Since its IPO at the beginning of last year, gaming firm JackpotJoy (LSE: JPJ) has struggled to win over investors.
The reason for investor caution is clear. The company is drowning in debt. At the end of 2017, JackpotJoy had an adjusted net debt balance of £387m and an adjusted leverage ratio of 3.6 times.
However, while the debt mountain is concerning, JackpotJoy is a cash cow and it’s rapidly paying off creditors. The company generated a free cash flow from operations of £97.8m last year, giving a free cash flow yield of 15.5%.
Management is committed to cleaning up the balance sheet over the next few years and it has the resources to do so. A recent trading update declared that revenues during the first two months of 2018 have increased by 12%. That puts the company on track to generate a similar debt-reduction performance again in 2018, as well as meeting other obligations.
And once debt is brought down to a more sustainable level, I believe JackpotJoy will start returning excess cash to investors, so this could also be a future dividend champion.
Less than cash
Another out-of-favour recovery play I like is Game Digital (LSE: GMD).
Like many of its high street peers, Game is suffering from its high fixed cost base (rental leases), rising costs overall, as well as shifting consumer shopping habits. These pressures resulted in the group announcing a 56% decline in profit before tax from its core retail operations for the 26 weeks ended 27 January.
Thanks to a positive £2.6m contribution from its growing Esports business for the period, overall profit only declined 26%. But more importantly, Game generated £32.2m in cash from operations during the period, up 25.3% year-on-year.
Game ended the period with £85m in cash and equivalents with almost no debt, compared to a market capitalisation of £63.6m at the time of writing. Put simply, the company as a whole is now worth less than the value of cash on its balance sheet, making it a traditional value play.
Including intangible assets, the shares are trading at a price-to-book value of 0.5.
My final ‘absurdly cheap’ pick is motor retail and aftersales company Lookers (LSE: LOOK).
Shares in this car dealer have lost more than 27% of their value over the past 12 months because of concerns about the state of the car market in the UK. Indeed, after years of above-average growth, fuelled by easy credit, new car sales slumped 15.7% in March, extending the run of falling sales to 12 months. As a result, fearing bad news ahead, investors have fled car stocks.
I believe this presents an excellent opportunity for value investors. You see, while headline numbers show car sales in the UK are collapsing, according to official figures from the Department of Transport the average age of vehicles on Britain’s roads is now more than eight years, its highest level since the turn of the century. Nearly 20% of cars are at least 13 years’ old. Sooner or later, drivers will have to replace these vehicles.
And when sales growth does pick up, shares in Lookers could see a substantial re-rating. The stock is currently trading at a forward P/E of 6.7, which, in my opinion, is factoring in the worst case scenario and leaves no room for positive surprises.