Today was a rare day in the market – flat. Stocks haven’t ended this close to where they started in over a week.

In all of the wild action recently, there have been some encouraging signs for our value stocks. As you may have noticed, many of our companies have been acting very well. Yesterday, for example, our Buy List overall was little changed as the major indexes got whacked – the S&P 500 was down 1.6%. Our stocks followed that up with another solid showing today.

There has been a real divergence this year between the major indexes and most of the stock market. The big companies have done well and they have propped up the indexes, but a lot of other stocks have struggled. I’ve noticed here in the last few days that stocks that were hit hard before the indices really starting slipping, such as Standard Motor Products (SMP) and Hillenbrand Industries (HI), have been among the best recent performers.

We may well be seeing a shift here where momentum in the market has been broken and investors are seeking stocks that offer true value – solid upside potential with less downside risk – the kinds of stocks we’re buying. I expect this trend will continue, and the coming weeks and months could be very good for the stocks we currently own and the ones we’ll add, as more stocks hit our screens if the decline continues.

We’re taking advantage of one today – an undervalued stock that has also outperformed in some of the recent carnage.

CSS: Putting a Bow on Value

It’s that time of year when stores are inundated with holiday-themed décor ranging from Halloween to Thanksgiving and even Christmas! Retailers often stock up on these items early (too early if you ask me) because it’s one of the biggest shopping seasons of the year, and even frugal consumers will open their wallets to get in the holiday spirit.

Most of these consumers, and most of us, too, have likely purchased something made by CSS Industries (CSS), which designs, manufactures and sells seasonal products like gift wrap, greeting cards, photo albums, Valentines for classroom exchanges, Easter egg dye kits and more.

But beyond the bows and tissue paper is an intriguing opportunity in a stock that has a lot going for it right now. It has held up nicely in the recent selling, still sports a very attractive valuation, and is on track to continue growing earnings.

Let’s start with the deep value here. Currently selling at 12X March 2015 fiscal year earnings estimates of $2 a share, CSS boasts an attractive EV/EBITDA (enterprise value to earnings before interest, taxes, depreciation and amortization) of just over 4X expected EBITDA of $35 million. The company also has current assets (net of all liabilities) of $179 million, which is 79.2% of its $226 million market cap, and offers a 2.5% dividend yield that adds a nice income component to the name.

Next, to understand where this value story is headed, let’s take a closer look at CSS’ business operations.

In a move to drive greater efficiency, CSS combined its three major operating businesses – C.R. Gibson, Berwick Offray and Paper Magic Group – into one business last year. Management also sold the Halloween division of Paper Magic to concentrate on more profitable operations. Total proceeds of the sale will come in between $6 million and $7.5 million.

Profitability and efficiency have remained key goals in 2014. In April, CSS acquired decorative ribbon manufacturer Carson & Gebel to add another layer to its vast array of products, and management expects the deal to boost earnings here in the current fiscal year.

While sales have been negatively impacted by lower Christmas card and ribbon sales in recent years (falling 16% to $320 million between fiscal 2011 and 2014), it’s important to note that the rate of decline lessened last year. Fiscal 2014 sales would have been just 4.4% lower compared to a 5.5% decline in 2013, excluding the sale of the Halloween business. Plus, the company has done a great job of stabilizing margins through manufacturing efficiencies and administrative expenses cuts, and has been able to more than offset the top line pressure. As a result, earnings in the same four-year period rose from $1.77 to $1.97 a share.

I also like that CSS generated approximately $22 million in free cash flow last year, and assuming it can keep up this level of profitability for the next two years, the company’s net current assets will come close to equalizing its current market value – roughly valuing it at a liquidation price. That’s very cheap for a company that’s growing earnings. I believe any slowing of the Christmas card business is well priced into the stock at this point, and CSS’ strong cash-generating abilities will push the shares higher over time.

Plus, the company has the option to reduce its share count by funding a $62 million buyback program anytime the stock is trading under $27 per share – and the balance sheet would remain healthy. Buybacks create shareholder value, and fewer shares on the market by definition increase earnings per share, so it’s another possible path to growth.

Buy CSS under $26.50 for a target of $30.50. I like the timing of this play given the upcoming holiday season but also because deep value stocks like CSS are poised to do very well in a market that has grown nervous over the weakening global economy. We’ve seen evidence of that this week as buyers have stepped in even amid the higher volatility.

Earnings Preview: STJ

St. Jude Medical (STJ) will report third-quarter results before the market open tomorrow. Analysts are expecting earnings of $0.96 a share compared to $0.90 a share last year and sales growth of 3.6% to $1.39 billion. The company should also see steady results across most of its product lines thanks in part to recent acquisitions. While foreign currency may start to have a slight negative impact on the top line, I believe we will see margins expand on higher sales volume, allowing EPS to grow at an even better rate than sales.

I continue to like STJ, especially as recent acquisitions and new products can help counteract the company’s recent disappointing growth performance. This will help revalue the stock closer to the multiple that many of its peers enjoy. Buy STJ under $64.

Sales Growth Buoys BKE

The Buckle’s (BKE) improved sales trend continued in September, with total sales up 4.1% and same-store sales up 2.2%, just shy of the expected 2.7%. Strength in the men’s department (up 9% in September and now accounting for more than 40% of total sales) remains the driving force behind BKE’s sales growth.

After initially falling on Thursday in sympathy with weakness in The Gap (GPS) – which fell sharply after announcing the resignation of the company’s CEO – BKE bounced back nicely despite the overall market sell-off. I believe we will see shares rally further as investors focus on stable names with no foreign exposure in this unpredictable market environment, so continue to buy BKE under $47.50.

CTB Bought Out of Chinese Venture

Cooper Tire and Rubber (CTB) had been doing relatively well in the market until recently falling back after announcing that Chengshan Group Company will buy out CTB’s 65% interest in Cooper Chengshan Tire, one of the company’s Chinese joint ventures. Although CTB is expected to receive $268 million per the buyout agreement, the transaction will weigh on earnings in the near term, which led to the decline.

Management indicated that it remains committed to China and will continue to sell tires to Cooper Chengshan through at least 2018. The company will also maintain its investment in its other Chinese joint venture, Cooper Kunshan Tire.

I will get a better idea of how dilutive the transaction will be once the company reports earnings on November 7, and I’m looking for management to discuss its plans for the buyout’s proceeds. I wouldn’t mind seeing a share buyback, which would be extremely accretive for CTB at current prices, and I would still expect the company to see earnings of $2.80 per share in 2015. That’s lower than the current $3.05 expectations, but shares seem to be rallying after last week’s sell-off, so other investors see the value here as well. Continue to buy CTB on dips under $29. Due to the Chinese buyout, I am lowering my target to $33.

Staying in Touch

Between the market action and earnings season ramping up, it’s a busy time here in Value Authoirty! I’m working hard on some new features that will help us stay on top of all the news that I hope to share with you soon. In the meantime, I’ll be in touch with Flash Alerts if we ever need to make a quick move and you can always send me your questions or comments at valueauthority@kramersgamechangers.com!

Sincerely,

Hilary Kramer
Editor, Value Authority

P.S. I hope you’ll join me and 40+ of my fellow financial experts at The World MoneyShow in Toronto, October 16-18. I’ll be sharing my insight on how to position for your portfolio for profits in the year ahead, including value and options plays. Click here to register for free!