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Is this FTSE 100 stock the market’s most undervalued?

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There is one stock in the FTSE 100 that looks cheaper than almost every other UK listed blue-chip, and that is steelmaker Evraz (LSE: EVR).

At the time of writing, the stock trades at a forward P/E of just 7.4 and an enterprise value-to-EBITDA ratio (EV/EBITDA) of 4.4. To put this into some perspective, the rest of the market trades at a median EV/EBITDA ratio of 10.9 and the global metals and mining sector commands a multiple of 7.1.

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However, the question we have to answer is, why is Evraz so cheap in the first place?

What’s the deal? 

I think there are three main answers to this critical question. First of all, Evraz is a Russian headquartered business, so there’s a bit of country risk here.

Second, it operates in a highly cyclical industry where any number of factors can decimate profits. Indeed, the company has only been profitable for the past two years, and between 2013 and 2016 it racked up nearly $2.5bn in net losses.

And third, the group has quite a bit of debt. Net debt as a percentage of equity was 211% at the end of 2018. On this last point, the company is making progress. It reduced net debt from $6.4bn to $3.5bn between 2013 and 2018.

Evraz has been able to reduce debt so quickly because it is throwing off cash. Free cash flow has totalled $8.5bn over the past six years, which is why the company was able to distribute $1.6bn to shareholders via dividends last year.

This cash generation doesn’t entirely make up for the company’s other faults, but in my opinion, it does show how resilient this business is. Some investors might not be comfortable investing in a business that is so exposed to Russia, but I think a lot of this risk is already reflected in Evraz’s discount valuation and a dividend yield of 8.8%. So, if you’re looking for value stocks, it might be worth considering Evraz for your portfolio.

Too cheap to pass up? 

Another value stock that I think might be worth your research time is Petra Diamonds (LSE: PDL).

Petra is very similar to Evraz, in my opinion, because this company is also struggling with a high debt load and volatile earnings. But once again, I think the majority of this risk is already reflected in the stock’s valuation. It is dealing at a forward P/E of just 3.7 at the time of writing and EV/EBITDA ratio of 4.2. 

That being said, I believe the business does deserve to trade at a discount to the rest of its sector because earnings are falling. Today, the company announced a 7% increase in fiscal third-quarter revenue due to a 6% fall in sales volumes. Net debt did fall marginally during the stated period (down 1% quarter-on-quarter), but this still leaves the business with a net gearing ratio of 120%.

These figures are not that impressive, but as I mentioned above, I think Petra’s current share price already reflects most of the pessimism surrounding a business and even a small uptick in expectations might lead to a significant re-rating of the stock. With this being the case, it might be an attractive investment for risk-tolerant value investors.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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