Friday, May 31, 2013
Along with the rest of the consumer discretionary space, retailers have been among the market leaders so far in 2013.
Consumer spending has been surprisingly resilient despite the slow growth in the economy, and the market is apparently betting that the trend will continue.
The resurgence in housing, of course, has played a major role in the growth in retailing. While companies like Home Depot (a name that Merrill still likes) are direct beneficiaries of improving home sales, other companies also indirectly benefit from improving consumer confidence.
Yesterday's meeting featured three of Merrill's three retailing analysts: Lorraine Hutchinson (specialty realty and department stores), Denise Chai (hardline retailers), and Robert Ohmes (apparel, footwear, and food retailers).
The story they told was somewhat mixed. Although each featured a few stocks that they particularly favored, they were largely lukewarm on the majority of companies they follow.
Part of the problem, I think, is that many of the companies have had a very strong run over the last year. Although there were a few exceptions, valuations on many of the stocks only make sense if you believe that the second half of 2013 will see a pick-up in economic growth.
I thought I would highlight a couple of the ideas I heard.
This has been a "home run" pick for analyst Lorraine Hutchinson, who has been bullish on Macy's for at least a couple of years.
Management has been able to maintain margins through a number of initiatives, including their "omnichannel" approach which combines traditional retailing with eCommerce. Although the company does not officially report sales channels, Lorraine feels that almost 45% of its sales comes from the internet, making the company one of the largest on-line retailers.
Trading at less than 12x earnings, Lorraine thinks that Macy's has become the best run department store in the U.S.
Lorraine also likes the fact that management is committed to increasing shareholder returns either through stock buybacks or dividend increases.
Lorraine's price target of $52 offers only modest upside from current levels, since M is trading at around $49 a share. However, I got the sense that she is leaning towards rising her target over the next few months.
This was analyst Denise Chan's top pick.
Although it is one of the leading global appliance manufacturers, Whirlpool is only followed by nine Wall Street analysts, which is a pretty small group for a $10 billion company. In Denise's opinion, this represents an opportunity.
Appliance sales follow new home sales, which have been booming. Denise feels that the improvement in housing will continue, and WHR will be the beneficiary, since it has a 40% to 45% market share of the U.S. market.The stock trades at less than 10x her 2014 earnings estimate, and pays a 1.7% dividend yield.
The key to the WHR, in my opinion, is the significant improvement in operating margins that Denise is modeling in her earnings projections. She thinks that WHR operating margins could reach by 9.5% by 2015, which would represent more than a doubling from 2012 levels. Denise feels this is achievable, since the company has been aggressively wringing out costs and closing older facilities that are less efficient.
Denise has a price target of $140 for WHR, which would offer a pretty reasonable gain from today's price of $129.
Thursday, May 30, 2013
Although the market has rocketed almost +17% higher so far this year, the leading sectors has been those areas that are normally considered "defensive".
Health care (+25% YTD); Consumer Discretionary (+20%) and Consumer Staples (+17%) have led the market for the first five months of 2013, while Technology (+10%) has brought up the rear.
This year's market action reflects the continued skepticism about stocks that pervades the thinking of most investors. Many investors are buying stocks for their dividend yields and presumed relative safety, and ignoring underlying fundamentals.
This has driven valuations on many slow-growth companies to levels not seen for many years. On the other hand, faster growing companies that offer meager payouts are being shunned as too risky, despite being priced very modestly relative to their earnings growth.
Global equity strategist Savita Subramanian of Merrill Lynch put out a piece this morning noting how stretched the price/earnings multiples have become in several sectors (I have added the emphasis):
Low beta, high yielding stocks are trading at near record valuations to their higher beta, lower yielding counterparts. Utilities has been trading at the highest relative forward P/E that we have seen in at least two and a half decades....low beta stocks have been trading near a 10% premium to the market, and have eclipsed high beta stocks's valuations for the last 11 months, the longest stretch we have seen in the history of our data (from December, 1986).
In other words, investors favoring a conservative style have been able to "have their cake and eat it too"; they have enjoyed high dividend yields and good relative performance from a group of stocks that historically would lag the market that has rallied so strongly.
So what happens from here?
Here's what Savita thinks:
Another common misconception by investors is that the highest dividend yield stocks will offer the best hedge against losing money, because even in a down market, one can clip the coupon - and the higher the coupon, the better the downside protection. We have repeatedly pointed out to investors the "Quintile 2" phenomenon - that the second tranche of stocks by dividend yield actually offer far more attractive risk to reward characteristics than the highest yielding stocks. Stocks that pay the highest dividend generally have higher payout ratios and lower growth, and those are less likely to grow dividends. And many stocks migrate into high dividend yield territory from falling prices, and these stocks actually are more likely to cut their dividends than to retain or grow dividends.
Savita's work indicates that this year's unusual market action has created numerous buying opportunities in areas like financials, industrials and technology.
On the other hand, she would be looking to move out of telecommications stocks, as well as REITs, where the risk/reward seems unfavorably skewed.
Wednesday, May 29, 2013
For the twelve months ending April 30, 2013, telecommunications stocks have been on a tear.
The group - which is mostly just two stocks, Verizon and AT&T - rose by nearly +23% over the past year. Not only were investors cheered by the recent strong growth of wireless, but both stocks paid very attractive dividends (over 4%) which was very alluring for many investors.
I have never been a big fan of the stocks. Both companies have huge cost structures; large pension obligations; and very expensive health care obligations to their retirees. Moreover, the product they offer is fairly commodity-like; while service is important in choosing a wireless carrier, many people are driven by cost. Finally, the wireline business has been dropping like a stone in recent years; most people under the age of 30 do not even get a phone installed in their home.
So it goes without saying that I missed the move in telecom stocks over the past year.
Recently, however, the stocks have been weak, and I have been wondering whether a buying opportunity was developing.
I had the chance to talk yesterday to Michael Rollins of Citicorp yesterday. Michael is a highly-respected telecom analyst, and has been consistently among the top vote-getters in the annual Institutional Investor survey.
In general, Michael did not disagree with my overall lukewarm view of the stocks in his group. Revenue growth has been a meager +1% to +2% a year over the past few years, and there is little likelihood that this will accelerate any time soon. With the weakness in wireline, and the price-sensitive nature of the wireless business, Michael agreed with my assessment that it is hard for the industry to create value for shareholders.
That said, Michael did feel there were other ways other than organic growth for the stocks to work. First, there are numerous restructuring opportunities in both companies that could result in significant cost savings and bottom line improvements. Second, the companies could try to figure out new ways to drive top line growth either through promotions or price reductions. And, third, there are numerous smaller telecommunications companies that could still be acquired that could be immediately accreditive to earnings.
Michael's favorite stock is Verizon. There was a rumor that Verizon was going to offer Vodaphone $100 billion (!) for the part of Verizon Wireless that the European company owns. Although I gulped at the numbers involved, Mike said that their analysis indicated that it was very doable, mostly because of today's very low interest rates. He felt that if Verizon were able to convince Vodaphone to sell it would be a +20% boost to earnings in the first year.