Some of the biggest opportunities in the stock markets arise when shares of fundamentally strong companies are hit by the market's shortsightedness. These companies are capable of riding out both macro- and micro-challenges and growing steadily in the long run. Their current stock prices don't reflect this growth potential, offering investors great bargains.
When we asked three Motley Fool contributors to identify a stock they believe is absurdly cheap right now given its prospects, they picked Brookfield Infrastructure Partners (NYSE:BIP), Transocean (NYSE:RIG), and Western Digital (NASDAQ:WDC). Here's why.
There's a lot of room to run here
Neha Chamaria (Brookfield Infrastructure Partners): Brookfield Infrastructure Partners has consistently delivered strong operational numbers in recent quarters, and the company generated record funds from operations (FFO) in the trailing 12 months. Yet, the stock's still down almost 11% year to date, as of this writing.
On one hand, the market fears that rising interest rates will pressure Brookfield's margins. On the other, investors fear that accelerated asset sales this year could drag the company's revenue and cash flows lower, at least until management finds suitable investment opportunities to plow the money into. Brookfield Infrastructure buys assets in transport, utilities, energy, and telecommunications sectors, typically at distressed prices, operates them to generate cash flows, and resells as and when assets mature for better alternatives.
However, Brookfield's cost of debt is reasonably low and will likely remain so. As for assets, management revealed that it plans to invest around $1 billion over the next six months to one year on acquisitions even as it announced several deals in recent weeks, including in the high-potential data infrastructure field. Management believes these investments can generate average FFO yields of 10% initially.
In other words, Brookfield's FFO growth could decelerate in the near term, but it should continue to head higher nonetheless. The company generated $3.21 in FFO per unit in the trailing 12 months. At its current share price, that places a price-to-FFO valuation of only 12.5 on a stock yielding 4.6% and targeting annual dividend growth of 5% to 9% in the long run, making Brookfield Infrastructure a great value buy.
This market-beating stock still looks dirt cheap
Jason Hall (Transocean): Even after a recent decline, shares of offshore driller Transocean are still up 35% over the past year, out-gaining the S&P 500 as well as many other energy stocks:
But even after these gains, Transocean remains solidly in value territory, trading for 42% of the book value of its tangible assets, including all of its drilling vessels, cash, real estate, and other hard assets. For context, here's a look at how the market has typically valued Transocean by this metric:
As you can see, it's not uncommon for Transocean to trade for a much higher book value multiple than the current level. As a matter of fact, its recent value range is the cheapest Transocean's stock has traded for in decades:
Here's the real kicker: Transocean has removed its oldest, least-capable vessels from its fleet and replaced many of them with newer, high-spec drillships far more competitive in the current offshore market. This underpins a significant portion of its value.
Lastly, offshore drilling is set for a potentially strong period of investment, after years of underspending. Transocean is one of the best-positioned offshore drillers to profit from what is likely to be multiple years of increased offshore investments. Trading for half its book value, investors could do very well to buy Transocean and hold for years to come.
A beaten-down storage specialist
Ashraf Eassa (Western Digital): Shares of computer storage specialist Western Digital haven't performed well so far this year. As of this writing, the stock has shed approximately 20% since the start of 2018 and has lost about 40% of its value from the 52-week high it set earlier in the year.
Western Digital is far from a failing business, though. Over the last 12 months, the company generated nearly $3.4 billion -- $11.16 per share -- in free cash flow. It's a cash-generating machine. The stock trades at less than six times trailing-12-month free cash flow.
Not only does Western Digital bring in a lot of cash per share, but it seems to be doing a commendable job of returning that cash to shareholders via both dividends and share repurchases. The company recently unveiled a $5 billion share repurchase program, and it currently pays a quarterly dividend of $0.50 per share, which translates into an annualized dividend yield of 3.13%.
Western Digital, of course, isn't without challenges. In a recent investor presentation, the company admitted that it expects the market opportunity for its hard-disk drive products to be worth $24 billion by calendar year 2021 -- unchanged from what the opportunity was in 2017 as "significant growth in capacity enterprise [hard disk drives]" is "offset by [a] decline in Client."
The company said in the same presentation that it expects the market opportunity for flash-based products (Western Digital agreed to acquire flash storage specialist SanDisk in 2015 to diversify beyond the hard-disk drive market) to grow from $54 billion in calendar year 2017 to $81 billion by calendar 2021. CEO Steve Milligan's statement that Western Digital expects "pricing pressure to continue through the remainder of calendar year 2018" with respect to NAND flash probably wasn't what investors wanted to hear. Nor did they want to hear that Western Digital's current non-GAAP earnings per share guidance of between $3 and $3.10 represents a drop from the $3.56 per share the company generated in the same quarter a year ago.
However, Milligan did argue on the company's most recent earnings call that the market is "overreacting to the pricing pressures that we're seeing from a flash NAND perspective," and he even said that because of this overreaction, Western Digital has "the opportunity to repurchase shares at an attractive level."