Sometimes a stock trades at a very clear discount to the sum of its parts, similar to the way an exchange-traded fund (ETF) can trade at a discount to its net current asset value (NCAV). However, that undervalued stock often lacks a catalyst for capital appreciation.
But if the undervalued stock has strong future earnings growth expectations, then you’re probably looking at a near-term capital gain opportunity.
This is the case with Loews Corporation (L). That’s not a typo; the company I’m talking about is not Lowe’s Companies (LOW), the big box DIY retailer.
Loews Corporation is a multi-industry holding company with four distinct business operations, three of which are publicly traded.
• CNA Financial (CNA) is a global insurance company that’s 90% owned by Loews. CNA offers property, casualty, life and long-term care insurance coverage. The company’s EPS are expected to grow aggressively at 41% and 20% in 2016 and 2017, with very low corresponding P/Es of 12.4 and 10.4. The dividend yield is 3.0%.
• Boardwalk Pipeline Partners (BWP) is a natural gas pipeline and storage company, which is 51% owned by Loews. EPS are expected to grow 32% and 9% in 2016 and 2017, with corresponding P/Es of 14.3 and 13.2. The dividend yield is 2.4%.
• Diamond Offshore Drilling (DO), which is 53% owned by Loews, operates 32 offshore drilling rigs. Like many energy companies in recent years, Diamond Offshore is seeing its annual EPS decline. However, the company remains solidly profitable.
• Loews Hotels owns or operates 21 hotels in the U.S. and Canada.
Loews is going through an aggressive earnings growth phase, spurred by increases in oil and gas prices and better performance at most of its subsidiaries. Rising interest rates will enhance CNA Financial’s interest income.
Earnings per share (EPS) are expected to grow 33.4% and 28.4% in 2016 and 2017 (December year-end). For comparison, Apple’s (AAPL) profits are expected to fall 10.4% and rise 7.9% in 2016 and 2017 (September year-end). So you can see that Loews has some outstanding earnings growth in its near future—and it’s earnings growth that typically drives stock prices.
Loews’ corresponding price/earnings ratios (P/Es) are 16.5 and 12.8. The lack of consistency in Loews’ past annual EPS figures has led to big fluctuations in P/Es. However, when comparing past years of profitability that are similar to this year’s EPS expectation of $2.50, the stock’s typical P/E range has been between 13 and 19. You can therefore see that Loews’ P/Es are undervalued vs. its earnings growth rates, and also the P/Es are mid-to-low within its normal P/E range. PEG ratio enthusiasts should be quite pleased with this low valuation.
The company has $5 billion in cash. In the four years through December 2015, Loews repurchased 14.4% of its outstanding common shares. Loews had a long-term debt-to-capitalization ratio of 34% in 2015, which is quite fair for a company that owns a good amount of real estate. The company could use its cash to increase its 0.6% dividend yield, repurchase additional shares or pay down debt—any of which would enhance shareholder value.
The theoretical value of Loews’ stock is commonly assessed based on a combination of the value of stock in its subsidiaries, cash on hand and the value of its wholly owned subsidiaries. An assessment by a major Wall Street investment bank in July 2016 put the sum-of-the-parts value of Loews’ stock at about 48.40, about 17% higher than the current share price.
Prospects for Loews’ Share Price
This undervalued stock has been trading between 30 and 48 for the last seven years, largely due to the ebb and flow of its annual earnings numbers. More recently, the stock has continued to recover from the January 2016 market downturn and barely reacted when U.S. stock markets became volatile last week.
That’s good news, reflecting investors’ bullish attitude toward the stock.
Given a neutral-to-bullish stock market, Loews’ price could easily climb to 44 this fall, with a good chance of proceeding upward to price resistance at 48. Once the stock reaches 48, it will likely rest for a while. Traders should sell at 48.
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