2 cheap ASX stocks that might interest contrarians

Morning Star AU09-20

A few months ago, I re-read David Dreman’s book Contrarian Investment Strategies and illustrated what kind of stocks you might end up owning if you followed his approach.You can see that article here,...

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He would then sell the stocks when they reached the market’s average valuation, and rinse and repeat. By following this strategy, Dreman hoped to profit from the stock market’s tendency to get overly depressed about companies that are currently out of favour. Once sentiment improves from terrible to merely bad or average, the stock price can see a recovery.  In my view, this is more of a trading strategy than an investing strategy. But I do like the idea of exploiting overblown negative sentiment to find potential bargains.In that spirit, today’s article looks at two ASX shares that might interest Dreman. To do this, I screened for shares that trade far below the market average on at least three of the following metrics mentioned in Dreman’s book:Price to earnings – which is currently at 18 times Price to after tax cash flow – which is currently at 9 times Price to book value – which is currently at of 2.2 times Dividend yield - which is currently at 3.8%None of those metrics alone are enough to know if a stock offers good value. But unlike a few examples from my previous Dreman article, our analysts do think these two shares are cheap at the moment. We’ll take a look in the bargain bin shortly. But first, a quick reminder that a high Morningstar rating or “cheap valuation” doesn’t necessarily mean a share is right for you.Before considering an individual share or fund, you should have an investment strategy in place first. Go here for a step by step guide to building yourself an investment strategy.I’d also point out that none of the three companies below have an economic moat according to our analysts. As an economic moat protects a company from the competitive ravages of capitalism, we think it is an attractive feature to look for in companies that you are hoping to hold for the long-term.Santos (STO)Santos is Australia’s second largest oil and gas exploration and production pureplay behind Woodside Petroleum (ASX: WDS). The company has with interests in all Australian hydrocarbon provinces, Indonesia, and Papua New Guinea. Santos' Gladstone and Papua New Guinea LNG projects are attractive in that they are large, long-life, have low cash operating costs, and offer expansion potential. The company’s Barossa and Pikka projects, which are currently in constriction, also have the potential to significantly grow production and revenue.In a recent update, Santos said that Barossa is now 77% complete and on-track for first production in 2025. Meanwhile, the Pikka oil project in Alaska was on schedule for production in 2026.Taylor thinks Santos can grow its earnings per share at a double-digit clip for the next decade. This forecast is underpinned by Santos’ two new projects, share buybacks and a healthy demand picture for natural gas, which stands to benefit from efforts to minimise emissions.Santos’ net debt has fallen from a high of US 6.9 billion in 2015 to around USD 3.5 billion at the end of 2023. Meanwhile, the company’s operating cash flow remains robust. With a net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) of 0.9, the company could – in theory – pay off a significant amount of its debt in a single year with cash generated by the business. Despite these positives, Santos shares trade at a low valuation – optically, anyway – of 12 times earnings over the past year, under 9 times forward earnings and a price to book ratio of 1. At a recent price of $7.05 per share, Santos also trades roughly 45% below Mark Taylor’s Fair Value estimate of $12.50.Nine Entertainment (NEC)Nine is a collection of media businesses encompassing TV, publishing, radio and digital markets. Almost 50% of Nine’s earnings stem from TV, where it is one of only three players licensed to broadcast to Australia’s metropolitan markets.The advent of internet based content has eroded much of the benefits of this oligopoly. This has also led to increased competition in Nine’s publishing business, which is responsible for around 20% of earnings and is home to assets including the Sydney Morning Herald and the Australian Financial Review.The balance of Nine’s underlying earnings come from a 60% equity stake in Domain Holdings (15%), its Stan streaming business (around 10%) and radio stations (5%). With this in mind, it will come as no surprise that advertising sales makes up the bulk of Nine’s revenue. And as advertising spending has weakened in recent years, so has sentiment towards Nine’s stock. The shares currently trade at less than half of our analyst Brian Han’s $2.70 fair value estimate. While fiscal 2024 underlying EBITDA fell 12% to AUD 517 million, it exceeded Han’s forecast, driven by upside surprises in TV and publishing. He also noted that cost-cutting is having an impact and that the company remains well poised to benefit from a recovery in advertiser spending.His confidence in this regard was boosted by the fact that Nine’s TV audience grew modestly in fiscal 2024, a reporting period that did not include Nine’s coverage of the Paris Olympics. Han also notes that Nine’s balance sheet is strong enough to push through weak industry conditions. Although any closing discount in the discount between Nine’s shares and his Fair Value estimate will likely require poor marketer sentiment to reverse.Nine shares trade at roughly 17 times last year’s earnings but around 11x Brian Han’s forecast for earnings over the next twelve months. The shares trade at 6.8x after tax cash-flow, 1.2x book value and have a projected forward dividend yield of over 7%. As a result, they also appear to be cheaper than the market average on several measures that Dreman references in his approach.A couple of important remindersDreman’s strategy was a basket approach, one that he was betting would work on average and over the long-term. It was not a ploy to try and make quick gains in any single stock. This is why one of his book's 41 “rules” for contrarian investing suggests to “invest in 20 to 30 stocks, diversified among 15 or more industries”. Meanwhile, another of his rules simply says: “Don’t expect the strategy you adopt will prove a quick success in the market; give it a reasonable time to work out”.On the point of strategy, I’d like to stress again the importance of adding structure to your investment activity before you even get to considering individual shares. Step one is getting clear on what you want to achieve and when you want to achieve it by. You can see the rest of the steps here. More equity investing articles: Lessons from Nick Sleep's famous investing letters Mark LaMonica explains why dividend ETFs can disappoint income investors Five famous quotes and the lessons for investors Get more Morningstar insights in your inbox","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2469983346"}