Wall Street seems to be picking up good vibrations as of late, because stock valuations have been growing quite a bit. As a result, the list of quality companies with stocks trading at bargain-basement prices is getting smaller and smaller. For those price-conscious investors, though, there are still some small pockets of value left in the market.
Two companies that look to have that rare combination of a quality business model and a cheap stock price today are aluminum manufacturer Alcoa Corporation (AA), and offshore rig company Transocean (RIG -2.29%). Here's a quick look at why these companies are both worthwhile investments, and why their stocks look cheap.
Image source: Getty Images.
A fresh face on an old company
Image source: Getty Images.
Quite often, when a company splits in two, one aspect of the business is built to soar, while the other is left in this purgatory with less-than-attractive assets and a balance sheet that isn't in great shape. When Alcoa's traditional aluminum business and the new value add manufacturing business Arconic (HWM 0.06%) split, though, it was done in a way that allowed both companies succeed. Arconic is the higher-margin business with lots of opportunities for growth, so it took a larger portion of the combined companies' debt with it.
As a result, the legacy Alcoa business got a fresh start with a much better-looking balance sheet. Today, net debt to EBITDA is a very manageable 1.1 times, and its debt to capital ratio is also a very reasonable 13.9%. For a cyclical business like mining and metals, having a respectable balance sheet like that can really help it weather the ups and downs of the industry.
At the same time, Alcoa remains the world's largest bauxite miner and refiner of alumina, while remaining on the lower end of the cost curve for the two commodities since it has sold off several higher-cost assets in recent years.
Image source: Alcoa corporation investor presentation.
It may not be as envious of a place to be if the aluminum market were in structural decline, but aluminum demand is set to grow as the automotive and aerospace industries look to use the lightweight metal to improve fuel efficiency.
Even though the company has improved its competitive position in the bauxite, alumina, and aluminum markets and has a much better-looking balance sheet thanks to the Alcoa-Arconic split, shares of Alcoa trade today at 0.8 times tangible book value. That's an industry leader selling for less than its liquidation value. Like investing in other cyclical mining and metal companies, investing in Alcoa is going to have its ups and downs with the industry cycle. That being said, its current stock price suggests it's a great time to buy.
Not the same company that we saw at the beginning of the oil slump
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There was a lot of fear from investors that many offshore rig companies were going to go belly-up after oil prices started to fall. As a result, shares of Transocean have been absolutely hammered over the past few years, so much so that today, the stock trades at a price to tangible book value of just 0.36 times. Usually, that denotes a company in serious distress, with almost no chance of making out of this oil downturn alive.
If we were to look at this company three years ago, I would agree. It had one of the oldest fleets out there, and many of its rigs didn't meet the specifications needed to meet today's more complex drilling jobs in deeper waters and at deeper depths below the ocean floor. On top of that, it had a pretty large debt pile and several billion dollars' worth of obligations for new rigs currently under construction.
Fast-forward to today, though, and you see a very different company. Sure, it still has about $8.3 billion in long-term debt outstanding, but about only $2.5 billion of that is due between now and 2018. When you combine that with the company's current cash on hand, as well as the operational cash flows from its contracts in place, it looks as though the company is going to have plenty of cash to get through the next couple of years in pretty decent financial shape.
Image source: Transocean investor presentation.
As far as its fleet is concerned, it too is much different than just a few years ago. Under CEO Jeremy Thigpen, who took the reigns in April of 2015, the company has retired 30 of its older, less capable rigs. While there are still a few still on the books, the company expects that by 2020, 80% of its floating fleet will be either ultra deepwater or harsh environment -- think North Sea around Norway or the Arctic Ocean -- capable. This fleet mix will commend much better day rates as offshore drilling activity picks back up again.
The payoff for an investment in Transocean may be a ways off. The introduction of shale as a viable, economical source of oil could mean that offshore development gets pushed down the road. That being said, offshore oil will very likely remain a critical part of the production mix, and rig demand will come back. When it does, Transocean's fleet will be in much higher demand, and investors may be kicking themselves in the future for not looking at shares of Transocean at these prices.
