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A stock hangover as big spenders sober up
As signs of a consumer pullback mount, 3 kinds of companies are particularly vulnerable: makers of big-ticket items like RVs, those who depend on buyers with marginal credit, and home retailers with high fixed costs.
By Michael Brush
Times are tough, so naturally the tough have been shopping. In fact, thats what has kept the economy afloat. A big part of the spending spree has been funded by a credit binge, however, and there are signs that the party might be winding down.
If so, investors can expect trouble at three types of consumer-oriented companies. First, be wary of companies that offer big-ticket discretionary items such as those recreational vehicles made by Winnebago Industries (WGO, news, msgs).
Next, watch out for businesses whose customers have to borrow large amounts to make a purchase even though they have low credit ratings. Prime examples include manufactured housing vendors such as Fleetwood Enterprises (FLE, news, msgs) and Champion Enterprises (CHB, news, msgs).
Finally, home-oriented retailers such as Williams-Sonoma (WSM, news, msgs), Lowes (LOW, news, msgs) and Bed Bath & Beyond (BBBY, news, msgs) have built up a fan club cheering their record profit levels in recent quarters. But the stocks could have trouble recovering from recent weakness -- or may slip further -- because those juicy profit margins will be at risk if managers cant cut costs enough to keep up with declining sales.
The signs of trouble
Before we get to more detail on these companies, heres a quick look at why some analysts think consumers may be pulling back on spending soon.
Consumers are maxing out on debt. Thanks to easy access to credit cards and home-equity loans, household savings are near record lows and monthly debt payments are near record highs, says James Paulsen, an economist and market strategist with Wells Fargo. Home-equity loans and lines of credit, for example, are expected to hit a record $1 trillion this year. Thats a 20% increase from last year. The amount of borrowing to buy those homes has been rising rapidly, too. Last year, the combined book of business for home mortgage companies Freddie Mac (FRE, news, msgs) and Fannie Mae (FNM, news, msgs) surged 20%, or $471 billion, to reach $2.83 trillion.
We may also owe foreigners too much, as well. The current account deficit, a proxy for how much weve borrowed from overseas, widened to $37.6 billion in May. Every past economic recovery has begun with a current account surplus, which leaves a lot of room for domestic investment and consumption, says John Hussman, an economist who manages the Hussman Strategic Growth Fund (HSGFX), which is up about 13% so far this year. This time we dont have the same flexibility that we typically see at the beginning of robust expansions.
Credit card defaults are rising. Foreigners aside, theres nothing wrong with lots of debt as long as people can pay it off. Recently, there are alarming signs that they cant. While credit card companies typically write off about 5% of their debt each quarter because customers cant repay, that level spiked to 9.2% in the first three months of this year. Things recently got bad enough at Capital One (COF, news, msgs) that regulators asked the credit card company to increase loan reserves. If more banks have to tighten up lending policies, that alone could hurt consumer demand, say analysts at Bridgewater Associates.
High debt levels mean any economic weakness could build on itself. The economy has had some strength because consumers have been allowing their balance sheets to deteriorate, says Hussman. But that leaves the economy vulnerable if the jobless rate creeps up. More borrowers could default, which would reduce consumer spending and reduce growth. One ominous sign on this front, says Hussman, is continued weakness in the help-wanted index, a good measure of the demand for labor.
Consumer confidence is already slipping. Thats due in part to the stock market declines. Hussman thinks you can expect more weakness because valuations still look bad. Coming out of a recession, he says, the Standard & Poors 500 index ($INX) typically trades for about nine times peak earnings during the previous boom. Despite the recent declines, the market is still at 21 times prior peak earnings -- suggesting more downside ahead.
One big risk on the horizon, says David Tice, manager of the Prudent Bear Fund (BEARX), is a sharp decline in home values. Tice believes federal policy makers -- with the help of Fannie Mae and Freddie Mac -- have done little more than create a credit-driven housing market bubble to replace the tech bubble and keep the economy going. He thinks the housing market bubble will break sooner or later, too. Not everyone agrees. But Tice is worth listening to because he spotted the tech bubble ahead of many analysts.
Even if that doomsday scenario does not play out, consumers may be running into more credit problems -- and spending less in the coming months as the economy slows. Heres who might suffer.
Winnebago Industries
This producer of motor homes popular among older vacationers has a lot going in its favor. The company is taking market share, and it has a big backlog of orders. Next quarter is in the bag, in terms of revenue, says Craig Kennison, an analyst with Robert W. Baird. Whats more, demographics are working in the companys favor. The number of people who are between 55 and 74 years old -- the prime target group for Winnebago -- will grow 34% by 2010 and 74% by 2020.
Problem is, those folks are the same ones whose retirement portfolios have been decimated by the stock market rout. Thats likely to temper their hunger for Winnebago recreational vehicles. If so, that will hurt profit margins, in part because the company just spent a lot of money to expand capacity by 30%. It will be hard to cut costs enough if sales drop. Sure, Winnebago stock has come down a lot recently. But it is still about twice as high as average, measured by price-to-sales and price-to-book, says Hussman.
Manufactured housing stocks
Companies that make trailer homes went through their own version of the go-go years during the late 1990s. They extended easy credit terms and took on too many customers with weak credit ratings. Then the producers themselves borrowed too much to build more capacity to meet the demand.
When customers started missing payments, producers repossessed trailers and put them back on the market, which added to the excess supply. There was overcapacity, and companies are sitting here with a tremendous amount of inventory, says John Buckingham, an analyst with The Al Frank Fund (VALUX), which owns shares in several trailer home producers.
To make matters worse, lenders have since been reluctant to step back in, given the disaster that played out. There are rumors that General Motors Acceptance Corp., a finance division of General Motors (GM, news, msgs), may step up to the plate. That would help the group a lot. But right now it is tough for people to get financing, and that has hit these companies, says Robert Marshall, who follows the stocks for Wachovia.
And if economic weakness hits demand even more -- or forces more customers into default -- some of these companies could get into deeper trouble.
Especially vulnerable are producers such as Fleetwood Enterprises, Cavalier Homes (CAV, news, msgs) and Oakwood Homes (OH, news, msgs), because they have high debt loads relative to cash flow. Cash flows are depressed and earnings are depressed, which makes it more difficult to service the debt, says Hussman.
Even though Champion Enterprises is in the same boat, insiders have been buying a lot of the companys stock recently, says Michael Painchaud, director of the Seattle-based Market Profile Theorems. Brokerage analysts point out the company recently bought a finance company, which should help the company ramp up lending. Trailer home producers with decent free cash flow to debt levels include Clayton Homes (CMH, news, msgs) and Skyline (SKY, news, msgs). We still think it is a growth industry over the long term, says Buckingham.
Home-related retailers
This group has come down a lot recently as players such as Maytag (MYG, news, msgs) and Stanley Furniture (STLY, news, msgs) warn of softening demand and rising inventories. But Hussman thinks several companies in the space still look overvalued -- such as Lowes, Williams Sonoma and especially Kohls (KSS, news, msgs). Earnings are somewhat vulnerable for many of these companies because it is difficult to cut costs fast enough when revenue growth slows down, he says.
He thinks others have fallen to the point where they dont look that pricey. Examples include Bed Bath & Beyond, Furniture Barn (FBN, news, msgs) Stanley Furniture, Quaker Fabrics (QFAB, news, msgs) and Home Depot (HD, news, msgs), where insiders have been buying recently.
Even if these stocks appear fairly valued down here, theyre not likely to rebound as long as investors have doubts about the consumer and the economy. Wont anything brighten the outlook? After all, the Federal Reserve board rate cuts havent done the trick.
Paulsen, the Wells Fargo economist, thinks three recent developments may make a difference next year. He cites the weaker dollar and bigger federal deficits -- which both stimulate demand -- as well as long-term market yields that started coming down earlier this year. Together, these changes should bring about some economic growth, says Paulsen. But they work with a lag.
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