8 Cheap Stocks for a Pricey Market

Cenovus Energy

• Market capitalization: $8.0 billion
• Annual sales: $10.4 billion
• Estimated earnings growth: This year, 211%; next year, 25%
• Price-earnings ratio: 36
• Dividend yield: 1.5%

Although energy stocks have recovered a bit from a nasty 18-month-long slide that started in the middle of 2014, the group remains depressed. And few stocks have been hit harder than Cenovus (symbol CVE, $9.66), which produces oil and gas, mostly in the tar sands of the Canadian province of Alberta. Its U.S.-traded shares have plummeted some 75% from $40 in 2012. Some investors clearly have given up. But for bargain hunters willing to take on high risk, this is a story worth considering.

Cenovus has long been a highly regarded player in the tar sands. Yet as crude prices slid again in March, investors reacted negatively after Cenovus announced plans to buy the tar sands assets of ConocoPhillips (COP) for $13.3 billion (U.S.). The deal, which closed on May 17, doubled Cenovus's reserves and production, but it also saddled the company with heavy new debt. What's more, Cenovus issued 208 million new shares to ConocoPhillips, which plans to begin selling them in mid November. Anticipating that selling pressure, the stock has sunk 36% so far in 2017.

Yet the upshot of the ConocoPhillips deal is that it will immediately generate "robust" free cash flow that Cenovus can use to quickly pay down debt, says investment research firm CFRA. (Free cash flow is cash profits after the capital expenditures needed to maintain a business.) What's more, thanks in part to Cenovus's "best in class" technology for extracting oil from tar sands, CFRA sees operating earnings rising sharply in 2018, to 45 cents per share (U.S.), from an expected 17 cents per share this year. Of course, another drop in crude prices could dim the outlook for the stock. But the cheaper it gets, the greater the potential reward if Cenovus's bold move turns out to be as smart as the company has promised.

CVS Health

• Market capitalization: $77.8 billion
• Annual sales: $179 billion
• Estimated earnings growth: This year, 0%; next year, 8%
• Price-earnings ratio: 13
• Dividend yield: 2.6%

The drugstore chain’s pharmacy business was on a roll from 2012 to mid 2015, boosted in part by the millions of Americans who received health insurance under Obamacare. CVS Health (CVS, $76.29) had been one of the industry's stars, thanks to its retail chain (now 9,600 stores) and its huge pharmacy-benefits management unit, which manages and distributes drugs for health insurers. But after peaking at $113 in 2015, CVS shares have declined by one-third.

CVS has faced a barrage of negative headlines: tougher competition in the pharmacy-benefits business, weak retail sales (a problem for many brick-and-mortar stores) and fear that the health insurance overhaul approved by the House of Representatives would slash millions of people from the insured rolls. CVS is calling 2017 a "rebuilding" year. First-quarter earnings fell 11.5% from the same period in 2016, and analysts expect essentially flat profit results for all of 2017, seeing earnings of $5.87 per share on record sales of $184 billion.

Adding to the gloom, pharmacy stocks were rocked in mid May by rumors that Amazon was considering getting into drug distribution. But with CVS shares selling for less than 14 times expected 2017 earnings, brokerage Barclays argues that the market "understates CVS's unique assets and cash flow, and overemphasizes competitive pressures." Free cash flow is expected to reach at least $6 billion this year. That gives CVS ammo to battle the competition, invest for the future and continue returning capital to shareholders via dividends and stock buybacks.

Delta Air Lines

• Market capitalization: $35.6 billion
• Annual sales: $39.5 billion
• Estimated earnings growth: This year, -2%; next year, 10%
• Price-earnings ratio: 9
• Dividend yield: 1.7%

Wall Street has had a dramatic change of heart about the airline industry since 2012. After years of mergers finally left only a handful of U.S. operators controlling most of the market, investors embraced the idea that the survivors could avoid the massive losses that periodically bedeviled the industry in the past. That lifted Delta (DAL, $48.49) shares from $10 in 2012 to $50 by early 2015. Yet even as Delta has remained highly profitable, the stock has mostly been stuck between $40 and $50 for two years.

Investors have several concerns. Delta last year agreed to boost pilots' pay a hefty 30% by 2019. Fuel prices have rebounded from their 2016 lows. And Delta now is offering low, no-frills fares to battle upstarts such as Spirit Airlines (SAVE) and Frontier. In the first quarter, Delta's profit slid by 36% on a 1% dip in revenue. But the company has been upbeat about its revenue outlook in the current quarter and has pledged to sharply limit route expansion plans until its profit margins widen again. Analysts on average expect profits of $5.20 per share in 2017 and $5.73 in 2018. The stock sells for about nine times the 2017 estimate. That could turn out to be cheap if the bad old days of recurring red ink really are over.

Brokerage Morgan Stanley believes Delta offers investors "just the right balance" of healthy finances, cash generation and long-term growth. The company also signaled its confidence this spring by announcing a 50% dividend hike, to an annual rate of $1.22 per share, and a new $5 billion stock buyback program. An earlier vote of confidence came from Warren Buffett. Berkshire Hathaway (BRK.B), the company he heads, revealed last year that it had taken large stakes in Delta and its three main rivals: American Airlines (AAL), Southwest Airlines (LUV) and United Continental Holdings (UAL).

Johnson Controls International

• Market capitalization: $40.0 billion
• Annual sales: $29.8 billion
• Estimated earnings growth: This year, -2%; next year, 15%
• Price-earnings ratio: 15
• Dividend yield: 2.3%

Long a big player in the auto parts business, Johnson Controls (JCI, $42.64) saw an opportunity in 2016 to transform itself into a more diversified industrial giant. In a deal completed last September, the 132-year-old company merged with Tyco International. The marriage brought Tyco's building-security and fire-protection businesses under the same roof as Johnson's global building-efficiency businesses, including heating and cooling systems, construction-design consulting and building energy management. All told, the facilities-efficiency unit should account for about 75% of the combined company's estimated 2017 sales of $30 billion. The rest will come from the firm's battery unit: Ireland-based Johnson is the world's biggest maker of conventional lead-acid auto batteries. It also is a leader in the booming market for so-called absorbent glass mat, or AGM, batteries for cars with fuel-efficient "stop-start" engines.

AGM batteries are a fast-growing business, but Johnson's main selling point to investors is the building-efficiency unit. Johnson sees itself riding the boom in urbanization worldwide and the demand for greater energy efficiency in "smart" commercial buildings and other facilities. The problem so far is that investors aren't convinced Johnson can deliver on promised post-merger growth. Brokerage Robert W. Baird notes that in Johnson’s second fiscal quarter, which ended March 31, the building-efficiency unit reported disappointing profit margins, further souring investors' mood. But that also presents an opportunity, Baird says. With the stock now selling for less than 16 times analysts' average estimate of $2.64 per share for the fiscal year that ends in September, stronger spring and summer results could finally ignite interest in Johnson's new story.

Nike

• Market capitalization: $68.1 billion
• Annual sales: $33.9 billion
• Estimated earnings growth: This year, 11%; next year, 5%
• Price-earnings ratio: 21
• Dividend yield: 1.4%
• Nike (NKE, $51.57) has been one of America’s great growth stories of the past few decades. But the swoosh has lost some of its swagger, as sales and earnings growth have slowed in recent quarters. Nike shares plunged 7% on March 22 after the company posted disappointing results for the quarter that ended February 28 and expressed caution about the near-term outlook. Nike is facing stronger competition from German rival Adidas. At the same time, Nike says, U.S. sales are suffering from shoppers' shift away from brick-and-mortar stores. Analysts now expect the company to earn $2.40 per share in the fiscal year that ends May 31 on sales of $34 billion. They expect only a modest 5% increase, to $2.51 per share, in fiscal 2018.

All of this has left the stock down more than 20% from its all-time high of $68, reached in 2015. The shares are priced at about 21 times estimated fiscal 2018 earnings — a steep decline from the P/E of 37 that the stock commanded at its peak. Bulls say the stock is a relative bargain for what remains a powerhouse global consumer franchise. They note that although sales in North America rose just 3% in the fiscal third quarter from the same period a year earlier, emerging-markets sales climbed 8%. Nike CEO Mark Parker in March detailed the company's game plan to speed its vaunted product innovation — getting new athletic shoes to the market faster, for example. He also pledged to achieve a more-personalized connection with consumers, both online and in retail stores, by tailoring products and services to customers’ specific desires. "The more directly Nike engages with the consumer, the greater the return," Parker said. Brokerage Stifel Financial says that Nike remains “well-positioned to succeed long term,” and that the company's "global diversity and financial flexibility" provide stability.

Shire

• Market capitalization: $170 billion
• Annual sales: $13.3 billion
• Estimated earnings growth: This year, 15%; next year, 17%
• Price-earnings ratio: 12
• Dividend yield: 0.5%

Over the past decade, this Irish drug giant has grown largely via acquisitions, some of which have been disappointments. But good news about one of Shire's new drugs has refocused investors on the company's product lineup. Shire (SHPG, $187.49) is coming off a roller-coaster three-year period that began in 2014 when the company became a takeover target of rival AbbVie (ABBV). But that deal fell apart, causing Shire's shares to tumble. By early 2015, Shire shares were roaring again amid a broad rally in biotechnology stocks. Then, in August 2015, Shire launched a hostile, $30.6 billion bid to buy Baxalta, a big player in hemophilia and immune-disorder drugs. It took a sweetened bid of $32 billion to win Baxalta early in 2016. By then, Shire's stock had plunged again as investors soured on biotech stocks' sky-high valuations.

Fast-forward to the present: With Shire's U.S.-traded shares down 31% from their record price of $268, set in 2015, the firm recently announced favorable results from patient trials for an experimental drug called lanadelumab. The drug treats a rare genetic disorder that causes horrid swelling of extremities and internal organs. Analysts believe lanadelumab and related Shire drugs could eventually be worth $2 billion in sales annually. That would complement Shire's portfolio of treatments for other rare diseases, such as hemophilia. The company also is a leader in treating attention-deficit/hyperactivity disorder (ADHD) with its largest-selling drug, Vyvanse. Although Shire faces challenges digesting Baxalta — including paying off a now-record debt load — brokerage SunTrust sees a "catalyst-rich year" for the stock with the lanadelumab trials and expanded sales of Xiidra, a treatment for dry eyes. Analysts on average expect operating earnings of $15 per U.S. share in 2017, up 15% from 2016, on sales of about $15 billion. Brokerage William Blair calls Shire "one of the highest-quality franchises in pharmaceuticals and biotech."

Tenneco

• Market capitalization: $3.0 billion
• Annual sales: $8.8 billion
• Estimated earnings growth: This year, 6%; next year, 10%
• Price-earnings ratio: 8
• Dividend yield: 1.8%

Until the 1990s, Tenneco (TEN, $55.81) had been one of the nation's biggest conglomerates, a mishmash of companies involved in disparate industries, including energy, shipbuilding, packaging and auto parts. After a spate of asset sales and spin-offs, all that remained under the Tenneco name by 1999 was the auto-parts business. As it turned out, Tenneco staked out two product lines with healthy prospects thanks in part to rising technological sophistication: emission controls and suspension systems. The company now produces those components for more than 40 car, truck and off-highway vehicle manufacturers worldwide. Sales are expected to hit a record $8.9 billion in 2017 and earnings a record $6.50 per share.

But Tenneco’s stock has struggled since 2014, in part because of fears of a global recession that, so far at least, hasn’t materialized. Weak sales of trucks and off-highway vehicles (such as tractors) also hurt investor sentiment. Yet in 2017’s first quarter, Tenneco's sales rose a strong 7% from a year earlier. Investment firm Northcoast Research thinks the stock, selling for eight times estimated 2017 earnings, is a relative bargain. Tenneco is benefiting from "ever-tightening emissions regulations and the growing interest in advanced suspension systems" worldwide, Northcoast says. Also, brokerage Goldman Sachs expects a continuing rebound in truck and off-highway vehicle sales, particularly in emerging markets. In the first quarter, Tenneco's sales to the truck market jumped 15%. Another sign of confidence: Tenneco decided in February to start paying a dividend, at an annual rate of $1 per share.

Tesoro Corp.

• Market capitalization: $9.8 billion
• Annual sales: $26.1 billion
• Estimated earnings growth: This year, -9%; next year, 40%
• Price-earnings ratio: 13
• Dividend yield: 2.6%

Few investors benefited from the collapse of oil prices in 2014 and 2015 the way Tesoro (TSO, $83.26) shareholders did. As crude sank faster than pump prices, the giant U.S. refinery operator reaped a profit windfall — and saw its stock soar from $45 early in 2013 to a peak of $120 in late 2015. Since then, however, the modest rebound in crude prices has pulled profit back down, and with it the stock. But investors may be under-appreciating Tesoro's next act. The company agreed last November to buy rival Western Refining for $5.8 billion. The deal, which closed this spring, will add three refineries (in Minnesota, New Mexico and Texas) to Tesoro's seven (all in the West). Tesoro will also gain 545 retail gasoline stations, bringing its total to more than 3,000. The combined company will be renamed Andeavor on August 1.

Research firm Morningstar notes that Western's three refineries will give Tesoro more access to low-cost U.S. crude oil, including from the fast-developing Permian Basin shale-oil drilling area of west Texas and New Mexico. Long term, Tesoro plans to get that oil to its refineries in California, a market where it is a major player. All in all, Morningstar says it sees "Tesoro's competitive position improving over the next several years." Analysts on average predict earnings of $5.57 per share in 2017, rising to $7.79 in 2018. JPMorgan Securities, one of Tesoro's investment bankers, expects the closing of the Western Refining deal to spark new interest in the stock, which the brokerage thinks could reach $97 by year-end.