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5 cheap stocks ready to take off

These market laggards have the potential to pay off big if investors' pessimism proves to be overblown.

  • By Tom Petruno,
  • Kiplinger
  • – 06/09/2014
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To find bargains in the stock market, you often have to go where investors fear to tread. That's especially true in the current bull market, which has seen share prices triple, on average, since stocks bottomed in March 2009.

To identify cheap stocks, we specifically looked for names that are trading far below their 2011 peaks, when the latest charge of the bull market began. We found five especially attractive companies. All of them face big challenges, so the stocks are risky. But that risk comes with the potential for hefty payoffs if it turns out that investors have been too pessimistic about the companies' prospects. (Prices and other data are through April 30.)

Ambitious chip maker

If you invested in tech the past few years, you probably made out well—unless you owned shares of Broadcom (BRCM). The Irvine, Cal., firm, a powerhouse in semiconductors for wireless devices, TV set-top boxes and other applications, has been spending big to develop new chips to take on wireless-tech kingpin Qualcomm. Broadcom wants to smash Qualcomm's dominance in "baseband" technology, which is at the heart of wireless phones, as the industry moves to the next generation of faster chips.

Critics say Broadcom is fighting an unwinnable war against Qualcomm, wasting much of its research spending in the effort. The firm has shelled out $8.6 billion since 2010, and that has helped depress earnings. Profits fell to 86 cents per share last year, from $1.25 in 2012, even as sales rose 4%, to a record $8.3 billion.

But bulls say the market is underestimating Broadcom's firepower across the broad spectrum of tech "connectivity"—the linking of everything electronic in the years to come. The company likes to say that 99.98% of all Internet traffic now crosses at least one Broadcom chip. As for the Qualcomm challenge, analysts at brokerage Jefferies Group see it as a win-win situation: Broadcom has reached the point at which it will either succeed soon, fueling earnings growth, or pull the plug and save a bundle on further research.

A bet on Canadian energy

Western Canada is loaded with oil, but that crude has run into transportation bottle­necks getting to the U.S. and other markets in recent years. The result: depressed prices for Canadian energy—and for stocks of energy producers such as Canadian Natural Resources (CNQ).

The situation began to change late last year with the opening of new rail transport lines. Construction of new pipelines will also help. Energy companies north of the border would get an especially large boost if the Obama administration were to approve the controversial Keystone XL pipeline, which would take western Canadian oil to ports on the Gulf of Mexico. (It appears that President Obama won't make a final decision until after the November elections.)

A rise in Canadian oil prices this year has helped lift Canadian Natural Resources' shares lately. But analysts at brokerage Canaccord Genuity say the stock price doesn't yet reflect the improved outlook. In a sign that executives are confident about the future, the company—which last year earned $2.1 billion, or $1.89 per share, on revenues of $16.3 billion—boosted its quarterly dividend by 12.5% in March, after hiking it 60% in November (figures are in U.S. dollars). Brokerage RBC Capital, which calls Canadian Natural its favorite oil-and-gas producer, sees the company as a major long-term beneficiary of more western Canadian crude making its way to global markets.

Shoemaker with legs

Wall Street is notorious for punishing companies that are willing to sacrifice earnings in the short run for potential long-term gains. That's part of what's been weighing lately on the shares of footwear firm Deckers Outdoor (DECK).

The maker of Ugg, Teva, Sanuk and other upscale shoe brands reported stellar earnings for the fourth quarter of 2013—up 46% from a year earlier, on a 19% rise in sales. But the Goleta, Cal., company also lowered profit expectations for the first half of 2014, citing among other things the cost of its continuing push to open more retail stores worldwide. Some analysts, including Corinna Freedman, of Wedbush Securities, think investors are being too shortsighted. Freedman expects sales in 2014 to rise 11%, to $1.7 billion, and earnings to climb 12%, to $4.65 per share.

Because it is free of debt, Deckers has a lot of financial flexibility. But it remains heavily dependent on its pricey Ugg footwear, which accounts for 83% of sales. The stock collapsed in 2012, when Ugg sales slipped 2% for the year and earnings slid 32%. But Ugg sales surged 19% in the fourth quarter of 2013 and 10% for the year. Deckers expects to use its growing base of retail stores to complement sales via other retailers and online. And it sees foreign markets—especially Asia—as hot growth areas. If the Ugg brand still has legs, so does Deckers stock.

Mattress maker firms up

Tempur Sealy International (TPX) is trying to buy its way back to growth in the competitive mattress business. But so far, many investors have hit the snooze button.

The Lexington, Ky., company, then known as Tempur-Pedic International, rode the popularity of memory-foam mattresses to great success from 2009 to 2012, and its shares soared from less than $10 to a peak of $87. But vicious competition in the foam-mattress segment led to slowing sales and slumping profits in 2012. That drove Tempur to snap up rival Sealy Corp., a deal that CEO Mark Sarvary promised would create "tremendous value" for shareholders. The combined company's sales hit $2.5 billion in 2013, making it the world's biggest bedding maker. But earnings haven't lived up to projections.

Sealy broadens the company's line of mattresses. But Sealy's lower-priced mattresses have lower profit margins than Tempur's higher-end memory-foam bedding, at a time when Tempur needs more cash to whittle down a $1.8 billion debt load bloated by the merger. Still, KeyBanc Capital Markets says Tempur is experiencing an "exciting transformation" driven by new products, expansion overseas and cost-cutting. Analysts see profits surging 22% in 2015. That kind of growth should help Temper shares emerge from their slumber.

On the watch list

Weight loss is a growth industry, which ought to mean great times for Weight Watchers International (WTW). But the firm's fortunes have faded badly over the past two years. Revenue is expected to total $1.4 billion this year, down from a peak of $1.8 billion in 2012. Earnings are expected to come in at just $1.40 per share this year, compared with $4.23 in 2012. The stock has plunged from a high of $87 in May 2011 to $20.

Executives were slow to realize the increasing threat posed by free diet-plan mobile applications. Meanwhile, the company loaded up on debt to pay for stock buybacks. That double whammy leaves the New York City firm facing a very real threat of oblivion.

But Morningstar analyst R.J. Hottovy thinks new CEO Jim Chambers is taking the right steps to revive the franchise. That includes meshing the firm's meal regimen and fee-generating dieter-support meetings with new online and mobile applications. The key, Hottovy says, is that, unlike so many other diet programs, Weight Watchers' plans have been proven to work. If the 50-year-old firm can reinforce its message with consumers, employers and health plans in the U.S. and abroad, it could grab back market share.

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© 2014 The Kiplinger Washington Editors, Inc.
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