A company’s book value is derived by summing up all of its assets and subtracting all its liabilities. This is, arguably, what would be left after a total liquidation of the company. Some investors focus on book value when investing because it is an accounting look at what one is buying without the bias of investor sentiment. To this end, it is as close as one can get to a pure picture of what a company is worth, keeping in mind, of course, that accounting isn’t exactly a pure science.
Generally speaking, a stock trading near or below book value is of the most interest, since such a company can be bought for close to or, better yet, less than what it is “worth” — at least by one measure. Clearly, investors looking at this largely value-oriented metric prefer buying a dollar of assets for less than a dollar.
It may seem odd to suggest that this is even possible, since efficient market theory dictates that arbitrage investors should quickly move in and bid up prices to the point where there is no longer a discount to book value. However, many of the companies that trade close to or below book value trade at such low valuation levels for a reason. Moreover, the total liquidation of a company isn’t a simple undertaking, so that quick money is far from assured. Thus, investors need to carefully research such companies and make sure that any risks are fully understood before investing.
To help value-oriented investors find companies that are trading near or below book value, a weekly screen listing such companies is included in the Summary & Index section of The Value Line Investment Survey. The screen shows the 100 companies with the widest discount to book value and includes Value Line’s proprietary Timeliness and Safety ranks, as well as recent price, book value per share, the percentage discount to book value, Beta, P/E, and dividend yield. Basically, that is everything one needs to start the research process. Highlighted here are PharMerica Corp. (PMC) and Citigroup (C).
PharMerica is a leading institutional pharmacy services provider to healthcare facilities and hospitals. It operates more than 100 institutional pharmacies in the United States. It also provides pharmacy management services to 85 hospitals in the U.S. The pharmacy business accounts for more than 95% of the top line, with Hospital Management comprising the remainder.
PharMerica posted mixed results for the June quarter. Revenues declined mid-single-digits relative to the prior-year tally. This reflected a 4.6% fall in the number of prescriptions dispensed, to 9.42 million. What's more, PMC’s revenue per prescription dispensed declined 150 basis points, to $45.73. Some of this downturn can likely be attributed to the shift toward lower-priced generic offerings. This is evident in the company’s increase in gross profit per prescription, up 14.2%, to $8.77 each. Furthermore, share net climbed nearly 38%, to $0.44, thanks, at least in part, to a 2.6% decline in cost of goods sold as a percentage of revenues.
We are now more optimistic with regard to our 2013 full-year estimate. Our expectation of a 20% year-to year earnings increase largely reflects the shift toward PMC’s higher generic dispensing rates as well as cost containment efforts. This should help to counteract still sluggish top-line comparisons. In fact, the company recently announced the loss of a contract with Kindred Healthcare, which accounted for a fairly significant portion of the company’s hospital pharmacy management business.
These shares have lost significant value since our June review. We believe this reflected the announcement that PMC lost a large account (Kindred Healthcare). However, we believe the shift toward short-cycle dispensing could help boost sales longer term. It may be a bit early to tell, but many companies in this sector have been experiencing slight volume increases in dispensed prescriptions as a result of shorter-cycle dispensing. This is probably the result of multiple shorter-cycle scripts for the same patient and drug. These shares, which current trade at a sharp discount to book value, offer attractive recovery potential for the 3- to 5-years ahead. However, conservative accounts may wish to look elsewhere, given the issue’s subpar Price Stability score.
Citigroup is a diversified financial services company with operations in consumer and corporate banking, insurance, investment banking, and asset management. Businesses include Citibank, CitiFinancial, Primerica Financial Services, and Banamex. The company has about 200 million customer accounts in about 160 countries and jurisdictions.
We have increased our earnings estimates for each of the next two years at Citigroup. Management has taken painful, though necessary, steps to contain costs, including the elimination of about 11,000 positions, equivalent to 4% of the aggregate workforce. What’s more, Citi’s Tier-1 common ratio (an indicator of financial strength), which had been decreasing over the past year, made modest gains in the June quarter. Furthermore, revenues are rebounding faster than we had expected, and are set to climb double digits this year, before stabilizing at likely mid-single-digit growth in 2014. We now look for Citi’s bottom line to reach its highest tallies since the middle of the prior decade in 2013 and 2014.
These shares offer wide price rebound potential over the next 3 to 5 years, given that they are trading at a steep discount to book value per share. However, they do display an elevated level of risk so we advise ultra-conservative accounts to proceed with caution. Stock Price Stability is very low, at 5 out of a possible 100. On the positive side, though, we look for the company to return more capital to shareholders moving forward. Citi recently earmarked $1.2 billion for a share-buyback plan, with a targeted completion date of the first quarter of next year. Also, the quarterly dividend, which is currently a penny a share, might well be raised to $0.18 per quarter by next year. These shareholder friendly moves were made possible by an agreement with Fannie Mae aiming to avoid possible litigation down the road. In a nutshell, the lender will pay Fannie Mae $968 million to resolve potential future repurchase claims for “breaches of representations” of 3.7 million residential loans originated by Citigroup between 2000 and 2012 and sold to Fannie.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.