2 Spinoff Stocks with 40% Upside or More

Back in February, I explained how corporate spinoffs (when a company separates, or “spins off” a division into a separate company) have solid track records of beating the market.

I’m usually on the lookout for investment opportunities that pay off within 12 to 18 months, but two of the three companies I profiled in February are already outpacing the market. Sara Lee’s (NYSE: SLE) stock is up close to 15%, while Fortune Brands (NYSE: FO) is up a couple of percent. The S&P 500, meanwhile, is roughly flat during the past six months. My other pick, ITT Industries (NYSE: ITT), has yet to pan out, but like Fortune Brands, is still in the process of splitting into three publicly-traded companies. I still like its prospects.

Below is an overview of three firms that have already been spun out to shareholders. I also like their prospects during the next couple of years and see potential upside between 40% and 60%..

1. AMC Networks
Date of spinoff: July 1, 2011
Market Capitalization: $2.6 billion
P/E: 22

AMC Networks (Nasdaq: AMCX) is one of the most recent spinoffs to trade on the market. On July 1, it was spun off from New York cable giant Cablevision Systems Corp. (NYSE: CVC). Cablevision has had a rather steady campaign of spinning off businesses so that the market better understands and realizes the value of its many cable and entertainment assets.

The AMC cable channel is riding an impressive viewership rise with hit shows including Mad Men and Breaking Bad. However, AMC is just part of the story. The firm also owns other channels, such as IFC and the Sundance Channel, both of which focus on independent shows and films, as well as We tv, which specializes in entertainment for women.

The market is just getting familiar with AMC Network, and this represents a unique opportunity for individual investors to get ahead of the game. Right now, analysts project 2011earnings of $1.66 per share for 2011 on revenue of nearly $1.2 billion. However, this understates AMC’s cash-generating potential. Media companies usually have high amortization and depreciation expenses because it is very expensive to start a cable channel and develop early programming. Running and maintaining the business is much less costly after initial spending.

In AMC’s case, last year’s net income was only $118 million, but free cash flow was roughly $248.8 million, or almost $3.50 per share. This translates to a very reasonable free cash flow multiple of 10.3, quite a different story than the stock’s stated price-to-earnings (P/E) ratio of more than 22.

2. Huntington Ingalls Industries
Date of spinoff: March 31, 2011
Market Capitalization: $1.6 billion
P/E: 9.3

Huntington Ingalls Industries (NYSE: HII)
is a recent spinoff of defense giant Northrop Grumman (NYSE: NOC) in March. The company builds large ships, and its main clients are the U.S. Navy and Coast Guard. The company lays claim to being the only builder of nuclear-powered aircraft carriers as well as other unique amphibious assault vessels and ships for the Coast Guard. As a result of the deep pockets of its clients, Huntington’s sales are stable and predictable.

The flip side is that Huntington is a relatively slow grower. This was a primary reason Northrop chose to spin it off. But as history shows, Huntington should be able to boost growth and overall profitability as a stand-alone company. Huntington plans to do this by strengthening its existing product line and finding new business, such as by using its nuclear expertise to find clients outside of the U.S. Navy.

Huntington posted 2010 sales of $6.7 billion and net income of about $95 million, or $1.60 per diluted share. And as with AMC Networks, free cash flow generation is higher than reported profits. Last year, free cash flow was about $168 million, or nearly $3.40 per diluted share. 
Analysts project a similar level of sales for the coming year but also a big boost in profits to almost $3.60 per share, or nearly double last year’s levels.

This puts the forward P/E in very reasonable territory below 10. Like AMC, Huntington is starting out with a heavy debt load (about $1.8 billion) but plans to pay it down. Overall, a modest boost to sales combined with cost cuts and other efficiencies newly formed spinoffs are capable of implementing could easily boost cash flow generation by a significant clip.

Action to Take –> AMC Networks has potential to grow sales in the double digits going forward, with profits improving at a similar pace. Cablevision placed a heavy debt load on AMC Networks as part of the spinoff, but the stock could rally 40% or more to $51 per share based off of a couple of years of double-digit cash flow growth and a free cash flow multiple that eventually expands to 12.

Huntington’s business is a slow-grower, but it can use cost-cutting moves to leverage modest sales growth into what could be double-digit annual profit gains. With three years of double-digit cash flow growth and a cash flow multiple that rises to 12, the stock has the potential go above $50, which is 50% above current levels

P.S. — We’ve just identified six surprising events that could break your portfolio wide open in 2011. Knowing these pivot points in advance lets you focus your investing strategy like a beam of light in the dark… and make a lot of money in a hurry. Get them free by simply watching this video presentation.