The casual dining space within the restaurant sector recently has seen improving numbers coming from consumer confidence picking up in the working middle-class customer, as well as a refocusing on the dining experience, rather than menu prices, says Will Slabaugh, Research Analyst at Stephens Inc.
“What you’ve seen is the traditional casual diners that have been winning throughout previous decades have slowed after the recession, and it’s become much more of a value push to try to hold your traffic by pushing price points,” he said. “So the bigger casual diners that weren’t pushing price points were hurting, and the guys who were out there taking share were offering something different than just a price point, offering an experience.”
Slabaugh favors Buffalo Wild Wings, Inc. (BWLD), which he says has had a solid 2012, because it started with a strong fourth quarter. However, he likes BWLD because of its experience-based advertising and marketing campaign.
“I think also they’re at an inflection point of hitting that broader national public awareness, and so that’s why I think you’re seeing the same-store sales accelerate to industry highs. Year to date, same-store sales are running nearly 13%, which is extremely big for a system that has nearly 850 units,” Slabaugh said.
Changes in the delivery of health care are creating pricing pressure on some of the largest medical device categories, such as hip and knees and defibrillators, and slowing the growth of these types of products dramatically, says Raj Denhoy, a Managing Director in equity research at Jefferies & Company, Inc.
“Certainly, the economy has had an impact on utilization, but there are other factors at work too. The payers and hospitals have gotten more sophisticated, and they’re looking to these things as the commodity-type products that they largely are,” he said. “You’ve also seen a whole wave of pushback on the utilization of medical technology. Lots of these categories should come under scrutiny as to whether the technologies are being overused.”
Denhoy has chosen Edwards Lifesciences Corporation (EW) as his top pick in the medical device industry, specifically in the transcatheter valve space. Despite current macroeconomic headwinds affecting the sector, he says EW is working on its third-generation devices, and it is about two years ahead of its competitors in terms of getting them on the U.S. market.
“Edwards Lifesciences is really pioneering, thus far, the use of transcatheter heart valves. That’s certainly an area that is getting a lot of attention. There is a little choppiness in the initial adoption of those products in United States, which has caused a little bit of softness in that stock, but I think the long-term prospects for transcatheter valves are enormous,” Denhoy said.
Restaurant stocks have been strong investments over the past several months, in part because of mild winter weather, as well as what appears to be increased likelihood of an easing in commodity inflation, which would bolster margins, says Sharon Zackfia, CFA, a Partner and Group Head-Consumer Sector, at William Blair & Company, L.L.C.
“I think the good news, from an investing perspective, is that for the most part investors looked through the commodity-cost pressure of last year, because companies with strong traffic growth typically have sufficient pricing power to ultimately support margins,” she said.
Zackfia likes Chipotle Mexican Grill, Inc. (CMG) because it’s been a stock that has performed well over the past several years although Chipotle did not top earnings expectations much in 2011. She says she believes the company is at an inflection point, and consensus estimates are again beatable. Also, Chipotle, which experienced significant commodity-cost pressure in 2011, still rose roughly 60% last year.
“We think there is the opportunity for Chipotle to potentially take more price, but at a minimum, it seems all but assured that commodity inflation will ratchet down to something more in the mid-single-digit range this year versus the double-digit inflation that the company periodically experienced last year,” Zackfia said.
Many of the diversified companies in the medical device sector are favored over some of the sector-specific names due to their position to be able to expand operating margins on a fundamental basis without needing the broader markets’ pickup, says Joanne K. Wuensch, Research Analyst at BMO Capital Markets Corp.
“Also, because of their diversified nature, they are buffered in many ways from a lot of the pressures in hips and knees, spine, ICDs and devices of that nature,” she said. “Finally, they have been relatively resilient to price pressure given that they don’t have high ASP products, which as one executive said to me: Doesn’t put a bull’s eye on their products.”
Wuensch recommends Covidien plc (COV) because it has diversified its medical technology portfolio. She says COV is currently in position to spin out its pharmaceutical division, which should increase the company’s revenue growth rate and expand operating margins.
“With Covidien, I think that they truly get what the business model is and that it’s changed at the hospital level,” Wuensch said. “Since four years ago, when they were spun out from Tyco, they’ve done an excellent job of selling off noncore businesses, making acquisitions and returning 25% to 40% of free cash flow to shareholders.”
Consumer preferences are shifting toward more healthful foods, as key age demographics and the rising U.S. Hispanic population choose fresher ingredients and healthier products in the food-at-home vertical, says Scott A. Mushkin, Managing Director and a Senior Research Analyst at Jefferies & Company, Inc.
“The Hispanic population tends to index higher on fresh,” Mushkin said. “Baby Boomers are retiring, so health and staying healthier is even more important to that demographic, and the Millennials are forming households, a very important time in people’s lives where they are making decisions.”
Mushkin names Whole Foods Market (WFM) as a top pick in the healthy eating category. He says the growth trajectory at WFM is strong and the company could see its comps go into the low-double digits. On top of that, the management team is focused on improving return on invested capital.
“The thing that you have going for you with Whole Foods is the cyclical nature of the food-at-home business, in particular. The secular trends we discussed, Millennials, Baby Boomers, in particular the better-for-you trend, are blowing very hard at Whole Foods right now and the whole organic industry,” Mushkin said.
Some large packaged food names in the U.S. are expanding internationally through investment events and acquisition activity, some splitting their domestic operations from their emerging markets operation in an attempt to realize upside from all of the different market circumstances, says Alexia Howard, an Analyst at Sanford C. Bernstein & Co., LLC.
“But for the large packaged food companies with no event-driven story, I am cautious,” she said. “Valuations are stretched, they’ve come in a bit as we’ve seen positive earnings revisions in other sectors, but relative valuation is still stretched versus the market.”
Howard recommends Kraft Foods Inc. (KFT) as an “outperform” stock. She says KFT managed to increase its sales in emerging markets through its acquisition of Cadbury and now the company has opportunities for revenue synergies as it pushes Kraft products into Cadbury’s distribution channels. KFT also plans to split its international operations from its domestic business, Howard said.
“There is not value to be created directly through the split, but it creates two different companies with very different mandates,” she said. “The North American grocery business will be a cash-generative, fairly stable business that is focused predominantly in the U.S. But the other business will be a global snacking business that has all of the margin upside opportunity and strong revenue growth potential.”
Robust product pipelines in the medical device market help to alleviate continuing pricing pressure in the sector as signs of increased stabilization in the utilization environment are a major focus for investors, says Kristen M. Stewart, Director and Senior Company Research Analyst at Deutsche Bank Securities Inc.
“Pipelines continue to be very important for this sector,” she said. “New products help these companies get pricing premiums. They help expand markets, and certainly they are very important to the success of any company and stock.”
Stewart has a “buy” rating on St. Jude Medical, Inc., (STJ) partly due to its strong product pipeline. She says the pipeline should help offset the challenges STJ may see with its cardiac-rhythm management business, because the end markets are mature.
“And we think that they can sustain growth in the mid-to-high single digits on the top line, with leverage to get to double-digit EPS growth. We think they should be able to get there even in 2013, despite the device tax, due to restructuring savings they should recognize beginning next year,” Stewart said.
Misperceived large-cap companies with high-quality, dividend-paying stocks, which historically have been able to increase those payouts to shareholders, offer growth opportunities for investors’ portfolios, says Harry D. Cohen, Chief Investment Officer, Managing Director and Senior Portfolio Manager at ClearBridge Advisors, LLC.
“We like our companies that have been misperceived for a long period of time when the excesses have been wrung out, where you have long bases, where any disappointed shareholders have been washed out of the stock, where downside is limited, and where things go right, the stocks could really do well,” he said.
Cohen favors MetLife, Inc. (MET), a company ClearBridge Advisors took a substantial position in when the stock suffered during the past few months after scrutiny by the Federal Reserve. He says he believes MET was misperceived by the market.
“And they got a secondary buying opportunity when the Federal Reserve said they could not buy in shares or raise their dividend because they still had a bank holding company, and they had to pass a stress test,” Cohen said. “And the stock got killed even though, in our view, they can easily pass those tests and they will, so the stock has been a recovering candidate since then.”
A small subset of community and regional banks that were well positioned going into the economic downturn, with limited real estate exposure, generic bond portfolios, plenty of capital and little leverage at the parent company, are showing signs of improvement, says Jeff K. Davis, Managing Director at Guggenheim Securities, LLC.
“These institutions are increasing the distance between themselves and the pack, and they are doing that primarily through taking share and employees from struggling institutions. It’s a bit harsh for me to describe it this way, but I think the oxygen is slowly being sucked out of the room for many community banks,” he said.
Davis favors Comerica (CMA), a bank with significant operations in California. He says Comerica is an instructive example to the regional and community banking sector because it entered the state in 1990, during the previous banking crisis, and built a franchise, which doubled in 2000, when CMA acquired Imperial Bank.
“I think the executives will tell you they have been pleased with their experience there with the caveat that the initial integration of Imperial had a few rough spots. Also, the credit scrub in 2006-2007, in anticipation of a housing downturn, missed a builder portfolio with about $1 billion of loans in which the builders were selling homes to subprime borrowers. But all in all, they have performed well in the state,” Davis said.
Some data center REITs offer the potential for above-average growth and reduced risk in the long term from a portfolio perspective relative to real estate due to less exposure to employment or GDP rates, says Dave Rodgers, CFA, a Director at RBC Capital Markets.
“There is a differentiating factor to some of these specialty REITs, including data centers, that really give them a unique aspect to investing,” he said. “You put it in your portfolio, that offers a differentiation and diversification, which should reduce risk over time. So we do like that, and again, it does offer above-average growth.”
Rodgers favors CoreSite Realty Corporation (COR), a small company with solid execution in its first year as a public company in 2011. He says COR remains active in the higher-growth aspects of data centers, which are the network and interconnection businesses, and he expects growth in those areas, where the company is having meaningful success and has been able to drive dividends.
“COR remains what I would call a little bit of a middle-of-the-road player dabbling in the wholesale, or power side, of the business, but aggressively pursuing the network side with fundamental characteristics suggesting a small company with the ability to grow,” Rodgers said.
