Investors are optimist based on two factors: 1) Signs that the coronavirus may be reaching its peak in Europe and 2) The incoming federal bailout which will inject trillions of freshly printed dollars into the US economy.
While it is impossible to predict in which direction the markets will move next, diligent long term investors know that time in the market beats timing the market. Thus, they invest incrementally to hedge against market down volatility and take advantage of dips to dollar-cost average their positions. This means choosing companies who are market leaders in their field, have competent management, solid balance sheets and promising future growth prospects.
Here are 3 potentially undervalued stocks that may present attractive opportunities for long-term investors.
1 – CARNIVAL CORPORATION (NYSE: CCL)
This choice may prove to be controversial.
First, cruise companies were recently left out of the federal bailout. Indeed, lawmakers refused to include them on the grounds that they are incorporated offshore and that the majority of their workforce is foreign. Apparently, the Trump administration offered to provide federal aid if the cruise lines would agree to incorporate their business in the USA. Unwilling to give up the comfort of their tax-free paradises, the cruise lines simply refused the offer.
Second, cruise companies attracted heavy criticism for ignoring the first signs of coronavirus outbreak on their ships.
Second, cruise companies attracted heavy criticism for ignoring the first signs of coronavirus outbreak on their ships.
Third, all cruises are cancelled until further notice. This has dried up all of their cash flow and raises questions as to their long term solvency.
As a result of the negative economic outlook, CCL’s share price plummeted 84% in three months, going from $51.90 on January 17th to a low of $7.97 on April 2nd, before bouncing back to $12.42 on April 9th, 2020.
While many investors are still avoiding this stock at all costs, there may be reasons to believe that CCL will survive this crisis and return to profitability as soon as they are allowed to continue their operations.
- MARKET SHARE & BALANCE SHEET
With over 100 ships and 11.5 million passengers a year, CCL controls almost 50% of the entire cruise industry. They operate 10 different cruise lines, the most famous of which are Carnival, Princess, Costa, AIDA, and Cunard, which built the infamous Queen Mary 2, the world’s biggest cruise ship at the time (which even boasted a planetarium on board).
Their Income Statement reveals solid financials: 2016-2019 Revenues increased 27%, going from $16.3 billion to $20.8 billion; and their 2016-2019 EBITDA increased 13%, rising from $4.7 billion to $5.4 billion.
Cruise lines have the reputation of being high-volume, low-margin businesses. However, CCL’s 2019 gross margin of 38% and its 2019 net margin of 14% are quite respectable. Evidently, the company is leveraging its dominant market position to generate economies of scale and control costs.
- DEBT & CASH FLOW
Initially, investors were worried about CCL’s ability to pay off its short term debts as a result of its cash flow drying up. Indeed, the company’s 2019 Current Ratio of 4.43 suggests that it does not have sufficient assets to pay off its short term liabilities.
Realizing that its chances of receiving a bailout were slim to none, the company reacted quickly by emitting $6.25 billion of fresh debt: The debt offering includes $4 billion of senior secured notes with a coupon of 11.5%, $1.75 billion in convertible notes at 5.75%, and $500 million of common stock.
Before the new offering, CCL’s debt burden was reasonable. The company’s Balance Sheet reveals a Debt Ratio of 0.42 and a Debt to Equity ratio of 0.77 which are both good. However, the current crisis is not about honoring long term debt but meeting short term obligations.
Although the new debt will negatively impact the company’s balance sheet, it was necessary to ensure survival. The company states that the liquidity raised will provide enough cash to last until 2021…By then, the coronavirus crisis should be resolved and ships sailing again.
- SAUDI INVESTMENT
Investors usually look favorably on sovereign fund investment. Thus, both long time and recent investors were understandably excited by news that the Public Investment Fund of Saudi Arabia (PIF) acquired an 8.2% share of the company (more than 43.5 million shares). The PIF must have done their due diligence and come to the conclusion that CCL is a worthwhile investment.
Indeed, they would not have invested such a large amount of capital if they believed the company would go bankrupt. Shareholders have a vested interest in seeing a business succeed because, during bankruptcies, the company’s assets are used to pay off creditors first; shareholders are last in line.
Given their long term strategy of diversifying their economy away from oil, it is doubtful that Saudi Arabia would invest money without studying the business’ fundamentals first.
- NO DIVIDEND? NO PROBLEM.
CCL recently announced that it would suspend its dividend and buyback programs. The suspension of these measures is aimed at conserving much needed capital to deal with the short term obligations incurred by the coronavirus crisis. While this news will disappoint dividend investors, the company had little alternatives.
Indeed, the $6.25 billion raised will go towards paying off short term liabilities. Paying dividends would have forced the company to take on significantly more debt and this could have been potentially fatal for the company’s long term future.
However, given CCL’s history of generous dividend payments, investors can expect the company to resume paying them out once its business goes back to normal. Although they may not immediately hit the highs of yonder, ($2.00 annual payout per share), we can expect the management to start paying them out again as soon as the company’s financial health allows it to do so.
- PRICE ACTION: RISK/REWARD
When we look at the recent price action, we notice major support near the $8 range. As a result, the current price of $12 per share presents limited downside.
In sum, if the company is really valued anywhere between $30-$50 when business is good, which it probably will be within a year or two, then the potential upside is very attractive.
2 – THE FOX CORPORATION (NYSE: FOXA)
The stock is currently trading for $25.99, a 51% discount from its all time high price of $39.34. The stock may have been slightly overvalued at $39 but in my opinion it has reasonable upside potential.
- MARKET SHARE
The Fox Corporation deals primarily in the television broadcast, news, and sports broadcasting industries. The company controls the following market shares by segment: Filmed entertainment (21.94%), television (12.89%), cable network programming (42.58%), affiliate fees (33.01%), and advertising (19.65%).
The company’s website claims that “FOX Network’s primetime entertainment lineup accounted for seven of the 2017-2018 broadcast season’s top 20 new broadcast entertainment series” and that the network “has aired the most watched television program, NFL’s America’s Game of the Week on FOX, for ten consecutive years, and in 2018, the NFL on FOX regular season pulled in an average of more than 18 million viewers“.
In addition, the company claims that it “finished 2018 as the most-watched basic cable network for the third consecutive year in both primetime and total day viewing. FOX News has held its number one national cable news network status for 17 consecutive years. FOX Business Network has been the most-watched national financial channel for more than two years in business day viewership“.
These bold claims appear to be backed up by reality: In February 2020, the Forbes published an article analyzing Fox’s performance and concluded that “with an average prime time audience of 3.5 million viewers, FNC hit its 44th consecutive month of beating not just CNN and MSNBC, but all networks in basic cable. Among news networks, February was Fox News’ 218th first-place finish in a row“.
In sum, Fox Corporation is a leader in cable news and entertainment.
- STRONG FINANCIALS
The Fox Corporation is in very good financial health as both the top and bottom lines of its Income Statement are increasing: 2016-2019 Revenues increased 28%, 2016-2019 Net Income increased 48% and 2016-2019 EBITDA increased 29%.
This indicates that the company is growing year in year out and increasing its profitability faster than its revenues along the way. This signals that management is very effective at controlling costs.
- DEBTS & CASH
The company’s Debt Ratio of 0.48 is very low and indicates that growth is not dependent on debt.
Further, while the long-term debt of $6.7 billion is significant, it is not worrisome. Indeed, the company’s 2019 total cash was $3.2 billion, its current assets $6.4 billion and its current ratio 3.78, which indicate that the company generates sufficient cash to pay off its short term liabilities.
Lastly, FOXA’s Free Cash Flow is increasing steadily since 2016, with 2019 FCF of $2.2 billion up 131% from 2016 when it stood at $990 million. Fox has a lot of cash on hand which means that it can sustain its growth by acquiring competitors and investing internally to produce better content.
- BONUS: THE DIVIDEND
Fox’s annual dividend payout of $0.46 per share represents a modest 1.77% yield. However, investors should remember that the company has only just started paying out dividends. Given that the business is growing, management will most likely increase the dividend in coming years.
3 – BERKSHIRE HATHAWAY (NYSE: BRK.B)
Berkshire Hathaway is an American multinational conglomerate holding company headquartered in Omaha, Nebraska, United States.
Founded in 1839 by Oliver Chace, Berkshire was originally a textile manufacturing company. Legendary investor Warren Buffet started buying shares of the company in 1962 and acquiring a majority stake in 1964. He then proceeded to expand the company’s business to insurance and other investments.
Today, Berkshire owns a diverse range of businesses ranging from confectionery, retail railroads, home furnishings, tech and utility companies. Forbes Global 2000 ranks Berkshire the 1st public company in the USA and the 4th largest in the world, the 10th largest conglomerate by revenue and the largest financial services company by revenue in the world.
Lastly, the company’s stock boasts the enviable status of being the most expensive in the world: At their peak, BRK.A shares traded for more than $300K each. This is explained by the fact that Buffet has always refused to split the stock. Based on free-float market cap, BRK.B shares are the fifth-largest component of the S&P 500 Index.
Today, BRK.B stock is trading at a 15% discount from its Jan 17th, 2020 high of $230.20. This is a modest discount considering that the stock was trading for $162.13 late March, but we will see below why this could still be a good deal.
- AN IMPRESSIVE, DIVERSIFIED PORTFOLIO
Berkshire’s main business is insurance. The advantage of this specialization is that it is essentially recession-proof: Do you know many people who forego car insurance during a downturn? Neither do I.
Berkshire outright owns the following insurance companies: GEICO (2nd largest auto insurer in the US), Gen Re (global reinsurance business), NRG (Dutch life reinsurance agency), and Berkshire Hathaway Assurance (government bond company).
Berkshire also controls nearly 90% of Bershire Hathaway Energy, a holding company who owns numerous energy companies. The holding company’s finances are impressive, with total revenue of $17.4 billion, net income of $2.5 billion, total assets of $85.4 billion and total equity of $24 billion.
Further, Berkshire’s portfolio is incredibly diversified and includes the following sectors and companies: Clothing (Fruit of the Loom, Garan, Russell Corporation, H.H. Brown Shoe Group, Justin Brands, Brooks Sports; Building products (Acme Building Brands, Benjamin Moore & Co, Johns Manville, Clayton Homes); Flight services (FlightSafety, netJets); Retail (Dairy Queen, Ben Bridge Jeweler, Helzberg Diamonds, The Pampered Chef, See’s Candies, Oriental Trading Company, Nebraska Furniture Mart, Jordan’s Furniture); Media (Buffalo Evening News, Business Wire, Omaha World-Herald, and plenty others); Real Eatste (HomeServices of America, Home Capital Group Inc); Other (McLane Company, TTI Inc, Marmon Group,…). This is a non-exhaustive list intended to provide you with a general idea of just how vast Berkshire’s empire is.
In addition to owning the companies cited above, Berkshire has significant stakes in plenty of other behemoths: IBM, Apple, Moody’s, Bank of America, Coca-Cola, General Motors, Goldman Sachs, Delta Airlines, Kraft Heinz, Wells Fargo,…
- HISTORICAL PERFORMANCE
When investing in individual stocks, investors look to see if they have a consistent history of beating the S&P 500’s average annual returns.
How does Berkshire perform in this regard? $100 invested in Berkshire stock in 1968 would have grown to $850K by 2018; in comparison, the same investment in the S&P 500 would have returned just under $11K.
However, Buffet’s impressive record of outperforming the S&P is waning: In the last 10 years, Berkshire has under-performed the S&P 500. Point in case: Last year, during one of the best years in the S&P 500’s history, Berkshire Class B shares rose 11% while the S&P rose by more than 30%. This means that BRK.B shares underperformed by a factor of 2.7.
Buffet has repeatedly told shareholders not to expect consistent above-average returns. Indeed, he is notorious for purchasing solid companies and holding on to them forever. He has said that he finds the current market very expensive and void of bargains. Thus, he prefers to live off his dividends rather than invest his cash needlessly.
So why should one buy Berkshire shares at all?
The main reason why investing in BRK.B could pay off long term is that Buffet is sitting on a +$100 billion war chest. We can suppose that he will use this enormous amount of cash to invest if the opportunity arises. This may be that opportunity. More on this below.
- STRONG FINANCES
As expected, Berkshire’s top and bottom lines are very healthy: 2019 revenues of $327 billion are up 46% from 201- when revenues were $223 billion and 2019 Net Income of $81.4 billion is up 238% from 2016 when it was $24 billion.
Berkshire’s debt ratios are also very healthy: Debt ratio of 0.477 is very good and the Debt to equity ratio of 0.91 is reasonable. Buffet loves to invest in companies with limited debt burdens so it is no surprise that his own company performs well in this regard
- CASH ON HAND
Even more impressive is Berkshire’s $168 billion raised from Sales/Maturities of investments in 2019. This is testament to Buffet’s shrewd investments that generate massive cash flow. As a result, Berkshire is in the very enviable position of having mammoth cash reserves that it can allocate to investment opportunities that may arise. His total disposable cash reserve is estimated to be almost $130 billion.
In 2019, while investors were greedily buying up equities, Buffet was hoarding cash. Some believe he was doing this to reassure investors in case he or Charlie Muger were to fall sick. Indeed, to avoid a massive sell off of BRK stock in case the founders’ lives were at stake, Bershire’s management could use the cash reserves to buy back tons of stock and prevent a hemorrhage.
However, I believe this explanation only constitutes part of the answer. Indeed, in his 2019 shareholder letter Buffet himself declared that “Prices are sky-high for businesses possessing decent long-term prospects“. Being the cautious value investor that he is, perhaps he was strategically building up his cash reserves to pounce on a future market correction.
He wasn’t the only one warning investors that the current market was potentially overvalued. Those trying to analyze market valuation by looking at the Buffet Indicator, which gauges the relative cheapness of equities by factoring the ratio of equity market capitalization to GDP, tended to agree with Buffet’s reasoning.
Although nobody could have predicted the current coronavirus outbreak, it appears that Buffet is being vindicated. He is certainly satisfied with his decision to defer purchasing equities to raise cash. We do not yet know what he is buying but we can safely assume that he is actively scouring the market for opportunities.
For all of the above reasons, I believe that buying BRK.B shares could be a smart long term investment. When the smoke settles and Buffet reveals his portfolio, the stock could soar to previous levels and far beyond.
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DISCLAIMER: This is not financial advice. Conduct your own research before investing in any asset. At writing, author owns shares of CCL and may open positions in BRK.B and FOXA in the coming weeks.