Some companies have cheap stocks because they operate lousy businesses. Others are cheap because of a temporary bump in the road. The number of reasons a stock can be cheap is relatively endless.
Needless to say, when a company loses its luster with investors, it can be painful to watch the decline of its share price.
One stock where investors are losing hope is Fitbit (NYSE:FIT), the maker of wearable devices. Down 31% over the past year, Fitbit has struggled to be relevant in the smartwatch category.
However, a glimmer of hope surfaced Sept. 20 on speculation Fitbit’s management was considering selling the company to a company like Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL), which has deeper pockets and a more visionary management team.
FIT stock jumped 22% on the news to $4.48. It has since fallen back below $4, but still much higher than where it traded at the end of August.
Sometimes, it makes sense for a company to put itself up for sale. That’s especially true when we’re talking about a stock that’s unappreciated by investors because cheap stocks often remain this way for a long time.
If you own any of these seven stocks, you better hope they consider a sale, sooner rather than later.
Cheap Stocks to Watch: Chesapeake Energy (CHK)
Chesapeake Energy (NYSE:CHK) is down 27% year-to-date and 66% over the past 52 weeks.
With a current market cap of $2.4 billion, the independent oil and gas producer had a market cap of $40 billion as recently as January 2008. It has been downhill ever since.
I’ve been negative on Chesapeake stock for a long time, my most recent lambasting came in April when I questioned why anyone would want to own CHK stock. It’s down 55% in the six months since.
My InvestorPlace colleague, James Brumley, has spoken of the company’s untapped potential. He’s argued that CEO Doug Lawler’s rebuild has been one of the best in the energy business, suggesting the company’s results are getting stronger by the quarter.
For example, in the second quarter ended June 30, Chesapeake’s adjusted EBITDAX (earnings before interest, taxes, depreciation, amortization, and exploration expense) was $612 million, 18.1% higher than a year earlier. In addition, it generated an operating profit of $96 million in the first six months of the year, a big turnaround from an operating loss of $118 million a year earlier.
If not for $9.7 billion in long-term debt and the interest expenses that come with such a debt load, CHK would be reasonably profitable.
If. If. If.
In the hands of a bigger operator, some of Chesapeake’s shale assets could be very valuable. It’s time for the company to put itself up for sale.
Mohawk Industries (MHK)
Mohawk Industries (NYSE:MHK) is up 4% YTD, but down 35% over the past 52 weeks. In fact, if you invested at Mohawk’s all-time high of $286.85, which it hit in December 2017, you’d be down 58% in the 21 months since.
The big problem for Mohawk has been that its business has kind of flatlined over the past three years as other housing-related stocks have gone on a bit of a run.
If one looks at the second quarter of 2019, compared to Q2 2018 and Q2 2017, you will see that sales have increased by just 5.3%, while EBITDA declined by 13.8% and operating margins fell by 500 basis points.
Sales growth is slowing while margins are falling, a combination that’s lethal when facing intense competition and significant trade issues with China.
To illustrate just how bad things are for Mohawk Industries at the moment, the iShares US Home Construction ETF (NYSEARCA:ITB), which can be considered a proxy for the housing sector, is up 15.3% over the past year — more than 50 percentage points better than Mohawk’s stock.
When it’s better to buy an exchange-traded fund than an individual stock to achieve decent returns, you know it’s time for a company to find an eager buyer. Whether it’s a strategic buyer or private equity, it’s time for Mohawk to hand the company over to someone else.
Janus Henderson (JHG)
The asset management business has become one of commoditization and scale. In addition, active portfolio management has taken it on the chin while passive plays like iShares continue to take market share around the world.
The May 2017 merger of Janus Capital Group and Henderson Group brought together Janus’ strength in the U.S. with Henderson’s strength in the U.K. and the rest of Europe. It was considered a merger of equals with $331 billion in assets under management.
In the trailing 12 months, Janus Henderson generated $540 million in operating income from $2.2 billion in revenue. In the same trailing 12 months, BlackRock generated $5.3 billion in operating income from $13.9 billion in revenue.
BlackRock’s operating margin is 38.1% — 56% higher than Janus Henderson.
Trading at less than two times sales — BLK has a P/S ratio of 5.1 — shareholders would be better served if it put itself up for sale to a strategic buyer.
A.O. Smith (AOS)
A.O. Smith (NYSE:AOS) is up 13% YTD, including dividends, but down 18.5% over the past 52 weeks. A $10,000 investment in AOS stock a decade ago would be worth $81,875 today.
This has been one of my favorite U.S. stocks for several years. In 2012, I called it a company to own forever. If you’ve never heard of A.O. Smith, it manufactures water heaters and boilers for sale in the U.S., China, India and elsewhere.
“A.O. Smith is hardly an overnight sensation in China. It’s taken 17 years to build the infrastructure necessary to capture 20%-plus residential market share. Its closest competitor is Haier, a Chinese conglomerate, with 18%,” I wrote in July 2012.
Today, A.O. Smith has a 25% market share in the water heater market in China with the middle class there expected to double to more than 700 million people. So, that’s a big market for the company. In addition, it has a 40% market share in the U.S. residential business, and 50% in the commercial side of things.
The problem for A.O. Smith is that 34% of its business is in China where the economy has been slowing to unheard-of growth rates — in June, growth was the lowest it has been in 27 years at 6.2% — and that has put downward pressure on its stock.
Add to this a short report in May from J Capital Research that centered around the soundness of its operations in China. While the company set the record straight about the situation, there remains some lingering doubts in some investor circles.
I believe A.O. Smith would make a good strategic acquisition for an industrial company currently operating in the water treatment industry. Long-term, I have no doubt, AOS is a winner.
CBS/Viacom (CBS, VIAB)
The multi-billion-dollar merger between the two media companies — expected to close in December — brings the two back together as stablemates after a split in 2006.
Bob Bakish, the head of the merged entity, believes that investors aren’t considering all the upside potential of a CBS/Viacom combination.
“Clearly we’re disappointed with how the stocks are reacting,” Bakish told CNBC’s David Faber on “Squawk Alley” September 17. Bakish has spent the past few weeks “making sure they [investors] understand the tremendous opportunity ahead for CBS and Viacom.”
While CBS All Access is participating in the streaming market, experts suggest that its older demographic won’t bring it the kind of engagement other video streamers can such as Disney+ and Netflix (NASDAQ:NFLX).
If CBS and Viacom shareholders want to see real returns on their investment, Bakish had better find a much bigger partner if he wants to play with the big boys.
Harley Davidson (HOG)
Harley Davidson (NYSE:HOG) is up 7% YTD, including dividends, but down 18.5% over the past 52 weeks. A $10,000 investment in HOG stock a decade ago would be worth about half as much today as an investment in the entire U.S. market over the same period.
Harley Davidson announced Sept. 24 that it would invest $1.6 billion in its business over the next four years in a turnaround effort to revive its iconic status among U.S. companies. As part of its plan, the company will spend up to $275 million annually for capital investments and another $450-$550 million for operations over the course of the four years.
Analysts worry this will put a serious crimp in the company’s future cash flow and earnings.
However, Harley Davidson believes its push into other markets outside the U.S., along with its move into electric bikes, should help generate more than $1 billion in incremental revenue and $250 million in operating profits by 2022.
While its prototype electric bike looks pretty cool, it’s possible that the company’s turnaround is too little, too late.
I believe a private equity buyer would be ideal in this situation.
Urban Outfitters (URBN)
Urban Outfitters (NASDAQ:URBN) is down 26% YTD, including dividends; over the past 52 weeks, it is down 40%. A $10,000 investment in URBN stock a decade ago is worth $7,924 today.
Urban Outfitters is a retail stock that continues to disappoint investors despite the fact that it’s profitable and well run.
In its Q2 2019 report, URBN generated revenue of $962.3 million from its three major brands: Anthropologie, Urban Outfitters and Free People. Unfortunately, that was 3% lower than in the same period a year earlier. If not for a 6% increase in its comps at Free People, the quarter would have been a complete write-off from a revenue perspective.
On the bottom line, it still managed to deliver an operating profit of $78.1 million in the quarter. However, that was down significantly from $116.9 million a year earlier.
The company launched Nuuly July 30, a subscription rental service that will allow customers to rent clothing for a monthly fee, swapping them out for new stuff every month. All of the merchandise they rent can also be purchased if desired.
While this might seem like a small endeavor for a business with more than $4 billion in annual sales, it’s the wave of the future. Hudson’s Bay (OTCMKTS:HBAYF) recently sold Lord & Taylor for $100 million to Le Tote, a San Francisco-based clothing rental subscription business.
Financially, there is nothing wrong with Urban Outfitter’s balance sheet. However, as long as its three brands continue to sputter, a private equity firm might be able to extract value from it by focusing on Free People and selling off its other two brands.
Sure, it would mean getting smaller, but good things often come in small packages.
At the time of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.