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5 stocks ready to ring in 2006
The year-end rally has been strong, but looks ready to fade. As investors dump hot technology and consumer stocks, corporate spending will drive the new winners.
By Jim Jubak
Now what? We're within shouting distance of a change in market leadership. If you're looking out even six months, the time horizon of my weekly picks for CNBC, this isn't the time to chase the winners in this rally but to look ahead to the first half of 2006.
I think it's time to think about taking some of the profits from this end-of-the-year rally in the technology and consumer sectors and putting them to work in the stocks of companies that produce goods and services for corporate customers.
The stock market is in the midst of one of its traditional year-end rallies.
Leading the way have been technology stocks such as Marvell Technology Group (MRVL, news, msgs), up 19% in the last month, and Komag (KOMG, news, msgs), up 28%; and consumer stocks such as Amazon.Com (AMZN, news, msgs), up 22%, and Williams-Sonoma (WSM, news, msgs), up 12%.
Time to look ahead
But that's old news, even if this rally does have another three to six weeks of life left. You'll find the new news -- the news that's likely to drive the stock market in the first half of 2006 -- in a number that came out on Nov. 29. Orders for durable goods -- that's stuff like airplanes, construction equipment, and production machinery -- climbed 3.4% in October. That's a huge rebound from the 2% drop in September. Orders for non-defense capital goods -- an indicator of investment by companies -- was even better, climbing almost 7% in the month.
Related news and commentary on MSN Money
Business investment, rising at a strong 10% annual rate over the past two years, looks like it will keep going, and maybe even pick up speed as we go into 2006.
That's important, because the trends driving the current end-of-the-year rally are running out of steam.
The technology stock rally at the end of the year is driven by seasonal trends. The fourth quarter is always the strongest quarter for earnings in this sector -- which sends stocks higher after the seasonally weak second and third quarters. But first-quarter earnings are often a letdown after fourth-quarter numbers. Stocks that rally in December on projections of fourth-quarter earnings can wind up looking pricy in light of January's projections for first-quarter results.
The consumer sector, another pillar of this rally, is also running out of fuel. The real estate boom -- in housing prices and in home refinancing and home equity loans -- has made up for very slow income growth and a huge surge in energy costs. But housing prices are now leveling off, which means that consumers won't be able to increase their borrowing against the value of their real estate holdings in order to keep spending.
Corporate sector to the rescue
That leaves the corporate sector to keep the economy chugging along. Fortunately, the sector is up to the job. Balance sheets are in good shape -- clearing the way for more capital spending. Profit margins are solid after the cost-cutting of the last few years. And demand, even with the possibility of a slight retreat in consumer spending by U.S. consumers, looks good in 2006. Good enough at least to lead companies that have been reluctant to spend on expanding capacity or adding new equipment for the last few years to put a bit of those profits to work. That's especially true when the capital spending buys equipment or services that can help lower costs.
5 picks for 2006
In my regular weekly appearance on CNBC's "Morning Call," I picked these three stocks for a market rotation in 2006 toward companies that serve the corporate customer.
Middleby (MIDD, news, msgs) fits my capital spending theme perfectly. The company is making hay from a cyclical upswing in the restaurant sector, as customers are ordering new cooking equipment to replace aging gear. Because Middleby has designed its new product lines to cut labor and to save energy, restaurant owners can cut their operating costs with this capital investment. Middleby's new conveyor oven, to be shipped in 2006, reduces energy costs by 30% or more while cutting cooking time by 25%. Middleby has been able to cut its own costs this year, pushing gross profit margins up 2.7 percentage points in the quarter that ended on Sept. 30, despite increases in steel and energy prices. Wall Street projects earnings growth of 34% in 2005 and 13% in 2006. The stock currently trades at 20 times projected 2005 earnings per share and 17 times projected 2006 earnings. Our StockScouter rates the shares a 7 out of a possible 10.
Terex (TEX, news, msgs) reported a third quarter that bodes well for the company's performance in 2006. The construction segment reported a 15% gain in sales, with a 0.5 percentage point improvement in profit margin. The crane segment grew sales by 8% and margins climbed by 1.4 percentage points. The materials and mining segment saw 35% sales growth or 18% excluding sales added by the company's acquisition of Reedrill. Sales of Terex's aerial work platform climbed by 57%, thanks to strong demand in the rental market. Operating margins climbed by almost a percentage point. The only disappointment came in the road-building and utility segment, where sales grew by 4% and the company recorded a small operating loss. Even there, Terex should be able to count on improvement in 2006 thanks to federal highway construction spending. The stock now trades at 14 times projected 2005 earnings per share and at 11 times projected 2006 earnings. The Wall Street consensus sees earnings growth of 36% in 2006. Our StockScouter rates these shares a 10 out of a possible 10. (Caveat: Terex is in the middle of an internal and Securities & Exchange Commission accounting review of its financial statements for 2000-2004. I don't think these will be an issue for the stock in 2006, as the company has promised its lenders to complete the review by February 2006. That's my opinion, but investors should do their own due diligence.)
Canadian National Railway (CNI, news, msgs) isn't a producer of goods for corporate customers; instead it's a service company for these customers. Its traffic mix is slanted toward heavy, bulky raw materials and finished goods that are best sent by rail. That is likely to produce volume growth in the mid-single digit range, according to management. That doesn't set Canadian National Railway apart from the rest of the sector but this does: Unlike almost all of its competitors, Canadian National still has room on its system for lots more traffic. That should enable the company to pick up more than its share of growth in coal shipments, for example. Further out, Canadian National should see increases in intermodal traffic (containers that travel on trucks, rails, and then ships) with the completion of its Prince Rupert port in British Columbia in the second half of 2007. That will give the railroad North America's closest port to Asia by about 30 hours' sailing time. The stock now trades at 18 times projected 2005 and 15 times projected 2006 earnings per share. Wall Street estimates earnings growth of 35% in 2005 and 16% in 2006. Our StockScouter rates these shares an 8 out of a possible 10.
And, as always, I have two "exclusive" picks for readers of CNBC.com on MSN Money.
General Cable (BGC, news, msgs) is up about 9% since I first recommended it on July 13 and up 3% since I added it to Jubak's Picks on Sept. 9, 2005, and I think it's got an even better future ahead in 2006. Want to send electricity from here to there? General Cable makes the big wires that let utilities do just that. The energy division, which accounted for 36% of revenue in 2004, saw revenue climb 20% in the third quarter on strong demand from utilities upgrading their transmission systems. Want to move electricity around an automobile or some other product? General Cable's flexible power cords do just that. Revenue in the industrial segment, which made up 37% of sales, climbed 7% in the first quarter. Want to move voice and data over copper cables or optical fiber? General Cable makes the cable and the connectors to do just that. Overall revenue grew by 11% in the first quarter. That growth in sales translates into even better growth in earnings thanks to cost-cutting and price increases that drove operating margin to 5.5% in the third quarter -- that's the best level in four years. The stock now trades at 19 times projected 2005 earnings and at 15 times projected 2006 earnings per share. Wall Street analysts project earnings growth of 118% in 2005 and 26% in 2006. Our StockScouter rates these shares a four out of a possible 10.
Norfolk Southern (NSC, news, msgs) has something special going for it: Its main geographical competitor, CSX (CSX, news, msgs), is just plain terrible at running a railroad. In the third quarter, CSX, which had been making progress at getting its trains running on time, took a step backward: Its train speeds fell by 2% from the same period in 2004 and the number of re-crews per day, an important measure of labor efficiency for a railroad, increased by 1.6%. The line's on-time record did improve but it remains stuck well below the 50% level at just 43%. Any wonder then that Norfolk Southern, with a proven ability to get stuff where it needs to be on time, has picked up volume at the same time as it's been able to raise prices. Carload volumes grew by 1.7% in the third quarter and prices jumped by almost 14%. The result: a 16% increase in railroad operating revenues. Earnings climbed 23% in the quarter. The stocks now trades at 16 times 2005 and 14 times 2006 projected earnings per share. Wall Street analysts see earnings growing by 25% in 2005 and 14% in 2006. Our StockScouter rates these shares a 9 out of a possible 10.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak did not own or control shares of any of the equities mentioned in this column. He doesn't own short positions in any stock mentioned in this column.
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