As a value investor, I'm always interested in good companies trading at a discount to the value of their assets. These can be very profitable investments.
Today I'm going to look at two FTSE 250 companies that are both trading at big discounts to their net asset values. As we'll see, I believe gains of 50% or more could be possible on both stocks.
A power play
Power generation specialist Drax Group (LSE: DRX) is working hard to leave its coal-fired past behind and become a more diverse business, built around renewables.
The company now generates 63% of its power by burning renewable wood pellets, rather than coal. Drax has also acquired a gas generation company and is building a business which sells energy directly to business customers. In my view, the group is becoming more like a regular big utility.
I'd expect a business like this to trade above its book value. However, although Drax shares rose by 20% last year, they currently trade at a 34% discount to their tangible book value of 494p per share.
Drax stock would have to rise by 52% from its current level of 325p in order to trade in line with its book value.
This could be an opportunity
I don't expect its share price to rocket up to 494p overnight. As things stand, the group's profits aren't high enough to justify such a valuation, in my view.
However, when sound companies trade at a discount to their book value, it's often an indicator that a future re-rating is likely when profits recover.
Drax's adjusted earnings are expected to rise by 148% to 12.4p per share this year. A further increase of 47% is pencilled-in for 2018. These figures put Drax stock on a forecast P/E of 26, falling to a P/E of 18 in 2018. The shares also offer a prospective yield of 2.5% for 2017, rising to 4.4% in 2018.
If Drax can deliver on these forecasts and maintain this momentum, then I think the shares are likely to rise further. Drax has gone onto my watch list as a potential value buy.
A luxury bargain?
FTSE 250 hotel operator Millennium & Copthorne Hotels (LSE: MLC) operates about 125 upmarket hotels in top destinations such as New York, London and Singapore. Around half of these are owned or leased, while the remainder are managed or franchised.
Millennium's stock currently trades at 441p. That's a discount of 55% to the group's net asset value of 976p per share. Although property groups often trade at a modest discount to their net asset value, this seems excessive to me given that the group appears to be in reasonable financial health.
Admittedly M&C is facing some headwinds. Underlying revenue per room fell by 2.3% last year. Costs are rising and room rates are falling. Only the weaker pound helped boost the firm's reported profits last year.
The group's growth may yet come under more pressure. But the balance sheet still looks quite safe to me, with net debt of £707m representing just 17% of the value of properties and investments.
Although the short-term story looks uncertain, I believe that the stock's big discount to book value suggests that the long-term view is more positive.
Roland Head has no position in any shares 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.