Yesterday, Yahoo (YHOO) announced that it will repurchase 40 million of its shares from billionaire investor Dan Loeb’s hedge fund, Third Point, LLC, at $29.11 a share. As of result of the repurchase agreement, the activist hedge fund will be left with 20 million shares, which gives it a less than 2% stake in the company. Additionally, Loeb and two other Third Point-nominated directors will resign from Yahoo’s Board of Directors at the end of the month.
The news of Loeb’s departure seemingly unsettled investors as Yahoo posted a 4.29% drop on Monday. For some, Third Point’s decision to sell off two-thirds of its largest corporate holding signifies that Loeb sees very limited upside potential for the stock, despite the fact that Yahoo has returned 75.05% over the past year, beating the industry average of 36.96% and the S&P 500 Total Return Index average of 27.25%.
On the other hand, Yahoo saw a significant 12% decrease in ad prices during its second quarter, which led the Internet company to revise its earlier 2013 revenue forecast to $4.45-$4.55 billion from $4.5-$4.6 billion. The company reported revenue of $1.07 billion in its second quarter, falling short of last year’s $1.8 billion and missing analysts’ estimates of $1.8 billion.
In the wake of Loeb’s major Yahoo sale, we decided to take a closer look at the other holdings in his portfolio to see what stocks still appear to have upside potential. Although Q2 2013 has ended, Third Point LLC’s 13F SEC filing isn’t yet available, so we referred to the fund’s holdings per its Q1 2013 13F SEC filing to construct our initial universe of stocks.
Given Yahoo’s revenue struggles, we selected a financial metric that takes into consideration company revenue and profits. We narrowed down our universe by screening for companies that have reported rising gross profit margins year-over-year for the last three years. Gross margin refers to the percentage of profit a company makes for each dollar it generates in sales after deducting production expenses. Examples of these expenses include overhead, payroll, and taxation.
Gross Margin = Gross Profit / Revenue
The higher the percentage, the greater the gross profits a company takes from its revenue. When a company has rising gross margins, it indicates that the firm is quite capable in controlling its costs.
Next, we looked for signs of undervaluation as indicated by a low Price/Sales (P/S) ratio. A low P/S ratio means that the stock’s price is cheap when compared to what the company generates in revenues. If a stock has a P/S below 1, it can be considered undervalued. However, investors should note that this ratio doesn’t take expenses or debt into consideration, and variation between industries is normal.
For this list we screened for stocks with P/S ratios under 2, which means that the company’s market cap isn’t greater than 2x its annual sales. We use 2 as our limit after speaking with Neil Hennessy, Portfolio Manager and Chief Investment Officer of The Hennessy Mutual Funds, who told us that it is one of his favorite investing strategies.
We were left with four stocks on our list.
Click on the image below to see sales data over time. Quarterly sales data sourced from Zacks Investment Research.
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Do you expect these companies to continue to increase their gross profit margins? Use this list as a starting point for your own analysis.
1. WESCO International Inc. (WCC, Earnings, Analysts, Financials): Supplies electrical, industrial and communications maintenance, repair, and operating (MRO) products.
Market cap at $3.19B, most recent closing price at $71.81.
Gross profit margins increased from 19.46% to 19.72% during the first time interval (12 months ending 2010-12-31 vs. 12 months ending 2009-12-31). For the second time interval, gross margins increased from 19.72% to 20.19% (12 months ending 2011-12-31 vs. 12 months ending 2010-12-31). And for the final time interval, gross margins increased from 20.19% to 20.24% (12 months ending 2012-12-31 vs. 12 months ending 2011-12-31).
Price/Sales ratio: 0.47.As of 3/31, Third Point, LLC owns 1 million shares of WESCO International.
2. Hess Corporation (HES, Earnings, Analysts, Financials): With its subsidiaries, operates as an integrated energy company.
Market cap at $25.08B, most recent closing price at $73.05.
Gross profit margins increased from 23.16% to 24.65% during the first time interval (12 months ending 2010-12-31 vs. 12 months ending 2009-12-31). For the second time interval, gross margins increased from 24.65% to 24.66% (12 months ending 2011-12-31 vs. 12 months ending 2010-12-31). And for the final time interval, gross margins increased from 24.66% to 26.12% (12 months ending 2012-12-31 vs. 12 months ending 2011-12-31).
Price/Sales ratio: 0.77.
As of 3/31, Third Point LLC owns 1 million shares of Hess.
3. LyondellBasell Industries NV (LYB, Earnings, Analysts, Financials): Manufactures and sells chemicals and polymers, refines crude oil, produces gasoline blending components, and develops and licenses technologies for production of polymers.
Market cap at $39.27B, most recent closing price at $68.78. Gross profit margins increased from 4.26% to 9.65% during the first time interval (12 months ending 2010-12-31 vs. 12 months ending 2009-12-31). For the second time interval, gross margins increased from 9.65% to 11.26% (12 months ending 2011-12-31 vs. 12 months ending 2010-12-31). And for the final time interval, gross margins increased from 11.26% to 12.73% (12 months ending 2012-12-31 vs. 12 months ending 2011-12-31).
Price/Sales ratio: 0.89.
As of 3/31, Third Point LLC owns 950,000 shares of LyondellBasell Industries NV.
(List compiled by Mary-Lynn Cesar. Profitability data sourced from Fidelity. All other data sourced from Finviz.)
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Dig Deeper: Access Company Snapshots, Charts, FilingsWESCO International Inc. (WCC, Chart, Download SEC Filings) Hess Corporation (HES, Chart, Download SEC Filings) LyondellBasell Industries NV (LYB, Chart, Download SEC Filings)
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