The stock market has performed well over the last year. The FTSE 100 is up 25%. But not all stocks have risen equally. There are still some UK shares trading at big discounts to their book value.
I’ve been digging through the numbers, and I think I’ve found two stocks that are simply too cheap at current levels. Although there are no guarantees — both companies face turnaround challenges — I reckon that buying these shares for my portfolio today could deliver big profits over the coming years.
UK share #1: US oil opportunity
The long-term future of the oil industry may be uncertain. But global oil production stands at around 100m barrels per day at the moment. About 11.3m of these daily barrels come from the US. This region is the main market for equipment provider Hunting (LSE: HTG), my first pick.
Hunting manufactures and supplies wellbore products — equipment used ‘downhole’ when oil and gas wells are being drilled and prepared for production. Demand slumped after last year’s oil price crash, but things are starting to look up.
Sales of $244m during the first half of this year were broadly in line with sales during the second half of 2020. Analysts expect revenue to rise to around $350m during the second half of 2021.
Although Hunting reported an operating loss of $23m for the first half of this year, the interim dividend was increased. This suggests to me that management are confident of a continued recovery.
3 reasons why I’d buy
There are other oil and gas equipment providers out there hoping for a recovery. So why have I chosen Hunting? There are three reasons.
The first is that this business has a very solid balance sheet, but is trading below its net asset value. Hunting’s latest balance sheet shows net assets of £670m, or around 406p per share. This compares to a current share price of 209p.
That seems cheap to me, especially as the company ended the first half of the year with a net cash position of around $67m. I reckon this valuation provides a decent margin of safety if trading remains tough.
Another reason why I like Hunting is that it designs and manufactures its products, so owns the intellectual property. This is also a valuable asset.
Finally, I think there’s a catalyst in sight for this UK share to go higher. Hunting is planning to start listing its shares on the US market as well later this year. Most of the company’s revenue comes from North America, and most of its rivals are listed on the US market. This move will open Hunting stock up to a new pool of US investors. I think this could help the stock re-rate to a higher valuation.
Admittedly, Hunting still has some problems. A rebound in oil and gas drilling activity is not guaranteed. Hunting is expected to report a $15m loss in 2021, before returning to profitability in 2022. Even then, broker forecasts for a profit of $18m mean that Hunting shares already trade on 25 times earnings.
We have to look at 2023 before forecasts suggest Hunting’s profits will justify its net asset value. However, I’m not too concerned about this. Value stocks often look ugly when they’re cheap — I’d be happy to buy Hunting today.
UK share #2: a cheap property stock that could yield 6%+
As a general rule, I only buy property stocks when they’re trading at a discount to their net asset value. The reason for this is simple enough.
If a company that owns property is trading above the book value of its assets, then any further share price growth is likely to depend on rising property prices. Although this happens — a lot, recently — I don’t like to bet on a rising property market when I’m investing.
One property stock that’s caught my eye recently is urban regeneration specialist U and I Group (LSE: UAI). This £100m small cap specialises in creating mixed-use developments in London, Manchester, and Dublin. U+I shares currently trade at a 50% discount to their book value, as the group is emerging from a difficult period.
However, while the dividend yield this year is expected to be a modest 2.4%, broker forecasts suggest the yield on this UK share could rise to 6.9% in 2022/23, as profits start to recover.
U+I’s turnaround is in the hands of chief executive Richard Upton. Upton was the CEO and founder of Cathedral Group, which U+I acquired in 2014. He worked his way up through the ranks at U+I and took the top job in January 2021.
Refreshingly, Upton still seems to have a founder’s confidence in his company. Unlike many chief executives, he has been a regular buyer of U+I shares in recent years. Upton now owns 3.4% of U+I, giving him a holding that’s worth about £3.5m. In my view, Upton’s sizeable investment should mean that his interests are well aligned with those of private investors.
U+I: a bumpy road?
As I write, U+I shares are trading at around 82p. That’s a 50% discount to the company’s March 2021 net asset value of 163p per share.
I reckon this could be a bargain. But it’s certainly not a sure thing. To close the valuation gap and bring U+I’s share price closer to book value, Upton will have to prove that he can find and deliver new projects successfully. He’ll also have to show that he can do this profitably enough to justify a higher valuation.
U+I has already faced one unexpected setback this year. In June, the company was refused planning permission for a proposed project on the Albert Embarkment in Lambeth, London. This project is a joint venture with the London Fire Brigade and was expected to have a development value of £500m.
The company may yet find a solution and gain planning approval. But U+I shares have fallen by 15% since this news became public. U+I is quite a small business and doesn’t have too many other big projects on the back burner. If this project fails to go ahead, profits in future years could be lower than expected.
Despite this risk, I think U+I shares offer an attractive balance of risk and reward at current levels. I’d be happy to buy and hold this UK share as part of a diversified portfolio over the next few years.