Scraping the Barrel for Value

 | Apr 03, 2013 | 11:03 AM EDT
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As the U.S. equity markets flirt with new highs each day, many stocks seem to also be flirting with new 52-week highs, sometimes all-time high prices. That should come as no surprise, as a rising tide usually elevates the entire group. But there are stocks that have been pushed aside, cast away as untouchable by Mr. Market.

Some of these names are indeed untouchable -- they have been trading at bottom of the barrel prices for years, both before and after the recession. But a value-seeking investor, by nature, is always looking at this dark, unloved part of the ocean in hopes of finding a decent business that is severely mispriced.

A name I have yet to examine closely but which is worth sharing for the sheer statistical nature of its numbers is ITT Educational (ESI). ITT is a for-profit post-secondary education provider. Its campuses offer college and graduate degrees in  areas such as IT, healthcare and business. The entire industry has come under intense scrutiny relating to the legitimacy of its enrollment practices. Earlier this year, ITT paid Sallie Mae $4 million to settle a claim relating to a breach of contract that occurred in 2007.

That's why ITT now trades for $13, compared with over $70 a year ago. At this price, the company has a market cap of $295 million. The company has about $5 in net cash per share. Shares trade for less than 3x trailing earnings and less than 5x forward earnings. In 2010, free cash flow was over $500 million, in 2011 it was $360 million, and in 2012 it was $85 million. The company took this cash and bought back tons of shares -- share count has dropped from 30 million to 23 million over that time.

Tragically, the company bought most of those shares at prices between $50 and $100. If that cash had been preserved, the company would be in a different place today. Nonetheless, these types of numbers imply a share price that's at least three to four times the current stock price. At worst, the company should be investigated.

Restaurant operator Ruby Tuesday (RT) has all the ingredients for a turnaround -- the company must take those ingredients and create something tasty. Of the 786 Ruby Tuesday restaurants operated, 709 are owned, so there's an opportunity to expand the franchise count. In addition to its flagship restaurants, the company also operates 13 Lime Fresh Mexican Grills. 

The company recently shuttered its 11 Marlin & Ray's casual-dining restaurants, its two Truffles locations and one Wok Hay restaurant, Combined, these 14 restaurants were insignificant compared with the company's 700-plus other restaurants and didn't possess quality growth prospects. But Ruby Tuesday is keeping its Lime Fresh Mexican Grill concept and is looking to expand on it -- a good bet, in my opinion. Lime Fresh is in many ways a stepbrother to Chipotle Mexican Grill (CMG), offering freshly prepared Mexican food sourced from high quality ingredients. Lime Fresh Mexican Grill, in my view, offers tremendous growth potential.

Shares in Ruby Tuesday currently fetch $8 against a book value of over $9. The company's market cap is $477 million, and there is about $300 million in debt. Since the company generates over $70 million in annual free cash flow per year, the debt is easily serviced. Furthermore, asset disposals and perhaps a push toward selling the owned Ruby Tuesday restaurants and leasing them back could also generate lots of cash. And Lime Fresh is a gold nugget in the portfolio waiting to be exploited properly. All in all, Ruby Tuesday is a great setup in need of successful management execution. But the upside potential could be over 100% in the next two years if management is successful.

Now is the time to be looking at these unloved names that are showing sprouts of opportunity, because these are the companies that will likely outperform the market in the years ahead, as this rising market will ultimately lose steam.

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