Two Firms Selling at 80 Cents (or Less) on the Dollar
These stocks offer 15%-plus expected returns.
Following is a sampling of stocks that recently jumped to 5 stars. By way of background, we award a stock 5 stars when it trades at a suitably large discount--i.e., a margin of safety--to our fair value estimate. Thus, when a stock hits 5-star territory, we consider it an especially compelling value.
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Under Armour, Inc.
Moat: None | FV Uncertainty: High | Price/Fair Value Ratio*: 0.64 | Three-Year Expected Annual Return*: 29.1%
What It Does: Under Armour (UA) markets athletic apparel and footwear for men, women, and children. The firm specializes in developing technologically advanced "performance" apparel made of synthetic microfiber and designed to wick perspiration away from the skin and help regulate body temperature. Primarily a wholesaler to sporting goods stores, Under Armour also operates a handful of retail outlet stores domestically. About 6% of total revenue is generated outside the United States.
What Gives It an Edge: Although Under Armour has maintained a dominant position in the performance apparel category that it helped create a decade ago, Morningstar analyst Brady Lemos does not believe the firm benefits from an economic moat. Primarily, customer switching costs in athletic apparel and footwear are low, making it difficult for Under Armour to stay ahead of its competition indefinitely. That said, with market share approaching 75%, Lemos points out that the company can claim rare leadership over Nike (NKE) in a fast-growing and profitable industry. Even if competitors advance longer term, Lemos believes Under Armour has plenty of opportunities to expand in the meantime, such as increasing its presence in footwear and women's apparel.
What the Risks Are: Despite dominant market share in the performance apparel industry, Under Armour risks losing ground to a number of more powerful competitors such as Nike and Adidas. Competition should only intensify now that Under Armour has entered the athletic footwear market. Catering to fickle young consumers presents plenty of fashion risk.
What the Market Is Missing: While economic concerns have sent the firm's shares lower, as investors question whether Under Armour's sales will hold up amid lower overall consumer spending, Lemos believes the firm's durable brand and strong growth prospects are being overlooked by the market. According to Lemos, Under Armour has demonstrated substantial brand strength on its way to doubling sales over the last two years, which should keep near-term sales afloat. In addition, growth is well distributed among each of the company's divisions, suggesting that the brand's popularity will carry over into new categories including footwear and outdoor, golf, and women's apparel. Given the remarkable success of Under Armour's cleated footwear, Lemos anticipates that consumers will swarm to buy the company's recently introduced noncleated training shoe. Similarly, Lemos is encouraged by the growth prospects of its international markets, which are significantly underpenetrated and offer terrific opportunities for expansion.
Moat: Narrow | FV Uncertainty: Medium | Price/Fair Value Ratio*: 0.72 | Three-Year Expected Annual Return*: 23.8%
What it Does: Oshkosh (OSK) is a designer, manufacturer, and marketer of a broad range of specialty vehicles. Its primary products include military trucks, fire trucks, concrete-mixer trucks, refuse trucks, telehandlers, and aerial work platforms. Customers include the U.S. Department of Defense and municipalities in the public sector, and equipment rental, waste management, and construction companies in the private sector.
What Gives It an Edge: Morningstar analyst Patricia Oey assigns Oshkosh a narrow economic moat because of its long-standing status as a U.S. government contractor for military trucks, which allows the firm to sustain returns on invested capital in excess of its cost of capital. In addition, Oshkosh has diversified beyond military trucks over the past 10 years and now builds different lines of specialty trucks, including fire trucks, access equipment, refuse trucks, and concrete mixing trucks. Although Oshkosh's newer segments are exposed to more economic cyclicality, Oey is optimistic about the global growth opportunities for its access equipment segment, which includes aerial work platforms and telehandlers. Oey expects spending for this type of equipment to be driven by construction spending, particularly in developing markets.
What the Risks Are: Oshkosh's defense segment represents about 25% of total revenue and has one main customer--the U.S. government. Healthy government spending because of the Iraq war has driven double-digit growth and margins in this segment. Any change in strategy in Iraq will have an effect on Oshkosh's financial performance. Oshkosh's commercial and access segments, which make up almost 60% of revenue, service customers in highly cyclical industries. Finally, we highlight the possibility of future acquisitions performing below expectations.
What the Market Is Missing: Oey believes the market is concerned that two of Oshkosh's four segments (access equipment and commercial, which includes concrete mixing trucks) are exposed to a slowing construction spending in the U.S., and that a wind-down of the U.S.'s presence in Iraq will weigh on the defense segment. Although Oey admits that Oshkosh may be facing cyclical head winds in the near term, she thinks that the firm holds the number-one market share in many of its product categories, and that it is highly regarded by its customers for its product quality and service. Even if business slows in the nearer term, these traits should ensure that the firm achieves attractive long-run returns. In the meantime, Oey thinks that Oshkosh is likely to win a new contract for the JLTV, the next generation high-mobility multipurpose wheeled vehicle, or Humvee, providing an immediate boost to the firm.
* Price/fair value ratios and expected returns calculated using fair value estimates, closing prices, and cost of equity estimates as of Friday, June 13, 2008.