by Tim Melvin | October 2, 2013 9:16 am
Although I am by nature and habit an investor who focuses on value stocks, from time to time I like to look around the market place and see what is cheap on other measures.
I am well aware that there is more than one way to skin a cat, and I do not want to overlook an obvious opportunity. Often I find that looking around in other ways helps me identify sectors of the economy that are entering a peak phase of the economic cycle or about to falling into a trough.
One of my favorite ways to look around the markets is using a screen based on valuation measures that some of my friends in the private equity industry are known to use. I look for stocks where the ratio of earnings before interest, taxes, depreciation, amortization and depreciation (EBITDA) to the total enterprise value of a company (EV) is lower than 5.
I also want to see the EBITDA growing over the past few years, and make sure that the balance sheet is not already overly levered. I have used this screen to find some value stocks that are what I call “asset lite bargains” and that often can become takeover targets.
Right now, the refiners dominate the list. This catches my attention, as I know that these stocks have had a pretty good run over the past few years. Stocks like HollyFrontier (HFC), Valero (VLO) and CVI Energy (CVR) appear to be very cheap based on my private equity metrics.
A deeper look, however, tells me that the group looks cheap because EBITDA and earnings might be peaking.
Refiners have enjoyed great margins with an assist from an unusually wide spread between WTI and Brent crude that is narrowing quickly. We probably will see refining margins begin to regress, and stock prices probably will follow margins lower. When an entire industry that has been moving up in price appears cheap on EBITDA, earnings and cash flow measures, there is a good chance you are approaching an earnings peak, which means stock prices are vulnerable.
However, among what could be a group of iffy value stocks, there’s at least one stock that should be of interest to long-term investors — particularly those in search of income.
Star Gas Partners (SGU) is an MLP that distributes propane and heating oil to 416,000 retail and commercial customers in the Northeastern United States. They also install, maintain and repair heating and air conditioning equipment, as well as providing home services such as home security and plumbing to approximately 11,500 customers. SGU has grown over the years by buying up smaller competitors in what is very much a mom-and-pop industry, and the strategy has served Star Gas well. SGU is cheap on the metrics, trading with an EV/EBITDA ratio of just 5 and a debt-to-equity ratio of only 0.45.
SGU shares yield 6.7% at current prices, and appear to be a great income option for those looking at value stocks.
As of this writing, Tim Melvin was long SGU.
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