more positive future for Transocean LTD (RIG) stock after the Macondo oil spill in the Gulf of Mexico in 2010, citing improved operational procedures and the name trading at a discount:
“We like Transocean. It’s coming off of a hangover of sorts from Macondo and from some issues in Brazil. With the impact from Macondo becoming clearer and the liabilities slowly getting settled, Transocean is attractive. It’s traded at a discount to its peers recently, and historically it has traded at a premium,” said Trey Stolz, Managing Director of Oilfield Services Research at IBERIA Capital Partners.
The stock has also attracted the attention of activist investors:
“First, Carl Icahn got involved in Transocean early this year. Even though it was widely viewed as an undervalued name, I think Carl Icahn getting involved really brought the story to the fore again. I believe that it is a company that really did a great job re-engineering itself following Macondo. They launched a number of internal initiatives to address some of their shortfalls in procedures, and they are upgrading the whole infrastructure of the company. After about 18 months of that, I think that 2013 and 2014 will be very bright for Transocean, because a number of those initiatives should provide benefits in the upcoming years. I think that may be one of the many reasons why Mr. Icahn got involved in the name,” said Nigel Browne, Equity Research Analyst at Macquarie Capital.
Finally, they also mention RIG‘s cash return strategies:
“There are other companies such as Ensco, Transocean and Noble, which are in the process of returning more cash,” said Scott Gruber, Senior Research Analyst at Sanford C. Bernstein & Co., LLC.
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East West Bancorp (EWBC) has been posting positive metrics despite a low interest rate environment and a sluggish economic recovery in the U.S. This California bank’s exposure to the the West Coast and the Chinese market have driven above-average performance, says Aaron James Deer, Managing Director and Equity Research Analyst at Sandler O’Neill + Partners, L.P.
“East West Bancorp is one that I like. It has been putting up very good loan growth, and I think that it has a very strong franchise that benefits from a position of supporting businesses that operate here in the U.S. and have a tie with China, and so it does a lot of international trade and finance lending,” Deer said.
East West Bank trades at a discount despite positive metrics, Deer says, and he says the bank should also benefit from a shift in the trade direction between the U.S. and China. The bank serves as a full-service commercial bank serving businesses and customers in both sides of the Pacific.
“As you see more trade between the U.S. and China, not just the U.S. importing but also the U.S. exporting to China, that should continue to benefit East West. Additionally, it has above average profitability with a double-digit ROE, but despite the good growth and above average profitability, its stock actually trades at a discount to the group,” Deer said.
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ViewPoint Financial Group (VPFG) went through a second-step conversion and increased commercial loans during the height of the financial crisis, gaining market share from larger banks in the Dallas – Fort Worth area in Texas, says Jonathan S. Vyorst, Senior Vice President at Paradigm Capital Management, Inc.
“ViewPoint management had also done some interesting things during the financial crisis. It started a commercial loan business, and when a lot of the bigger banks stopped lending money at the height of the crisis, ViewPoint captured market share by hiring commercial mortgage lenders,” Vyorst said.
Vyorst says VPFG‘s is now more fully valued after its second-step conversion, before which the company was trading for a discount to book value, below what most banks tend to trade. Vyorst says financials don’t normally generate much cash flow due to the nature of their business, but he says he invests in companies with high equity-to-asset ratios and other strong financial metrics.
“ViewPoint is located in Plano, Texas. The Texas economy is doing much better than the rest of the country, and Plano is a nice suburb in the Dallas-Fort Worth area that is doing particularly well economically,” Vyorst said. “[VPFG] also had a warehouse funding business for residential mortgages, which did very well during that time period.”
