If I had to choose two cyclical equity investments trading at depressed valuations, HSBC (LSE: HSBA) and Petrofac (LSE: PFC) would be my preferred choices. And if I decided to be slightly less aggressive, I’d then pick up Unilever (LSE: ULVR) — at these prices, the consumer goods company looks really tempting.
Morrisons (LSE: MRW), however, could be the biggest bargain. Namely because with HSBC, Petrofac and Unilever, you have to embrace emerging market risk — the biggest threat to value in this environment.
Changing Times
Investors have been looking for the bottom in the food retail sector for about five years now, and there’s a good chance that we may be there right now. If that’s not enough to join the Morrisons family, consider that at 150p a share you’d be buying the stock of the same company that, based on very similar fundamentals, traded 40% higher at 210p back in March.
Not much has happened since, really, aside from a more enticing trading multiple of 6 times its adjusted operating cash flow at present! A decline in its market share — down from 10.9% to 10.7%, according to data from Kantar Worldpanel this week — doesn’t justify its lowly valuation based on its net worth. Investors do not trust the sector any more, but as with everything else in finance, there’ll come a day when today’s threat will be perceived to be a missed opportunity — and consolidation could be around the corner.
Correction
A correction in asset prices was long overdue, but if we focus on fundamentals then Unilever is by far one of the safest staples in the market. Currently trading at 2,595p, its stock has fallen only 17% from its 52-week high, but I maintain my personal price target of 3,400p into 2016. Most analysts believe that Unilever’s fair value should hover around 2,950p, but its fundamentals and trading metrics suggest that upside could be greater. In fairness, it has not been a fantastic year for shareholders, but you’d have not lost a penny if you had invested in it on 2 January.
Yield at 5.4% = 20% Capital Gain
At 500p a share, HSBC is the most obvious banking play right now, and that is because its asset base isn’t as bad as many fear, while corporate governance offers more reassurance than at its chief rival, Standard Chartered. As you might now, I am not a big fan of banks at this point in the business cycle, but a multitude of factors — attractive trading multiples based on book values and easy access to external capital, among others — point to only one possible recommendation, and that’s a strong buy in my view. A drop in its forward yield from 6.6% to a lower level of 5.4% spurred by a stock rally — under the assumption of constant dividends — would imply a 20% pre-tax capital gain for you.
Discount To Fair Value
Petrofac has been more volatile than I thought in recent days and weeks, but I have not lost faith. Its shares currently change hands at 770p, yet most of its core financial metrics indicate a fair value per share in the region of at least 950p. There are obvious risks with Petrofac; in spite of broader market volatility, however, its market cap has risen 8.5% this year, while its share price is closer to the lows that it recorded following a profit warning in 2014 than to the 52-week high of 1,203 that it hit this year before investors panicked! Also remember that management expects a stronger second half, which could bring some very nice surprises…