The appeal of gold as an insurance policy against potential increases in inflation is to have a 5% to 10% allocation of liquid assets in the precious metal or mining company stocks as an investment for a five-year run to higher levels, says Kenneth Gerbino, Chief Investment Officer and Head of Kenneth J. Gerbino & Company.
“I think gold is popular still and will become more popular, not only in the United States, but also in the European countries, as well as Japan and China and India, where money-supply increases are continuing at a very rapid pace. The appeal of gold is not to have all your money in gold,” he said.
Gerbino likes Yamana Gold, Inc., (AUY), a company that’s producing gold for less than $300 an ounce. He says AUY is growing at about 25% compounded. Gerbino also believes gold and silver mining companies with known deposits in the ground are the best bets for investors in the sector.
“They have a very strong portfolio and their cash flow growth for the next four years will increase by about 38% a year. So Yamana is a good, solid low-cost company. They have a million-ounce-plus production status and will be producing 1.7 million ounces by 2014,” he said.
U.S. biotech companies are expected to outperform the broader market over the next six to 12 months due to faster drug approvals by the FDA, as well as more mature product pipelines, says Dr. Jim Birchenough, a Managing Director at BMO Capital Markets Corp.
“We’re excited about the record number of product approvals that we’ve had over the last 12 to 18 months. We have seen a dynamic where there has been a bias toward shorting new product launches because of the time it takes to typically gain traction with novel drugs, but we’re at a point in time where we think that some of the slower launches last year will start to accelerate,” he said.
Birchenough points to Regeneron Pharmaceuticals, Inc., (REGN) as an example of a biotech company in the midcap space, where product launches have accelerated recently, and he expects to see more activity this year. He says Regeneron has a best-in-class entrant in the eye disease segment, a $5 billion category in the U.S., with Eylea.
“We’ve seen companies like Regeneron, a midcap company, more than double on a strong launch of their eye disease drug Eylea,” Birchenough said. “We expect Regeneron to be highly profitable off of Eylea as early as late this year, and off of that opportunity alone we think there is upside on the stock.”
Investing in large-cap value, dividend-income stocks that have attractive, predictable and growing dividend-income streams that can compound over time allows investors to not be solely dependent on capital appreciation with stock picks, says Sean Chaitman, Chief Investment Officer of Shelter Rock Management, LLC.
“By layering in an attractive and continuously growing dividend-income stream and by following a disciplined valuation process based on free cash flow, we are able to significantly improve our potential to achieve consistently attractive returns on our equity investments over the intermediate to long term,” he said.
Chaitman names Pepsico, Inc., (PEP) as a stock in the firm’s conservative allocation client accounts. He says PEP is somewhat of a contrarian large-cap dividend-income holding due to the company disappointing investor expectations for the past couple of years because it didn’t focus on its core brands. Last month, Pepsico announced a major strategic initiative, where it is restructuring and going to be heavily investing in marketing and advertising for its core brands, he said.
“As part of their announcement, they reset investor expectations to what we think is actually pretty conservative annual earnings guidance for the next few years. They guided for a 5% earnings decline this year, and now it’s 10% below the most recent analyst expectations,” Chaitman said. “They also guided for a high-single-digit earnings increase in 2013 as they begin to get traction from the marketing efforts.”
Focusing on companies that are statistically cheap, generate prodigious amounts of free cash flow and possess catalysts for improved operating performance that are not properly discounted by the market helps investors avoid value traps in small-cap investing, says Richard A. Giesen Jr., Founder and Chief Investment Officer of Elessar Investment Management.
“We have a dual mandate for the companies we want to own. They must be growing their enterprise in tandem with the appropriate capital structure, so a company that has been successful in meeting these objectives will be financially productive in terms of generating an attractive return on capital,” he said. “We have found the free cash flow yield to be the best indicator of future performance of a company’s stock throughout a market or economic cycle.”
Giesen likes ValueClick, Inc. (VCLK), a technology company that provides online marketing services including advertising exchanges, targeted display ads and mobile advertising. He says he expects the online advertising market to grow mid-double digits in 2012, as it takes market share from print and radio. Giesen bought the stock in 2010 at a price of $11.25, and currently the stock price is above $20. He believes ValueClick shares should trade in the mid-$20s, despite giving it a discount to its peers.
“We like the strong free cash flow generation of the company, which in turn enables them to invest in R&D and acquire complementary technologies. The company’s recent acquisitions have been very timely, especially their acquisition of Greystripe, which gives them a beachhead in the next leg of growth in online advertising, mobile advertising,” Giesen said.
Machinery replacement demand is a major theme in the industrials equipment sector in the U.S. and Canada, partially because contractors and rental companies cut their fleet expenditures dramatically in the downturn, to the point their fleets have become older and smaller than historical average, says Theoni Pilarinos, an Analyst at Raymond James & Associates, Inc.
“So in many cases that means they are insufficient even to meet the current or base level of activity in construction. So we have seen this game of catch-up and rebuilding fleets to even maintenance levels, and on top of that you’re seeing some activity increases, which is helping incremental purchases as well,” she said.
Pilarinos likes Caterpillar Inc. (CAT), which she says estimates that the fall in equipment sales was about 80% from when its sales in the U.S. peaked in 2006 to its bottom in 2009. Since then, she has started to see demand return without a strong rebound in the end markets.
“We have seen 50% growth in Caterpillar dealers’ unit sales to end users, for example, in construction equipment, but we certainly have not seen that kind of rebound in end-market activity,” Pilarinos said.
The long steel segment within the Latin American metals and mining sector is favored over the flat steel side due to issues from overcapacity, as well as cost and price pressures, says Jonathan L. Brandt, CFA, an Analyst at HSBC Securities (USA) Inc.
“I think long steel demand in Brazil will be very good over the next couple of years,” he said. “Remember, long steel is generally construction. Flat steel is more for manufacturing. If you look at the long steel side, Brazil has a lot of infrastructure projects with the World Cup and the Olympics coming. There are some government programs there that will require construction.”
Brandt points to Vale S.A. (VALE) as a favorite name, although it is rated “neutral,” and he is a little hesitant to upgrade it to an “overweight” because a lot of its production growth isn’t coming on for three to four years. He also says for Vale, he looks at its competitive advantages, and they have low-cost iron ore assets.
“Vale tends to produce iron ore somewhere between $30 and $35 per ton and sells it for $120 or $130 per ton. They have very good margins. They have very attractive valuations, trading at 3.5 times to four times EBITDA, maybe 5.5 to six times p/e; and they have a 5% dividend yield,” Brandt said.
Despite most forecasts for commodities in the industrial space being flat to down and the belief there are more opportunities for the precious metals producers, a barbell approach to the mining and metals sector with equal ratings on both segments is favored to hedge one’s bets, says Jorge M. Beristain, Managing Director at Deutsche Bank Securities Inc.
“Frankly, we still don’t know which way the world’s going to shake out in the next few years. The cumulative effects of all of the monetary quantitative easing that we’ve seen in the U.S., Europe and Japan aren’t known,” he said. “I think that inflation driven by quantitative easing could be a reason why investors want to own either industrial or precious names.”
Beristain picks Barrick Gold Corporation (ABX) as a favorite name on the precious metal side. He says they company is the world leader in gold production and the largest company by market cap, but it has also diversified somewhat into the base metals space through an acquisition in 2011.
“That has raised their nongold exposure to about 20% of revenue. On the gold side, I think they have some fairly attractive and large-scale projects. They own and/or will consolidate something like four of the top 10 largest gold mine projects in the world, and they also have a track record of execution at the mine level,” Beristain said.
Private markets within the engineering and construction sector in the U.S. are growing at faster rates off of a much lower base than the public side of the space, which may see a broader softening now without the boost of an economic stimulus package, says Avram Fisher, a Vice President at BMO Capital Markets.
“On the public side, the most obvious assets that are built by the E&C companies are roads and highways, railroads, bridges, mass transits,” he said. “On the private side, it’s nonresidential buildings, including refineries, petrochemical facilities, specialty chemical facilities and then institutional construction of museums, hospitals, government buildings, hotels and schools.”
Fisher has an “outperform” rating on Jacobs Engineering Group Inc. (JEC), which he says has an attractive valuation and offers growth at a reasonable price. He says JEC is trading below its normal historical multiple, because of the company’s federal government exposure, which in his view is a function of headline noise around federal budget risks.
“Jacobs Engineering, they have exposure to the Canadian oil sands in something called SAGD, steam-assisted gravity drainage, which is a more efficient and less invasive method of removing the bitumen from the oil sands,” Fisher said. “They also have relatively new Middle East exposure that’s gaining significant traction in the refining and petrochemical space.”
The combination of increasing demand and a tight supply side in the metals and mining sector will lead to tightness in general in the commodities, and commodity prices are expected to rise into the second half, as a general observation on the global outlook, says Rob Clifford, an Analyst at Deutsche Bank AG London.
“On the supply side, we see the miners continuing to struggle to get tonnage out. Many will have flat output this year, and the absolutely eye-watering capex numbers that they’re talking about don’t actually deliver volumes really until next year, at the earliest, and beyond,” he said.
Clifford likes Rio Tinto plc (RIO) because he says iron ore remains a strong place to be in the sector. He favors Rio Tinto’s significant exposure to iron ore and its low-cost expansion capability in the Asia-Pacific region, next to the booming growth arena.
“We also think that China has GDP growth of 8.6%. So we’re constructive as a house on China. We see monetary policy in China easing to help drive that particular growth. So overall, we see some pickup in global demand into the second half of the year,” Clifford said.
Early signs of improved capital investment in the U.S. in certain end markets in the engineering and construction space are starting to lead to backlog growth developing, organic revenue growth accelerating and early signs of profit margin improvement, says Alex Rygiel, a Managing Director at FBR Capital Markets & Co.
“Certain end markets that are favorable right now include domestic telecom, capex for both wireline and wireless infrastructure, domestic electric transmission and domestic gas pipeline, particularly in the shale regions. These are trends we are seeing throughout the engineering, planning and construction phases,” he said.
Rygiel has Dycom Industries Inc. (DY), a smaller-cap stock with $750 million, as his top pick in the E&C sector. The average E&C company is trading at 5.5 times 2012 enterprise value to EBITDA, which is below the historical 15-year average of 9.5 times trailing EBITDA. Rygiel says he believes this is an early sign of improving fundamentals that are not yet appreciated in the valuations of these securities.
“The company has seen accelerating backlog and revenue growth and pretty meaningful margin expansion over the last several years. It is a company that historically was a pure-play telecom wireline contractor that has recently started to expand into wireless,” he said.
