5 Decent-Looking Recovery Picks

LONDON -- It's no secret that some of the FTSE 100's (INDEX: ^FTSE  ) biggest businesses are under the cosh right now. For bargain hunters, this can offer up some juicy pickings -- under-valued shares, in short, that could be set to soar.

And that's true for both income investors and those looking for capital upside, too.

Take mighty Tesco (OTC: TSCDY) (LSE: TSCO.L  ) , for instance. This FTSE 100 stalwart has seen its share price fall by 25% over the past two years, with the biggest plunge in the wake of January's profit warning. Over the same period, London's flagship FTSE 100 index has climbed almost 10%, delivering a whopping 35% differential.

Yet Tesco's annual dividend per share has continued its steady climb, putting the shares on a tasty 4.9% forward yield. Buying an income from Tesco has rarely been bettered.

Even so, Tesco isn't one of my picks today. In looking for decent recovery plays for this article, I've discounted Tesco -- even though I personally hold the shares and have significantly increased my holding after January's shock slump.

Screen
I began by running a screen on FTSE 100 companies, looking for businesses trading on a historic price-to-earnings ratio that is at a 20% discount to the FTSE's average of 9.85 -- in other words, a P/E of 7.9 or so.

Straightaway, that eliminated some interesting prospects that didn't quite make the 20% cut -- Legal & General, for instance, currently trading on a P/E of 8.3. It also eliminated Tesco; the share may be beaten down, but it's trading on a measly 7% discount to the FTSE's average P/E.

Next I eliminated very cyclical mining businesses. Their P/Es might be low, but mining isn't for me at the moment -- especially when coupled to concerns over corporate governance issues.

So it's goodbye Rio Tinto on a P/E of 7.6, Eurasian Natural Resources on a P/E of 7.4, and Vedanta on a P/E of 5.9, for instance.

Finally, I kicked out businesses where the discount to the FTSE's average P/E did not, in my view, provide an adequate margin of safety, bearing in mind the industry risks they were facing -- at which point I bade farewell to Barclays and RSA Insurance Group.

Last five standing
This left me with five businesses with beaten-down share prices but -- to my mind, at least -- decent prospects for recovery.

Interestingly, too, it turned out that I held all five. So what are they?

Company

Share Price

Historic P/E

Discount to FTSE Avg.

BP (NYSE: BP  )

436 pence

6.3

36%

AstraZeneca (NYSE: AZN  )

2,706 pence

7.6

23%

BAE Systems

291 pence

7.2

27%

Aviva (NYSE: AV  )

313 pence

5.6

43%

GKN

206 pence

7.9

20%

Average

   

30%

Dogs or divas?
Coincidentally, most of the five have had recent and relevant news flow.

BP, for instance, issued its first-quarter results this week, prompting my Foolish colleague David Holding to declare that BP looks like a buy. While there are still concerns over Russia and the fallout from the Gulf of Mexico oil spill, I agree with David that, at today's share price of 436 pence, an awful lot of bad news is fully priced in.

BAE Systems has also reported this week, pointing to trading for the period being consistent with management expectations, and anticipating modest growth in underlying earnings per share. Changing hands at 291 pence this morning and yielding a whopping 6.4%, I reckon that BAE's shares should provide long-term investors with handsome returns.

AstraZeneca? Well, the board has ditched chief executive David Brennan and signalled unambiguously that a change of direction is required. Meanwhile, AstraZeneca is that FTSE rarity -- a company with no net debt -- and remains a favourite with Neil Woodford. Yielding a hefty 6.8% on today's price of 2,706 pence, AstraZeneca too would seem to have a lot of bad news priced in.

Aviva, too, has seen troubled times, but it's difficult to find anything in the fundamentals to set off alarm bells. Certainly, my Foolish colleague Stephen Bland remains a fan, and I'm happy to hold the shares myself. The yield -- 8.5% on today's share price of 313 pence -- will be too rich for some, but the company gives no indication that it's under threat.

Which leaves GKN, where an interim management statement on April 18 spoke reassuringly of trading in line with expectations -- equating to underlying sales up 8%, a 19% increase in profit, and improving margins in each of the business's four divisions. Yielding a forecast 3.6% on today's share price of 206 pence, GKN looks to me like an undervalued business that will provide investors with a decent income while they wait for value to out.

Foolish bottom line
As ever, these aren't blind recommendations -- even though, as I've said, it turns out that I hold them myself.

Instead, use them as a starting point to form your own conclusions as to their merits. Aviva's yield, I know, will put off some, as will AstraZeneca's drugs pipeline.

So: recovery picks or value traps? Have your say in the box below.

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Malcolm owns shares in Tesco, BP, AstraZeneca, BAE Systems, Aviva, and GKN. He does not own any other of the shares mentioned. Motley Fool newsletter services have recommended buying shares of Tesco. The Motley Fool has a disclosure policy.
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