|  | | Price | 63.190 | | | Change | +0.690 | |
Research Wizard
Add to MSN Stock List
Message Board
|  | | Price | 18.590 | | | Change | +0.280 | |
Research Wizard
Add to MSN Stock List
Message Board
|  | | Price | 27.850 | | | Change | +0.290 | |
Research Wizard
Add to MSN Stock List
Message Board
Related Resources
Look up the latest Market Summary
Track your investments on MSN Money
Who owns your favorite stock?
Check how our StockScouter tool ranks your stock
Company Focus
Recent articles:
• Our spies decode the earnings season, 5/14/2003
• Back a winner in the TV revolution, 5/7/2003
• 15 stocks you can buy for 'free', 4/30/2003
More...
| | Company Focus
5 premium stocks at discount prices
These large-cap companies have suffered blows and are trading at a discount to the market. But each has the potential to grow twice as fast as the S&P 500 in coming years, says one money manager.
By Michael Brush
Like most individual investors, youre probably intrigued by the recent stock-market strength but reluctant to pull the trigger -- even on a dip like we saw early this week.
If so, heres a potentially safe way to tiptoe back in. Stock up on some well-known fallen angels -- stocks that now trade at a discount to the market even though the companies are growing twice as fast as most. This disconnect suggests shares in these companies will rise as they reclaim the premium they once had -- and still deserve.
Five top candidates are: MBNA (KRB, news, msgs), Pfizer (PFE, news, msgs), Cardinal Health (CAH, news, msgs), PepsiCo (PEP, news, msgs) and Home Depot (HD, news, msgs).
Money manager Mark Petrie, of Hokanson Capital Management in Solana Beach, Calif., recently added these (and other) names to his portfolio because they have a couple of things in common. On a price-to-earnings basis, each trades near or below the levels of the S&P 500 stocks. But over the next few years, these five stocks should grow about twice as fast as the companies in the S&P 500, which are expecting 6% to 7% earnings growth.
There have only been a few times in last seven years where the highest quality companies were selling at no premium to the market, says Petrie. And every time it has been a good opportunity to buy them.
Next, these are quality companies -- a squishy concept to be sure, so lets define it. Quality means they are recognized brand-name businesses with a better return on equity than the S&P 500 stocks (see chart), lower debt levels, and medium-term earnings growth thats superior.
Companies like these should be selling for a 30% to 50% premium to the market, and they normally do, says Petrie. But at each company, some sort of challenge has made it clear earnings growth will decline from levels seen in the late 1990s. Its not clear how far growth will sink. But its unlikely growth will fall to the S&P 500s 7% level. Today investors are still trying to figure out how fast they will grow, so they are sitting on the sidelines, says Petrie. And it is an opportunity to buy companies like these.
Heres a quick look at the five fallen angels.
MBNA
Worries about rising personal bankruptcies and unemployment helped push shares of MBNA -- the nations biggest independent credit-card company -- down to $13 in March from $26 a year before. The stock has rebounded to $20 in the past 10 weeks, though it fell back to about $19 this week. But MBNA still trades at a healthy 37% discount to the S&P 500. Thats odd, given that its expected earnings growth rate of 15% is more than twice that of the S&P 500. If MBNA even struggles back to a 10% premium to the S&P, that would put its shares at $33, for a 68% price gain.
To be sure, a weaker economy could do more damage to the finances of cardholders, forcing MBNA to write off additional bad debt. And thats the main thing that has investors worried. But the recent trend is in the other direction. Outright losses -- not to mention delinquencies, a leading indicator of trouble -- have both declined for the past three months at MBNA. MBNA says it expects this improvement to continue throughout 2003. One factor in MBNAs favor: It sticks with prime borrowers. The average cardholder has a family income of $71,000 and has an 18-year record of paying bills on time.
Besides, whether the credit market is getting better or not might not matter because MBNA has been taking share from other credit-card companies and banks, says Petrie. Customers are drawn to MBNAs affinity programs, which put the logos of cardholders' colleges or clubs on the Visa and MasterCards it issues. Thats one reason MBNAs card growth in the United States is nearly three times industry growth. MBNA is also branching out into the United Kingdom and Europe.
Pfizer
The world's largest pharmaceutical company by sales, Pfizer has an impressive bench of blockbuster drugs. Top-selling products include Lipitor, which lowers cholesterol; Viagra, for impotence; the antidepressant Zoloft; Celebrex, for arthritis; and Norvasc, a drug for high blood pressure.
Despite this advantage, several issues are spooking investors. Many of Pfizers drugs are going off patent around the end of the decade, which means competition from generics could be in store. And blockbusters like Viagra face competition from similar drugs under development at Eli Lilly (LLY, news, msgs), Icos (ICOS, news, msgs) and GlaxoSmithKline (GSK, news, msgs). Meanwhile, patent challenges threaten the juicy margins.
All these factors have investors wondering about Pfizers future, especially since the days of rapid-fire drug approvals by the Food and Drug Administration in the late 1990s seem like history. So Pfizer shares have slipped to 4% below the earnings multiple of the S&P 500, even though Pfizers earnings-growth rate is twice that of the S&P.
Todd Lebor, equity analyst for Morningstar, the research company, believes that three factors will sustain Pfizers 13% earnings growth medium term, enticing investors eventually to restore a premium of 30% to the market. That would drive Pfizer shares up to around $44 from recent levels near $33.
First, people are ignoring the huge product pipeline they are developing, says Petrie. Pfizer leads the industry in research and development. Second, Pfizers respected sales force and vast distribution network make it the partner of choice for cash-starved biotech companies looking for a marketing alliance. This will continue to add to Pfizers pipeline, according to Lebor.
Finally, Pfizer has lots of cash and a strong balance sheet. So we may see more buyouts of other pharmaceutical companies. Pfizer has a proven track record with recent purchases of Warner-Lambert and Pharmacia. These kinds of deals put more blockbusters into the Pfizer pipeline. They also help Pfizer realize higher profits through savings from cost-cutting and increased bargaining power with health-maintenance organizations. Morningstars Lebor thinks the stock is a buy anywhere below $31.
Cardinal Health
Worries about a slowdown in Cardinal Healths drug-distribution business have sent investors running from the stock in the past six months. Since October, Cardinal Health shares have fallen 20% to $57 from $71, while the S&P 500 index has increased 20%. At these levels, Cardinal Health trades at an 84% discount to the S&P 500, well below the 50% to 70% premium it used to carry.
But several factors should support 15% to 20% annual earnings growth in the medium term, restoring some sort of premium to Cardinal Health shares. First, Cardinal Health has been building its presence in areas away from drug distribution. The company now gets just about half its profits from drug distribution, down from 75% in recent years.
Outside of distribution, Cardinal Health has a business that repackages and reformulates pharmaceuticals so that the products can be pitched differently to consumers. The company distributes hospital supplies and medical devices. It offers inventory tracking systems to hospitals, and computer systems for pharmacies. They have really diversified quite a bit, says Petrie. But Wall Street is still obsessed with the distribution business and worried that it is slowing.
The company also has a clean balance sheet, with below-industry debt levels and solid free cash flow. Management has a strong track record of using that financial muscle to branch out by purchasing leaders in health care and then integrating them seamlessly. All that is worth a premium to the market, says Petrie. He reckons that Cardinal Healths superior earnings performance can help it regain a 30% premium to the S&P 500. If so, that would push shares back up to the upper $80 range, from recent levels of around $58.
PepsiCo
A slowdown in growth at competitors such as Coca-Cola (KO, news, msgs) and Kraft Foods (KFT, news, msgs) has investors worried about PepsiCo, too. So theyve knocked Pepsi shares down to just an 8% premium to the S&P 500. But several factors should help sustain Pepsis 11% medium-term earnings growth and move the companys stock back toward its usual 40% premium to the S&P 500.
First, even though PepsiCo is best known as the No. 2 soft-drink producer behind Coca-Cola, the company actually has a diversified lineup of products. This helps it power through tough times. PepsiCo gets just 22% of its revenue from drinks such as Pepsi-Cola, Mountain Dew, Slice, Gatorade, Tropicana and its Aquafina bottled water. The lions share of revenue comes from sales of popular snack foods such as Fritos, Doritos, Tostitos, Lay's, Ruffles and Cheetos. A wide array of popular brands like these leaves the company more room to boost sales by creating spin-offs of these names, like premium or healthier versions.
Next, PepsiCo has lots of free cash flow, which is expected to reach more than $3.1 billion in 2003. This means the company can reduce interest costs by paying down debt. Or it can buy back shares. Another option is to make acquisitions and boost profits by cutting costs. If economic growth continues to be moderate, as Petrie expects, investors will find the steady growth of a consumer-staples company like PepsiCo more attractive, driving up the shares. It makes sense to expect PepsiCo to approach its old 40% premium to the S&P 500, which would drive PepsiCo shares to the $57 range from recent levels of $43.
Home Depot
What made matters worse was that chief rival Lowes (LOW, news, msgs) prospered all the while Home Depot suffered, says Morningstar analyst Tom Goetzinger. Lowes enjoyed a 42% increase in earnings and a 20% gain in sales last year. This contrast served as a wake-up call to Home Depot; the company now knows it must spruce up its aging stores and improve customer service and inventory management, Goetzinger says. Home Depot has begun using its impressive financial strength to do just that, and analysts expect the effort will start paying off in the second half of this year.
Last years weakness will make any strength in the second half of 2003 look that much better. And another round of home-mortgage refinancing around the corner will put more money into the hands of homeowners -- some of which they will use on projects around the house.
But the key to future profit in Home Depot shares lies in the markets overreaction to last years slowdown. Home Depot was growing earnings 25% to 30% a year in the 1990s, and now it is expected to see 15% earnings growth, says Petrie. Thats a big drop off the cliff, so the stock has suffered dramatically. But again, the market has overshot.
A company whose expected earnings growth of 15% is twice that of the S&P 500 seems like it should re-establish a 30% premium to the market, and thats what Petrie expects. With Home Depot stock currently trading at a 7% discount to the S&P 500, that kind of advance would drive shares into the low $40 range, from recent levels in the low $30s.
|
