Monday, March 22, 2010

Including Debt In Your Stock Screen

I'm always on the hunt for new ideas, and one of the screens that I like to use from time to time identifies companies trading at relatively low multiples of enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (EBITDA).

Use enterprise value as the starting point to measure the value that the market is currently placing on a given company, instead of market capitalization alone. While market cap measures the value of the common equity, it ignores the capital that debt holders have also provided to companies. Enterprise value considers debt along with equity market cap and preferred stock, and subtracts out cash, so it is sometimes used as a proxy for the takeover value of a given firm. Enterprise value, which measures the value of the entire firm (in terms of capital structure), is more encompassing than market cap.

Enterprise value to EBITDA can act as a better indicator of a firm's profitability than the price-to-earnings ratio alone, especially for companies whose capital structure includes debt. All else being equal, of course, the lower the EV/EBITDA, the better.

Here's an example, using companies with the following attributes:

    * Market cap greater than $250 million.
    * EV to EBITDA of less than 10.
    * Total debt to equity less than 50%.
    * Price to book value less than 2.
    * No financial companies.

This search revealed a somewhat disappointing 18 names (that is, I was disappointed by the low number of names, not necessarily the quality).

Here are some of the more interesting names:

HP:  Primarily an onshore contract driller, this company has been around since 1920, and it was founded by the grandfather of current CEO Hans Helmerich. The company uses interesting drilling technology that was developed in-house called FlexRig, which allows for greater flexibility in drilling depths and also reduces the time it takes to move a rig to a new drilling site.

The balance sheet is strong and asset-rich. As of Sept. 30, 2009, the company owned 201 U.S. and 44 international land-drilling rigs, and nine offshore platform rigs. Helmerich & Payne also owns some real estate in Tulsa, Okla., including 210 acres of land, a shopping center with 441,000 square feet of leasable space, and 990,000 square feet of warehouse space. Helmerich & Payne also has long-term investments on the books with a market value of $367 million. This includes holdings in two other publicly traded companies: 8 million shares or 12.4% of Atwood Oceanics (ATW) , and 967,500 shares of Schlumberger (SLB) . HP currently trades at about 6.2 times EV to EBITDA.

FL :  This company has a very wide reach, with more than 3,600 stores in 21 countries.

Foot Locker was actually a net-net (trading below its net current asset value) in late 2008 when the stock price dipped below $6. Since then, it's been off to the races, but this company is still attractive. Foot Locker ended the fourth quarter with $589 million in cash, or $3.75 per share, and just $138 million in long-term debt. It currently trades at about 7.8 times EV to EBITDA and 1.17 times book value per share. The company also gives back to shareholders in the form of a 15-cent quarterly dividend, which makes for a nice 4.1% current yield.

Some of the other companies that made the cut include home improvement giant LOW, PFE, AAN and convenience store operator CASY. 

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