5 Decent-Looking Recovery Picks

Published in Investing on 3 May 2012

Cheap-looking shares, coupled to decent-looking businesses. What's not to like?

It's no secret that some of the FTSE 100's biggest businesses are under the cosh right now. Which, for bargain hunters, can throw up some juicy pickings -- under-valued shares, in short, that could be set to soar.

And that's true for both income investors and those looking for capital upside, too.

Take mighty Tesco (LSE: TSCO), for instance. This FTSE 100 stalwart has seen its share price fall by 25% over the past two years, with the biggest plunge in the wake of January's profit warning. Over the same period, London's flagship FTSE 100 index has climbed almost 10%, delivering a whopping 35% differential.

Yet Tesco's annual dividend per share has continued its steady climb, putting the shares on a tasty 4.9% forward yield. Buying an income from Tesco has rarely been bettered.

Even so, Tesco isn't one of my picks today. In looking for decent recovery plays for this article, I've discounted Tesco -- even though I personally hold the shares, and have significantly increased my holding after January's shock slump.

Screen

I began by running a screen on FTSE 100 companies, looking for businesses trading on a historic price-to-earnings (P/E) ratio that is at a 20% discount to the FTSE's average of 9.85 -- in other words, a P/E of 7.9 or so.

Straightaway, that eliminated some interesting looking prospects that didn't quite make the 20% cut -- Legal & General (LSE: LGEN), for instance, currently trading on a P/E of 8.3. It also eliminated Tesco -- the share might be beaten down, but it's trading on a measly 7% discount to the FTSE's average P/E.

Next, I eliminated very cyclical mining businesses. Their P/E's might be low, but mining isn't for me at the moment -- especially when coupled to concerns over corporate governance issues.

So, it's goodbye Rio Tinto (LSE: RIO) on a P/E of 7.6, Eurasian Natural Resources (LSE: ENRC) on a P/E of 7.4, and Vedanta (LSE: VED) on a P/E of 5.9, for instance.

Finally, I kicked out businesses where the discount to the FTSE's average P/E didn't, in my view, provide an adequate margin of safety bearing in mind the industry risks they were facing. At which point, I bade farewell to Barclays (LSE: BARC) and RSA Insurance Group (LSE: RSA).

Last five standing

Which left me with five businesses with beaten-down share prices, but -- to my mind, at least -- decent prospects for recovery.

Interestingly, too, it turned out that I held all five. So what are they?

CompanyShare priceHistoric P/EDiscount to FTSE average
BP (LSE: BP)436p6.336%
AstraZeneca (LSE: AZN)2,706p7.623%
BAE Systems (LSE: BA)291p7.227%
Aviva (LSE: AV)313p5.643%
GKN (LSE: GKN)206p7.920%
Average  30%

Dogs or divas?

Coincidentally, most of the five have had recent -- and relevant -- newsflow.

BP, for instance, issued its first-quarter results this week, prompting my Foolish colleague David Holding to declare that BP looks like a buy. While there are still concerns over Russia and the fallout from the Gulf of Mexico oil spill, I agree with David that, at today's share price of 436p, an awful lot of bad news is fully priced in.

BAE Systems has also reported this week, pointing to trading for the period being consistent with management expectations, and anticipating modest growth in underlying earnings per share. Changing hands at 291p this morning, and yielding a whopping 6.4%, I reckon that BAE's shares should provide long-term investors with handsome returns.

AstraZeneca? Well, the board has ditched chief executive David Brennan, and signalled unambiguously that a change of direction is required. Meanwhile, the business is that FTSE rarity, a company with no net debt -- and remains a favourite with Neil Woodford. Yielding a hefty 6.8% on today's price of 2,706p, AstraZeneca too would seen to have a lot of bad news priced in.

Aviva, too, has seen troubled times, but it's difficult to find anything in the fundamentals to set off alarm bells. Certainly, my Foolish colleague Stephen Bland remains a fan, and I'm happy to hold the shares myself. The yield -- 8.5% on today's share price of 313p -- will be too rich for some, but the company gives no indication that it's under threat.

Which leaves GKN, where an interim management statement on 18 April spoke reassuringly of trading in line with expectations -- equating to underlying sales up 8%, a 19% increase in profit, and improving margins in each of the business's four divisions. Yielding a forecast 3.6% on today's share price of 206p, GKN looks to me like an undervalued business that will provide investors with a decent income while they wait for value to out.

Foolish bottom line

As ever, these aren't blind recommendations -- even though, as I've said, it turns out that I hold them myself.

Instead, use them as a starting point to form your own conclusions as to their merits -- and feel free to share these conclusions in the box below.

Aviva's yield, I know, will put off some, as will AstraZeneca's drugs pipeline.

So: recovery picks or value traps? Have your say in the box below.

Sign up for a 30-day free trial to Motley Fool Share Advisor and get immediate access to all of our share recommendations and in-depth analysis.

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> Malcolm owns shares in Tesco, BP, AstraZeneca, BAE Systems, Aviva and GKN. He does not own any other of the shares mentioned. The Motley Fool owns shares in Tesco.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

countingcrow 04 May 2012 , 12:37pm

These are the kind of shares I love. I've already bought into TSCO and AV based on their beaten-down (or is it beaten-up?) share price.

I wouldn't touch AZ though, because of their poor pipeline, with little that I can see in the way of a strategy to improve it. And anybody who knows anything about Pharma companies will realise that it takes years to develop a sustainable pipeline. I'm more than happy to stick with my holding in GSK for that reason

4spiel 04 May 2012 , 1:07pm

I notice you card isd RSA with no good reason-indeed whilst there is plenty to be negative about with AVIVA - returns on pension investments in a time of increasing life expectancy not least. Whilst in RSA you have a company insuring general risks with wide geographical diversificationh good results -and high and rising dividend.

4spiel 04 May 2012 , 6:28pm

I was amazed you include Aviva but discard RSA with no valid reason -if you run down a company give reasons when prefering a crap performer !

Benatar 05 May 2012 , 12:32pm

I do wish people who quote figures understood %s. And ones being paid to write articles should refund their fees when they get them wrong. You should be ashamed of yourself!

You say Tescos down 25%, FTSE 100 up 10% so there is a 35% differential. Tescos are down to 75% of their original value. FTSE is up to 110%, therefore the differential is now 110/75, i.e. 46.67%

MDW1954 05 May 2012 , 3:53pm

Benatar,

From an initial perspective, the differential is:

(110-75)/100=35 =35%

That's the perspective given by charting tools, say, and the one I quoted.

After the event, you are quite right, the differential is:

(110-75)/75=46.67 =46.67%

Cheers,

Malcolm (author)

soozieqhairdo 05 May 2012 , 4:04pm

I thought that the supermarket price war meant that generally supermarkets were doomed!

gherkindweller 05 May 2012 , 6:33pm

I just loved the timing of this article: BP AZN BA AV and GKN down respectively on the day 2.8%, 0.6%, 2.2%, 2.1% and 4.2%. Comfortably averaging more than the FTSE100 dropped on the day. Next time you do an article can you give us all notice so that we can short them?

(Disclosure: own GKN and BP)

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