Comcast Corporation (CMCSA) is a top pick as the cable and satellite TV sector stands out right now as an attractive value within the leisure and entertainment space, and U.S. large-cap media companies continue to remain broadly overweight, says Doug Mitchelson, Managing Director and Senior Equity Analyst at Deutsche Bank Securities Inc.
“We have been quite constructive on cable, where all the stocks have done well, but valuations are still quite attractive and the companies can carry a fair amount of debt leverage, allowing return of capital to also be quite favorable, driving pretty strong bottom-line growth with a fair degree of visibility given the lesser cyclicality that those businesses have,” he said.
Mitchelson says Comcast, which has been growing revenue and EBITDA in the 5% to 6% range, has been well above the average industry growth, partly due to the level of investment the company has made in the past five years, including during the recession, when others were trying to conserve capital and reduce operating expenses.
“In media, our top pick is News Corp. (NWS), where we see 11.5% fiscal 2013 operating income growth, buybacks that could total 6% to 7% of shares outstanding, and the split off late next spring of its publishing group into a separate publicly traded company, which could spark a re-evaluation of the company,” Mitchelson said.
Smaller names in the defense and aerospace industry like Precision Castparts Corp. (PCP), TransDigm Group (TDG), LMI Aerospace (LMIA), Triumph Group (TGI) and Hexcel Corp. (HXL) may beat earnings estimates on the commercial side, providing investors with better value than larger caps like Boeing (BA), says Kenneth Herbert, Senior Vice President of Equity Research at Wedbush Securities.
“At the top of my list, from an execution standpoint, I put companies like Precision Castparts, TransDigm, LMI Aerospace, Triumph Group and Hexcel. These are all suppliers to the industry that, in my opinion, from an execution standpoint, are in a very good position to continue to beat expectations and drive better margins,” he said.
Herbert also says PCP and TDG are on the top of his list for better earnings through acquisitions, and expects these names to surprise on the upside. He says the industry has not seen much multiple expansion, and earnings growth above expectations is what will drive stocks on the upside.
“In the sector right now, you need to be owning companies that are going to be able to beat earnings estimates either though better execution or through acquisitions and a robust acquisition pipeline. And I am talking more about the commercial side. Don’t get confused about acquisitions on the defense side,” Herbert said.
TiVo (TIVO) and Viacom (VIA) are expected to overcome current hurdles that are keeping their valuations low, presenting opportunities for investors looking into the entertainment space, says David W. Miller, Managing Director at Caris & Company, Inc.
“TiVo is definitely a top pick from a valuation standpoint. Right now, I’d call it $9.50 a share. The stock is basically trading at cash across NOLs, plus $3 a share for the base business, which is just a joke. I mean it’s a growing business. We’re not under any sort of secular threat to value that business at only $3 a share, and it’s a huge opportunity for investors in our point of view,” Miller said.
TiVo is currently litigating to protect its DVR technology intellectual property, and Miller expects TIVO to emerge victorious and its stock to rise. Regarding Viacom, he says VIA has a history of either turning low ratings around, like the current ones at Nickelodeon and MTV, or innovating with new content.
“We also like Viacom. We like the valuation, and everything is going really well at the company right now, with the exception of ratings at Nickelodeon and MTV, and we’ve seen this before at Viacom. Every single time they’re in a metric situation or rating shortfall situation at these core networks, they usually find a way out of it. They usually are able to develop programming that gets them out of it,” he said.
Cable companies Comcast Corp. (CMCSA) and Time Warner Cable (TWC) are expected to grow more quickly and increase their dividends faster than wireless carriers AT&T (T) and Verizon Communications (VZ), according to Philip Cusick, Managing Director at J.P. Morgan.
“Comcast, Time Warner Cable declared dividends in the last few years in the range of 1.5% to 2.5% apiece, but we expect those dividends to grow by 20% to 30% next year versus AT&T and Verizon that grow their dividend by 3% or 4%,” Cusick said.
Cusick uses free cash flow per share as one of the important metrics to value cable companies. He says that, although CMCSA and TWC are yielding in the range of 7% to 8% free cash flow yields on 2013 numbers, and that may seem expensive, these names are still attractive relative to VZ and T.
“The cable companies are doing pretty substantial buybacks, buying back their own stock. So the capital return from Comcast and Time Warner Cable is comparable to where Verizon and AT&T are, and yet they grow more quickly and they have more free cash flow generation potential than T or Verizon,” Cusick said.
LeapFrog Enterprises (LF) recently released the second generation of its children’s tablet, the LeadPad2, creating a short-term opportunity with great potential in the small-cap space ahead of the holiday season, says Nancy B. Prial, CFA, Portfolio Manager and Managing Principal at Essex Investment Management Company, LLC.
“[The LeapPad 2] is flying off the shelves, both in terms of the physical locations that they distribute through as well as the Internet locations, and we think it is a company with the right product at the right time and the right place,” Prial said.
Prial says that, even though consumer spending may be moderate over this holiday season, she anticipates the consumer to spend on children products regardless, especially on products like LeapFrog’s that have both a education as well as an entertainment value to them.
“A name that we think has great potential, particularly in the short term as we look at the upcoming holiday season, is LeapFrog. LeapFrog, as I’m sure you know, is a company that plays in the children’s toy space. They make electronic toys focused on educational products for children,” she said.
Steel-recycling innovator Schnitzer Steel Industries (SCHN) is one of Jackson W. Robinson’s key holdings in his green investment portfolio. In his strategy, Robinson, Partner and Portfolio Manager at Brown Advisory Incorporated, focuses on companies reducing risks, lowering costs and enhancing revenue growth, he says.
“Schnitzer Steel [has] formed a partnership with fishermen to recycle their unusable heavy equipment, primarily nets. All these nets have steel railed to them for strength and weight. These have historically been abandoned by the fishing industry either on the ocean floor or sometimes they get to landfills,” Robinson said.
Robinson says 90% of the steel that is used is recycled steel, which is important because it reduces production costs and decreases emissions from the production process. He also says SCHN has partnered with Covanta (CVA) to recycle steel from heavy fishing nets, producing energy and reducing ocean-bottom pollution.
“Schnitzer is working with them to extract the metals from this waste stream and recycle the metals into new products, and the vertical part, lot of it is mesh, is going to Covanta and being used to create electricity. This is one example of how creative companies are recycling waste streams to reuse things in a more efficient way,” Robison said.
Activision Blizzard (ATVI) is trading at low valuations despite strong earnings power and free cash flow, a consequence of low investor interest in the gaming space, says Neil Doshi, Senior Equity Analyst at Citi Investment Research. Doshi says investors are concerned that players, in general, won’t buy consoles if the budget has already been spent on mobile devices and uncertainty regarding new console specs.
“Valuations have come down pretty dramatically for a lot of these companies, especially a company like Activision, which is now trading around 10 times next year’s earnings. If we remove the cash that they have on their balance sheet, the stock is trading around seven to eight times for a company that’s probably growing earnings in the double-digit range,” Doshi said.
Doshi says ATVI has best-in-class management, proven innovation capabilities with high margins, strong online gaming communities and they have major-scale participating in China. ATVI also has 30% operating margins, three times as much as some of its peers, and a strong focus on shareholder return.
“Last year, Call of Duty and World of Warcraft accounted for about 80% of ATVI’s operating profits. This year, they’re going to have about four key titles that include World of Warcraft, Call of Duty, Diablo III and Skylanders Giants. And next year, we’re going to see even more diversification, which will include those first four games, and Call of Duty China, a new game from the Bungee developers and StarCraft expansion as well,” Doshi said.
Comcast Corp. (CMCSA) and News Corp. (NWS) are among the favorite media stock plays of Doug Mitchelson, Managing Director and Senior Equity Analyst at Deutsche Bank Securities Inc. Cable stocks, he says, have had done well but continue displaying attractive valuations and the potential to return capital favorably, and NWS‘s networks are doing well.
“For cable and satellite, our top pick has been and continues to be Comcast, which has been growing revenue and EBITDA in the 5% to 6% range, sometimes higher, which has been well above the average industry growth,” Mitchelson said. “We also believe that there is a potential for return to margin expansion in 2014 and beyond as its high-margin telecom revenue grows to be a bigger and bigger percentage of its base.”
On the media side, Mitchelson also likes News Corp., Rupert Murdoch’s company. Mitchelson says the company is simplifying its business and projects income growth, and buybacks could be beneficial for shareholders.
“In media, our top pick is News Corp., where we see 11.5% fiscal 2013 operating income growth, buybacks that could total 6% to 7% of shares outstanding, and the split off late next spring of its publishing group into a separate publicly traded company, which could spark a re-evaluation of the company given it will remove the slower-growing publishing businesses from their fast-growing television businesses,” Mitchelson said.
Defense giants Lockheed Martin (LMT), Raytheon (RTN) and Northrop Grumman (NOC) attract investors into the defense space despite uncertainty in the federal defense budget for the upcoming years through aggressive cost controls and utilizing favorable interest rates and their strong cash flows to increase shareholder yield, says Kenneth Herbert, Senior Vice President of Equity Research at Wedbush Securities.
“Defense companies like Lockheed Martin, Northrop Grumman and Raytheon have successfully deployed their relatively strong cash flows to increase share repurchases and dividends, which have made these attractive yields,” Herbert said. “Second, most firms with defense exposure have aggressively started to reduce their cost structure, which has also helped earnings hold up.”
Herbert uses Lockheed Martin as an example of the large defense companies, saying LMT’s yield can be more attractive than fixed income investing given the risk profile, and he also says investors could further reduce their risk profile by looking into companies with exposure to commercial ventures.
“If you’ve got a stock like a Lockheed Martin that’s giving you a 4% to 4.5% dividend yield even at over $90 a share, and comparatively, if you do invest in fixed income instruments for that kind of risk profile, that’s a fairly attractive yield,” Herbert said.
Barack Obama’s re-election on Tuesday may shift investor interest toward health care stocks levered to the Affordable Care Act and the expected expansion of health care by 30 million more U.S. citizens, which may result in hospital and physician practices being open to additional capital expenditures for medical equipment.
In a recent interview, Thomas Carroll, Managing Director at Stifel, Nicolaus & Co., Inc. shared this favorite health care IT plays in the scenario of a Democratic victory in the presidential race and expansion of Medicaid.
Carroll’s favorite play is WellCare Health Plans (WCG). “We [are] recommending WellCare, a large Medicaid- and Medicare-focused specialty managed company. Medicaid and Medicare are poised to grow over the next five years, and migrating those populations over to managed programs, where a single company like WellCare takes the risk, should help to lower expenditures and keep some of the spread.”
Carroll favors larger-cap Humana (HUM). “One of the challenges on Humana is going to be 2014, when the Medicare companies are subject to an 85% minimum medical loss ratio. Humana has a little work to do there — not a lot, but still somewhat of a risk going forward. The demographics of the world certainly favor more and quicker adoption of private-sector solutions in order to gain your Medicare entitlement benefits,” he said.
On the hardware side of medicine, Steve Wilson, Chief Investment Officer and Analyst/Manager for Lapides Asset Management LLC, chooses Accuray (ARAY) as one of his favorite investment ideas. In a recent pre-election interview, Wilson described ARAY’s innovation, treatment efficacy and competitive dynamics among peers.
“What attracts me to this specific company is three things. One is they are in a very favorable, favorable growth area. The unfortunate reality is there will be an increasing number of people with these diagnoses,” Wilson said. Second is the radiosurgery aspect, a procedure with is less invasive than a mix of chemotherapy with traditional surgery, and which has equivalent efficacy. Thirdly, he says, the industry is consolidated.
“Last year, Accuray was digesting one of those acquisitions that are part of that consolidation trend. It set them back financially. They have now passed the anniversary point, they have turned the corner, and that’s why we’ve increased significantly our commitment to the company recently,” Wilson said.
