Stocks Below Book Value Getting Dear
ByTim Melvin, RealMoney.com Contributor
On Friday September 18, 2009, 3:00 pm EDT


My, how things have changed over such a short period of time. Earlier this year when I ran a simple screen looking for stocks in the S&P 500 that traded below book value, I found that more than 20% of the index was selling below book. When I ran that screen today, I found that only 7.5%, or 37 stocks in the index, currently trade below that level. The rally has pretty much emptied the cookie jar for asset-based value investors like me.

Financials still dominate the list of course. Some of Jim Cramer's favorite regional banks are on there, with Huntington Bancshares trading at 60% of tangible book value and Fifth Third Bancorp at 80%. Jim and I are at odds over the banks, but if you favor his view over mine, I would still suggest staying with those trading below book value to lessen the risk. I think it is too early to enter the sector, but I leave it to readers to decide which viewpoint they favor. Citigroup and Capital One are also below book, but they are at the top of my "not with a gun to my head" list of stocks that I think are just too dangerous to own.

A couple of leading refiners make the cut as well. It has been tough times for the refiners as declining energy demand and high supplies have limited growth opportunities and kept refining spreads pretty tight. The U.S. Energy Information Agency estimates that gasoline demand in the U.S. will fall by 0.11% in 2009 before rebounding in 2010 by 0.55%. Demand for distillates such as heating oil and diesel fuel is expected to fall 8.35% this year and rise 3.31% in 2010. As a result of this weak demand, refining margins are expected to tighten by 11% this year and widen by just 1% in 2010. With poor refining trends, the stocks are cheap.

In spite of the outlook, I like the refiners below book value. The idea of buying assets that are fairly irreplaceable is attractive to me. It has been decades since a refinery was built in the U.S. The combination of complex regulations and a general "not in my backyard" attitude makes it almost impossible to get a new refinery approved in this country.

I owned Tesoro last year and sold it a little too soon when it better than doubled early this year. I hope the stock continues to fall as it is a stock I would love to own for the long term. The West Coast refineries that the company owns are incredibly valuable assets. Tesoro has the largest refineries in Utah and Hawaii as well as the second-largest in California and Alaska. The company also has 879 retail gas stations and pipelines in North Dakota and Alaska.

It is a valuable collection of assets that is currently priced at 70% of tangible book value. The company has upgraded its refining facilities recently and has aggressively cut costs. CEO Bruce Smith told an investment conference last week that he is bullish on demand and thinks that the shares of his company are undervalued. I like Tesoro and will use a pullback to attempt to sell puts and back into the shares again.

Valero is another refiner trading below tangible book value. The company has 16 refineries around the country and is the largest refiner in North America. The company also has 1,010 retail gas stations in the U.S. and 412 in Canada. Prior to the collapse in 2008, Valero shares had not sold below tangible book value since 1999. Currently, they are valued at 70% of tangible book value. Valero has also been cutting costs and has cash on the books of $1.6 billion as a buffer against weak market conditions. I like the stock here and would love it lower.

ProLogis is an intriguing real estate play that is also below book value. The company directly owns 1,396 properties, with 217 million square feet of space. Most of the space is distribution and warehouse, but it also has some mixed-use properties in the portfolio. The company also has an investments management segment that has 1,339 industrial properties. At 70% of book, the property portfolio is interesting, but given my view of real estate right now, I am going to hold off. I also want to see how the company decides to handle the maturing debt next year given the current difficult capital markets. ProLogis is going on the watch list, however. I like the idea of industrial and warehouse property in a recovery.

It is getting harder to find asset bargains as the market has risen. There are a few around, but I think that it is critical to stay small and move slow. I suggest scaling into any long positions right now.