The Market Is Missing Something in These Three Companies

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

The market is missing something with chemical's company Axiall (NYSE: AXLL) and miner Pan American Silver (NASDAQ: PAAS). Both companies have very strong cash flows, generating huge amounts of cash, but despite this, the market is still placing a lower valuation on them than that of their peers.

Why is this?

Axiall has been sold off recently after a poor set of first quarter results. The company made a loss for the first quarter; however, under further investigation, it is easy to see that this loss was, for the most part, actually synthetic as the company took a one-off charge relating to a debt swap. This swap involved Axiall initiating a tender offer for $450 million of 9% notes while at the same time issuing $450 in 4.875% notes. Far from being negative, over the longer term this is going to be an extremely beneficial transaction for both Axiall and its investors.

Furthermore, studying Axiall's cash flows it becomes apparent how much value the company has to offer. For the past three years, Axiall has reported an average free cash flow of $130 million a year, which in itself is not that fantastic. However, during the last three quarters of 2012, Axiall reported strong cash inflows that totaled a combined value of $200 million, or about 10% of revenue per quarter.

What the market is missing here is the fact that if Axiall continues at this high rate of cash generation, the company will be producing approximately $95 million of cash per quarter, which on an annualized basis, works out as a 14% return on tangible assets and a 17% return on equity - in comparison, peers Dow Chemical and Du Pont produce a return on tangible assets of only 2% and 6% respectively.

There is no reason why Axiall cannot achieve this rate of cash inflow and analysts appear to support the bullish view, predicting EPS of $3.50 for 2013. (Note: this figure is unchanged from the figure of $3.45 reported at the end of 2012, but investors must take into consideration that the company has 69% more shares in issue than 2012 due to the merger earlier this year with PPG's chemicals business. Based on the larger free float Axiall's 2012 EPS would have been around $2.03 - 70% YoY growth).

One of the best sliver producers

The market is also missing a similar trend in Pan American Silver.

Pan American is one of the most cash generative silver companies on the market. Indeed, while many precious metal mining companies have been spending heavily to try and ramp-up output while metal prices are high, Pan American has been conserving its cash:

<table> <thead></thead> <thead> <tr><th> <p><strong>Company</strong></p> </th><th> <p><strong>Barrick</strong></p> </th><th> <p><strong>Goldcorp</strong></p> </th><th> <p><strong>Newmont</strong></p> </th><th> <p><strong>Pan American</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Reported net change in cash</p> </td> <td> <p>-$646</p> </td> <td> <p>-$22</p> </td> <td> <p>-$1,659</p> </td> <td> <p>$247</p> </td> </tr> <tr> <td> <p>Stock Issuance</p> </td> <td> <p>$1060</p> </td> <td> <p>$600</p> </td> <td> <p>$200</p> </td> <td> <p>-$115</p> </td> </tr> <tr> <td> <p>Debt issuance</p> </td> <td> <p>$7200</p> </td> <td> <p>$0</p> </td> <td> <p>$700</p> </td> <td> <p>$20</p> </td> </tr> <tr> <td> <p>Adjust change in cash</p> </td> <td> <p>-$8,906</p> </td> <td> <p>-$622</p> </td> <td> <p>-$2559</p> </td> <td> <p>$342</p> </td> </tr> </tbody> </table>

Figures in $ US million 2010-2012

Over the last three years, after removing cash flow affects from debt and stock issuance, Pan American has been one of the most cash generative companies around.

With its large cash inflow, Pan American has been able to build up a strong balance sheet and is looking to boost shareholders returns through buybacks. While much of the precious metals mining industry is suffering from poor cash flow problems and lack of investors support, Pan American has plenty of cash and cash flow to support itself through the downturn while still giving cash back to investors.

Still, the company, like the rest of the sector trades at a lowly valuation to the rest of the market.

There are other opportunities around

EMC (NYSE: EMC) also exhibits the highly cash generative nature of Pan American and Axiall, but the company does not trade at the same attractive valuations. That said, the nature of EMC's business means that it has relatively stable and predictable subscription revenues, unlike Pan American and Axiall, both of whom rely on the need for low input costs and high demand for their strong cash flows.

Still, EMC has produced approximately $1.5 billion in free cash flow for the past five quarters and a net cash inflow of $850 million, indicating that EMC is turning more than 20% of its revenue to free cash; beating peers San Disk and Western Digital, both of whom are turning less than 5% of revenue into free cash. With such a high free cash inflow, EMC is relatively debt free and shareholder equity is rising rapidly, up about 10% during the last year. Of course, with strong cash generation comes shareholder returns and EMC is well placed to continue buying back stock or issuing a strong dividend as the company is a veritable cash cow.

Foolish summary

All in all, Pan American and Axiall are both undervalued, relative to their cash flows. Unfortunately, the market is placing too much emphasis on the falling income of Axiall and deteriorating outlook of the silver industry to realize the cash generative potential of these two companies. This presents an opportunity for savvy investors who are willing to do the research to discover the value locked away in these two money-printing value stocks.

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Fool contributor Rupert Hargreaves owns shares of AXIALL CORPORATION. The Motley Fool owns shares of EMC. 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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