Are you feeling brave? The market meltdown of the past few days has created a multitude of opportunities for value opportunities, but the problem, of course, is that the broader market needs to cooperate for any long-side investment — no matter how well-reasoned — to work right now.
With the outlook so tenuous, the best course is to focus on stocks whose sharp recent declines and reasonable valuations have created an attractive risk-reward tradeoff. Many such stocks can be found in the industrials sector, and three in particular stand out: L-3 Communications (NYSE:LLL), Jacobs Engineering (NYSE:JEC) and Cooper Tire & Rubber (NYSE:CTB).
L-3 Communications
The worries related to the debt-ceiling debate and the efforts to reduce government spending have torched LLL shares in the past five weeks. After finishing June at $88, the stock has plunged into the low $70s. The outlook for a reduction in defense spending is weighing on the entire sector, as detailed here. The tea party wing of Congress has no particular affinity for high defense spending, a departure from the traditional Republican stance. Given the shrinking base of support for a large defense budget, stocks like L-3 have taken it on the chin.
While it’s difficult to fly in the face of this type of negative news flow, L-3 is one of the most compelling stocks in the defense sector. Lost amid the focus on the budget battle was that L-3 beat second-quarter earnings estimates, raised estimates for the full year and announced a plan to shed some of its lower-growth businesses. What’s more, the company is focused on higher-tech aspects of the defense business, such as cyber-security, which are less likely to get the ax in the event the defense budget is indeed cut. It should be mentioned that such cuts are no sure thing, providing room for upside in LLL if this fear turns out to be exaggerated (as it typically has been in the past). The stock trades at 8.1 times forward earnings and has a yield of 2.3%
L-3 isn’t an easy buy here, but the recent sell-off is a chance to buy a well-managed, financially healthy and technologically advanced company at the lowest valuation in its history.
Jacobs Engineering
JEC is an engineering and construction stock with a slew of recent contract wins, steady earnings estimates and projected earnings growth of 16% in 2012. So why is the stock off nearly 27% in just four months? The answer is the company’s exposure to three areas of concern for investors of late: falling oil prices, slowing economic growth, and weaker government spending.
This perfect storm of worries — which has punished the entire E&C sector — has knocked Jacobs’ stock down to just 12.5 times forward earnings, an attractive price for a growing, fundamentally sound company with exposure to the rapid build-out of infrastructure in the emerging markets. In addition, Jacobs has $6 of balance sheet cash underlying its $37 stock price. A look at the total picture, and not just macroeconomic factors, shows that JEC appears has significant pent-up value that should be realized once the broader market downturn runs its course. Analysts seem to agree — their mean price target is $54.24, which is 44% above current levels.
Cooper Tire & Rubber
As a maker of replacement tires, Cooper Tire & Rubber is as boring as it gets — and therein lies an opportunity. CTB, a small-cap with only a small analyst following, has seen its shares blasted in 2011 because of investor concerns about falling sales, broader economic weakness and rising input costs. After hitting an intraday high of $27.73 on the final day of April, the stock is now languishing below $16 — a loss of about 43%.
While CTB’s revenues are indeed under pressure, tire replacement can only be delayed for so long — particularly at a time in which slow economic growth is prompting vehicle owners to keep their cars on the road longer. This creates room for CTB to benefit from both improving earnings and a recovery of its valuation, as the stock’s current P/E under six times 2012 earnings is deep on the low end of its historical range. The stock yields 2.5%, which allows investors the luxury of some patience while this story plays out.
The bottom line: Although it’s a tough time to hit the “buy” button, the industrials sector is rapidly becoming fertile ground for contrarian investors to find undervalued stocks with meaningful room on the upside.
