Don't Overthink It: 3 Undervalued Turnaround Stocks

Josh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Despite the S&P 500 recently nearing all-time highs, a Foolish investor can still find many underappreciated stocks in this otherwise bullish market.  Regardless of new highs and generous valuations, I have managed to find a wide variety of stocks that appear cheap.  While the concept of finding cheap stocks is simple enough, it only tells half the story, as many great investments are not necessarily cheap, but simply undervalued. I present three companies that I believe are not only cheap, but blatantly undervalued by the market. 

Skullcandy

Why it's cheap: simply put, Skullcandy (NASDAQ: SKUL) trades at only 7x its earnings and 6x its forward earnings.  Following the departure of its CEO, slight guidance downward, a downgrade from Roth Capital, and an incredibly competitive market, the audio retailer's stock has dropped almost 70% since its IPO.  

Why it's undervalued: first, despite the departure of its CEO, Jeremy Andrus, former founder and CEO Rick Alden will be taking the helm on an interim basis, allowing his company the freedom to take a good hard look at its future CEO.  Second, the company welcomed new CFO Kyle Wescoat to the team and was recently cleared to buy back $28 million worth of its shares, potentially priming itself to be acquired. All things held constant, this buyback would represent a 20% premium if all the buyback value were to be exhausted at today's prices.  

My third point is Skullcandy's growth. Revenues grew at a 17% clip in its most recent quarter, but the stock was pounded by traders all the same.  Trading with a P/E of 7, however, the market has the company priced as if it is going out of business altogether, yet alone growing.  By acquiring Astro Gaming, Skullcandy has entered into the gaming headset arena, a strong market riding on the potential of mobile gaming.  Furthermore, the company acquired distribution rights for Europe and is setting up a direct business line of operations in Canada, Brazil, and China.

Highlighting my fourth and final point is the company's strength through its brand image.  Boasting a number of athletes in a wide variety of sports, the company has many huge names on its "Skullcandy team."  Ranging from Kevin Durant and Derrick Rose in the NBA, to model Kate Upton, musician Jay-Z, and to the company's roots in its snow and surf teams, Skullcandy has celebrity firepower to go up against many other huge competitors.  Facing off with Bose, Sony, Beats by Dre, JVC, and Soul by Ludacris, just to name a few, the company will need to maintain its strong brand image and pricing power to compete.  With its former CEO Rick Alden at the helm, I believe they can do just that, and at these valuations, I am willing to make an investment.

Molson Coors Brewing Company

Why it's cheap: Molson (NYSE: TAP) is trading with a P/B of one and a price-to-cash-flow of 8, well below its ten-year averages in each, at 1.2 and 11 respectively.  Furthermore, its forward P/E of 10 is its lowest P/E level for the entire decade, signaling that the company's short-term growth potential may not be fully priced in yet.

Why it's undervalued: cementing itself as the number two brand in the United States with its Coors Light beer, things are finally starting to look up a little bit for the beleaguered brewery.  While it is still far behind Anheuser-Busch InBev's Bud Light, it is great to see signs of domestic growth for the cheaply valued company.  Posting 6% growth year-over-year with its biggest American brand, Molson finally surpassed Budweiser and will be able to focus on its international operations a little bit more.

Following its acquisition of StarBev in 2012, Molson has become the proud owner of the #1 selling brand of beer in Montenegro, Croatia, Hungary, Serbia, and Bulgaria, putting itself in a dominant position in the Central European market.  With beer volume and beer consumption per capita expected to grow at a 3% rate  in Central Europe for the next three years, Molson is in the driver's seat for future growth in the area.  Furthermore, with a joint venture set up in India, and a 20% jump in its 2012 international sales, including Latin America, China, and Russia, the company has many international growth options yet to be fully expanded upon.

With the previously mentioned acquisition and a few smaller acquisitions being made as well, I am more than happy to buy Molson Coors at book value.  With a dividend around 3% and a decline in the number of shares outstanding since 2010, I have good incentive to hold for the long-term as well.

GrafTech

Why it's cheap: switching gears from the consumer market to industrials, we will take a look at one of my personal favorites, courtesy of the Motley Fool Money podcast.  Holding a P/B of only 0.9, GrafTech (NYSE: GTI) has plenty of room to appreciate, as it has fallen from its recent historical mark of around two.  Throw in a forward P/E of 7.5 and a five-year PEG of 0.8 and the company appears downright cheap.

Why it's undervalued: well, simply because of its huge moat.  In as simple of terms possible, they make graphite electrodes for Electirc Arc Furnaces (EAF's), and as of right now there are no known alternatives.  Pair that up with high barriers to entry and this is a great niche with a wide moat for GrafTech to be in.  Operating six plants in four different continents, the company's two biggest competitors, SGL Carbon AG and Showa Denko, only have plants on two continents.  Furthermore, fighting various Chinese companies that together produce over 65% of the world's graphite electrodes, GrafTech manufactures 15% of the world's supply by itself, making it the largest single producer in "the growth sector of steel."

Adding to the excitement, the company's second largest business operation, the production of needle coke, helps align the company's vertical integration, allowing it to bring home a profit margin of 12%.  As the key raw material in manufacturing graphite electrodes, GrafTech's needle coke production allows the company to manage 45% of its overall graphite electrode costs.

Despite holding over $600 million in long-term debt, the company's debt/EBITDA is only 2.5x and it is in solid financial position overall.  With a minisule P/B of 0.9, despite its profitability over the last six years, I am comfortable holding this steadily growing electrode manufacturer for the long term.

Foolish final thoughts

While all of these companies are cheap, they are, more importantly, undervalued by the market. With Skullcandy's growth and strong brand, Molson Coors' expansion into Central Europe and their 3% dividend, and GrafTech's wide moat in a growing niche, I am confident that these cheap stocks are currently undervalued.


joryko has no position in any stocks mentioned. The Motley Fool recommends Molson Coors Brewing Company. The Motley Fool owns shares of GrafTech International Ltd. and SKULLCANDY INC. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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