Strong Balance Sheets Make Hunting For Value Easier

During the last bear market (2000-2002) there were dozens of situations where individual stock valuations looked down right silly. This bear market will be no different, and long term value-oriented investors can take advantage of the fact that in times like these numerous bargains can be had, but most people are too afraid to take them.

A great way to find value in the market is to use enterprise values (market values after netting out the firm’s cash on hand and debt outstanding). Investing in companies with hoards of cash in the bank allow investors to get the operating businesses on the cheap. There are many examples of this, and I often talk about net cash positions of various stocks on this blog, but let’s use former Halliburton (HAL) subsidiary KBR (KBR) to show what I am talking about. I don’t own the shares, but it fits the description perfectly.

At $15 per share, KBR stock is down 66% from its 52-week high of $44 and sports a market value of about $2.55 billion. Earnings in 2007 were $1.08 per share, and are expected to jump to $1.72 this year and $1.98 in 2009. That quick glance shows that KBR appears to be a pretty cheap stock at about 10 times trailing earnings and less than 9 times current year projections, but KBR’s balance sheet tells an even better story.

As of June 30th, KBR had cash on hand of $1.85 billion and no debt outstanding. With a market value of only $2.55 billion, KBR’s enterprise value is merely $700 million. With $11 per share of net cash in the bank, investors who buy KBR at $15 per share are getting the firm’s operating businesses for the aforementioned $700 million, or only $4 per share. This for a company that has earned $428 million in operating income in the last 12 months.

A valuation of less than 2 times cash flow is truly silly, but in markets like the one we have right now, nobody really cares because they are too busy being concerned about overnight LIBOR rates and when the Treasury is going to start buying up assets from banks. What great news for long term investors who can seize on opportunities.

Full Disclosure: No positions in the companies mentioned at the time of writing, but positions may change at any time

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4 Thoughts on “Strong Balance Sheets Make Hunting For Value Easier

  1. market folly on October 16, 2008 at 9:47 AM said:

    yup good points. balance sheets are the place to be snooping. but, the only problem is that the cheap can get even cheaper since we all know markets love to remain irrational longer than we can all stay solvent.

    i really think the hedge fund redemptions/deleveraging/liquidations will be a domino effect on each other and should continue for numerous months/weeks, obviously increasing volatility and decreasing asset values further.

    KBR for example was a large holding by Tontine Partners, Jeffrey Gendell’s large hedge fund. He’s down 67% this year and there were rumors of his liquidation, etc. I’ve written a lot about hedge fund redemptions and deleveraging lately and how it will play out longer than people think.

    Curious on your take on AAPL… what’s your take on fair value for them? Cash rich company, no debt, cult consumer following. Yet, consumer recession ahead of us and luxury items would obviously be first to go. Not to mention, hedge funds/mutual funds are loaded on this name so it will probably get sold off even further. I originally thought $80 a share would be a solid… but if my calculations are correct and they have $23 per share in cash, then that’s pretty solid.

  2. Anonymous on October 16, 2008 at 10:12 AM said:

    KBR indeed looks cheap, but if Obama wins you can be 100% sure than KBR will lose some lucrative Iraq contracts of hundreds of million $$ that were awarded to them without competitive bidding. I find it amazing that people don’t speak about that anymore, even the press seems to have forgotten. I would expect to see this in the Third World, not in the U.S.

  3. Chad Brand on October 17, 2008 at 7:02 AM said:

    Re: AAPL

    While they are not immune to the economy, the act of gaining market share alleviates much of the sales loss because although the totoal ie is shrinking a bit, you are getting a bigger piece of it.

    Like with Google, sales weakness will be less pronounced than with other tech gadget firms because they are gaining share in PCs and phones.

    I think your $80 number is even a bit low. I think AAPL under $100 would be a good deal. If you take 15x operating earnings (~$5) and add in the cash ($23-$24) you get to a price in the high 90’s. I’d feel good with such an entry point.

  4. SiamTwin on October 17, 2008 at 8:43 AM said:

    according to CFO at recent investor presentation, company has about $600 million excess cash, since portions of cash on BS represent advance payments from customers or are embedded in joint ventures and therefore not accessible.

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