Investing

Stocks Which Could Double In Recession: An Industry Overview

It is not uncommon during a serious recession for the shares of many public companies to drop. 24/7 Wall St. has assumed, for the purpose of finding stocks which could rise sharply, that the current downturn will last from the second quarter of this year until the second quarter of 2009. We have gone though the stock market by industry looking for either sectors which have been damaged by present circumstance but could come out of a slump as a recession ends. We have also evaluated areas of the business world which tend to do well whether the economy is doing poorly or not.

Home Builders.. Among the most unlikely candidates for a big rebound are housing stocks, but, one of the hallmarks of a recession moving toward a recovery is first stability and then a rebound in home prices.

Wall St. could make the case that home-building stocks have nowhere to go but up, at least for those which remain independent businesses. The three strongest stocks in the sector are probably Pulte (PHM), KB Home (KBH), and Lennar (LEN). KBH and PHM are off over 45% during the last year and Lennar is off over 55%.

Home prices will drop between 15% and 20% from their peak in 2006, depending on which analysis investors use. The advantage that these three companies have is that they build homes expensive enough that they are not likely to be victims of subprime mortgage problems or the foreclosures which tend to be highest in low income areas.

KBH is a good example of what has happened across the industry. In the last quarter, the company lost $268 million. Sales fell 43% to $794 million. As a reaction to these numbers, KBH has sharply cut costs. The company still has over $1.3 billion in cash. Home-builders have, in many cases, been able to restructure debt payments and sell off some assets. The larger companies in the industry have relatively sound balance sheets.

The most likely set of circumstances for driving up the value of these three stocks short-term is aggressive intervention by the US government through more liberal practices for lending at Fannie Mae and Freddie Mac, new FHA practices, or Congressional action to put a moratorium on foreclosures for middle class as well as lower end homes.

Pulte traded at its current levels in mid-2003, before the three year run-up in housing. Can it move from $15 to $30 before the end of the recession? A reasonable housing market can make it a double.

Beaten-Down Financials.. While some financial stocks like JP Morgan (JPM) and Bank of America (BAC) have weathered the current market crisis fairly well, three of the big names in the industry have been driven down between 45% and 55%. Citigroup (C), Lehman (LEH), and Merrill Lynch (MER) had the largest exposure to mortgage-related paper and there have been legitimate concerns about whether they would survive. The case for these stocks moving up is based on the notion that most of the big write-offs in the sector will be over by the end of Q2 08 and that these companies will start to show positive earnings in the third quarter. If the firms have been aggressive in their write-downs and have raised adequate capital, they have a very strong chance of rebounding. Citigroup’s recent earning report did not indicate that the bank was in any danger and the shares traded up.

Another key to the future of the banks and brokerages is their ability to lay-off large numbers of people in hard times. Citi is talking about cutting 25,000 or more jobs. Merrill and Lehman have already cut a great many. Over the last few weeks the CEOs of Morgan Stanley (MS), Lehman, UBS (UBS), and Merrill Lynch have all said, in one way or another, that the worst part of the global crisis is over.

These three companies have good leverage if they cut costs far enough. The head of Citi recently told the Financial Times that he can take 20% of the cost base out of the conglomerate. If he is right, a fairly modest improvement in revenue should give the bank reasonable if not remarkable earnings in the second half of the year. Citi and Merrill have brought in new CEOs. They have a chance to engineer unprecedented turnarounds which gives them mandates to completely reorganize their companies.

E*Trade  (ETFC) is the online discount brokerage firm that lost its way by offering  mortgage products, getting too far into banking operations.  Even though it sold off much of its problems to Citadel, the company still is disclosing that it still has financial asbestos and it will potentially be paying for this for several years.  Its losses were wide and its revenues were shy, but the long and short of this company is that its "survival" is no longer in question.  How the company was able to continue opening new accounts and how it didn’t lose its total customer accounts is a testament to a business model success, and its catchy TV advertising campaign seems to have helped.  This one was truly deemed as being "at-risk of implosion" a few months ago.  ETFC also reported fairly positive firm quarter numbers

Healthy Living. One sector that goes out the door when times get tough is the "healthy living" sector.  When smoking stays high and drinking goes up, what else would you expect?  But people can only live off of cheap food, beer, and tobacco for so long. The second that things start looking better economically these stocks should have already started recovering.

NutriSystem Inc. (NASDAQ: NTRI) is an extremely well-known brand.  The company’s stock started seeing trouble before the economy fell off the cliff.  Its television commercials may irritate many watchers and its ad budgets have gone up to avoid a worse drop off.  This stock has been battered and the major growth period appears to be behind the company.  But its forward P/E ratios are actually under 9 for both 2008 and 2009. There is one other aspect to this company that many people actually do not take into consideration: you can actually live off of their food for cheaper than fast food.  An intro package for the first 28 days of NutriSystem for first time buyers currently runs $293.72 for women and $319.95 for men.  There is no free lunch out there, but to get that much food for that little may appeal to those on a strict budget even more.  At $20.01, this stock could double and then actually almost double again before going over its 52-week high.

Unitedhealth Group, Inc. (NYSE: UNH) has not enjoyed 2008.  As a health insurance provider, there are many risks to the model.  The sector has been pounded with earnings warnings; there is an election year with the threat of a potential trend toward some sort of universal health care mandates, and rising medical costs when insurers are under pressure to keep renewal rates low.  But there is a silver lining at Unitedhealth.  If the government does go in the direction of universal coverage it will almost certainly have to be via the private sector; Unitedhealth already is in that door.  Businesses have also cut back on certain premium plans, but that won’t last forever as the economy recover and employers once again have to offer better benefits.  With 70 million Americans served in some form or fashion, with its Medicare Plan D, and with its AARP contract it seems that some Americans already government health care.  Earnings come out late April with prior guidance for 2008 at $3.95 to $4.00, and analysts calling for $3.85 in 2008 and $4.35 in 2009.  At $37.25, that is a forward P/E of well under 10 and in a sector that many investors have paid much higher multiples for.  52-week trading range is $33.57 to $59.64.

Casual Dining Out. What is one of the first things that the consumer cuts back on when they bring their spending down?  Casual dining.  The good news is that this trend never lasts forever, and in cities like New York, Chicago, Houston, and other urban areas, the average adult eats out more than they eat in.  Why is Darden Restaurants (NYSE: DRI) not on this list? It has already recovered some 70% from lows.  As private equity firms went on a casual dining chain buyout spree, these have been shown to be steady earning companies through time.

One huge player that has felt the pinch is Brinker International, Inc. (NYSE: EAT).  This compnay owns major food chains such as Chili’s, Romano’s Macaroni Grill, On The Border Mexican Grill, and Maggiano’s.  As of December, 2007, it owned or franchised some 1,800 units in the U.S. and abroad, with some 100,000 employees and $4 Billion in sales.  The company has simultaneously been hurt by rising food costs at the same time that many consumers have been paring down their dining budgets. But with household brands that Joe Public likes to go to with regularity, this $1.9 Billion market cap might be a cheap franchise to acquire if private equity ever wants to go back into billion-dollar food deals.  Its below-market and below-peer forward P/E ratios of 13.2 for 2008 and 11.2 for 2009 also make this attractive for a steady food growth stock when consumers have fully recovered and gone back to normal habits.

Retail Apparel. The current economic environment is bad for most retail names, but it particularly hits mid-level and upper-middle level retail giants that have to still maintain inventory while many of their customers go discount shopping at clearance stores or at smaller chains.  While clothing expenses can be pared down for some time, it’s highly unlikely that eighteen months out we’ll be in an economy of loin cloths and flip-flops.

Macy’s, Inc. (NYSE: M) has had its share of hard times lately.  As its department stores are massive and as inventory level requirements are more than demanding, the company is simultaneously closing several stores, retooling its management ranks, and slowing its new store openings.  Its brands are also in the middle to upper-middle sector of retail, but aren’t in the lowest end, making it one of the more economically torpedoed stocks in mall-based retail and apparel.  Wall Street will likely give the company a pass now, like it did last quarter, as any great earnings for 2008 will be hard to imagine.  JPMorgan just downgraded this one this week to an Underweight rating and even called it a value trap, but the analyst’s under-street targets for earnings are still an under-market forward P/E of under 13 for 2008 and 12 for 2009.  A double from current levels would not even take the stock to new 52-week highs.  After the retail giants form a bottom, they just about always come back with a vengeance.

The other retailer that has seen its share of punishment in the mid-level apparel retail giant store formats is J.C.Penney Co., Inc. (NYSE: JCP).  Shares have been butchered more than 50% as consumers have dialed down spending.  The company has even launched its brand-new Ralph Lauren centers in the stores just in time to catch its customers when they were maxed-out and going to discounters.  But the company is still thought of as well-run with an entrenched team. Analysts have slashed and burned earnings projections.  Since estimates have been taken down so much, it trades at forward 2008 P/E ratios of 11.6 and a tad under 10 for 2009.  The other potential saving grace is that if there is one company in the group that was rumored to have private equity interest, it was J.C.Penney.  At one point, it was even thought that management and its employee pension plan would seek to take it private.  This one won’t turn around overnight, but with it in the lower part of its $33.27 to $83.64 trading range it looks like much of the bad news has been taken out of the stock.  A double from today’s levels would not even have shares at 52-week highs.

Douglas A. McIntyre and Jon Ogg

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