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An Undervalued Pick From the Midwest

Rising value guru Daniel Khoshaba was recently profiled in Barron's and mentioned one of his high conviction picks -- Owens-Illinois (NYSE: OI  ) . For those unfamiliar, the Ohio-based company is the largest glass container manufacturer in the world. Right off the bat, the company fits many value investor must-haves: It's an easy to understand business trading at a relative discount to its peers. Owens-Illinois is a money printer, generating hundreds of millions per year in free cash flow. Though mimicking the moves of high-profile hedge fund managers is not a guaranteed strategy by any means, Owens-Illinois remains a compelling pick despite its nearly 50% run-up in just 12 months.

Redemption value
The glass container business appears to be a good one. On a trailing basis, Owens-Illinois actually saw its top-line sales drop by a few percentage points, but cash is the name of the game here. Cash flow from operating activities last year was a sizable $550 million, and after $290 million in capital expenditures, the company hauled in more than $250 million in free cash flow. According to Khoshaba's estimates for fiscal 2013, the company could hit $450 million in free cash flow. For the current year, internal estimates for free cash flow are at least $300 million.

At a $4.85 billion market cap, that's a forward price to free cash flow ratio of just 10.7 times. Free cash flow is an important figure because it tells investors how a manufacturing company is able to fund operations and generate profits. It also allows investors to look at (relatively) pure operating performance, without the subtle trickery of one-time events and other accounting innovations. That cash flow is being put to good use, too, paying down the high debt load currently sitting on the Owens-Illinois balance sheet.

Using the more traditional metric, Owens-Illinois trades at under 10 times its estimated one-year earnings. If cash flow grows as estimated, the Street may today be undervaluing the company's growth potential. At least, that's what Khoshaba believes. He has a price target of $44 per share, and believes that the stock will hit its target within a year. If he's right, that's a one-year return of 50%. Keep in mind, though, that the hedge fund manager bought his shares in the fourth quarter of 2012, and has already earned a substantial return.

Other factors
The materials sector hasn't enjoyed the same rebound as the market at large. Analysts and investors seem tepid on the sector's businesses, even though macro factors, such as the housing turnaround and the boom in commercial real estate development, indicate ongoing demand for the products.

Firmly in that sector, Owens-Illinois may owe part of its seemingly cheap valuation to market apathy. When the market realizes this, and the tide turns, we may see a quick revaluation of some strong plays, such as Owens.

Of course, there is a flip side. The company is subject to commodity price fluctuations, which causes some concern as a result of ongoing industry consolidation.

For Owens-Illinois, strong cash flows and a management team dedicated to a healthier balance sheet may spell good fortune for value-seeking investors.

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9/30/2016 4:04 PM
OI $18.39 Up +0.13 +0.71%
Owens-Illinois CAPS Rating: *****