Cable networks are withstanding macroeconomic weakness through a mixture of domestic advertisement sales, subscription fees and international expansion in countries with low penetration rates, leading Analyst David C. Joyce, CFA, from Miller Tabak + Co., LLC, to rate several of them “buy.”
“[Cable networks] have a dual revenue stream of monthly affiliate fees that have contractual increases and they also get advertising, and it is their national advertising category that is holding up well and is still growing in the low double-digit kind of range,” Joyce said.
Joyce says Discovery Communications (DISCA) benefits from the international shift toward pay-TV and digital market. DISCA is the most distributed in the globe, with 180 countries having at least one of the company’s networks, and Joyce sees good upside from affiliate fees and international advertising.
“[Discovery Communications gets] about a third of their revenue internationally, but with more of the world upgrading to pay TV and from analog to digital, I think there is more opportunity for Discovery to extend its cable network brands around the globe. They are already the most distributed,” Joyce said.
Emerging market banks are growing book value, with up to 20% a year in some cases and a loan-to-deposit ratio on average of 80%, and are less dependent on wholesale funding than their European counterparts, says Lewis Kaufman, CFA, Managing Director and Portfolio Manager of the Thornburg Developing World Fund.
“Much has been made about the crisis of confidence in European banking. One of the reasons is that European banks on average in general are levered about 25:1, so that’s a pretty big disparity in leverage. Another real focus point in the debate about European banks has been funding. Most European banks have loan-to-deposit ratios of perhaps 120%,” he said.
Kaufman includes Sberbank (SBER03.ME), the largest bank in Russia, in his firm’s Developing World Fund. The bank on average has assets to equity of about 10 times and is able to drive returns on equity for shareholders because of its 53% market share of deposits and about 30% on lending products, he says.
“The markets are so consolidated that Sberbank enjoys a high degree of pricing power across most of its banking products. It has extremely low levels of leverage. It has a very limited need to access wholesale funding. So it’s mostly immune to a lot of the issues that plague the European banks,” Kaufman said.
The bioanalytical measurement segment of Agilent Technologies (A) outperformed the electronic measurement business, with profits growing faster and revenue declining slower, making the fairly nascent sector a new focus for the $13 billion conglomerate, says William Stein, CFA, an Analyst for Credit Suisse Group.
“In fiscal 2009, which was the recession year, the bioanalytic segments, life sciences group and chemical analysis group, revenue declined by 6% and operating profit margin increased by 20 basis points. Compare that to the electronic measurement business, where revenue declined by over 32% and the operating margin went from 13.4% to zero,” Stein said.
Stein has an “outperform” rating on Agilent. He says the company can become a market leader in bioanalytical measurement, and the purchase of Varian contributes to making the business less cyclical and less economically sensitive, and the company’s experience and overall size give it an edge over the competition.
“The bioanalytic measurement industry is significantly evolving,” Stein said. “Competition is less intense than it is in the electronic test business, and Agilent is a somewhat smaller player in that business. So the company’s opportunity to grow sales and profits in the bioanalytic market are much more robust than they are in the electronic test business.”
E-commerce is gaining market share at the expense of physical store transactions, as e-commerce offers more efficient ways to purchase items and allows for companies to reach customers in previously untapped geographies, says Herman Leung, an Analyst with Susquehanna Financial Group LLLP.
“One of the more important themes out there is just the most basic one, which is the secular growth of time spent on the Internet, whether it’s on more time being spent away from traditional media platforms, or more time being spent shopping on e-commerce platforms versus going out to shop in malls, or more time booking online transactions,” Leung said.
Leung has a “positive” rating on Priceline.com (PCLN) because the company enjoys faster transaction-based growth compared with its competitors. PCLN benefits from its expansion into areas of high fragmentation and a need for improved distribution to consumers around the world, says Leung.
“Priceline continues to enjoy the fragmented nature of the European hotel market, where they have the largest supply, and with the large supply they’re able to buy a larger and more relevant inventory of keywords to drive a very successful marketing campaign for the business for a very long time,” Leung said.
Internet security solutions are shifting from endpoint security toward the cloud along with the IT environment evolution, and are being followed by the large, inelastic budgets for cybersecurity of key verticals like government and payment card industry (PCI) compliance, says Todd C. Weller, Managing Director at Stifel, Nicolaus & Co., Inc.
“There are positive secular trends. Again, if you think of some of the stuff we talked about – virtualization, cloud – there is more and more centralization of computing that drives up network bandwidth and that drives data center growth, which drives a need for firewalls, intrusion prevention solutions, unified threat management,” Weller said.
Weller points to Palo Alto Networks as a high-profile private company with a disruptive approach to cybersecurity. Palo Alto offers a next-generation enterprise firewall solution which determines access to resources and information based on which applications and users are requesting access before setting an access policy.
“Palo Alto Networks – they just hired a new CEO, Mark McLaughlin, who was the former CEO of VeriSign. He just started at the end of August, and it’s kind of well documented in the media that they are likely to go public, again not sure of timing, probably a 2012 event, but that will be a very interesting IPO,” Weller said.
Hospitals are taking a less traditional approach to capital spending to combat budgetary constraints as a potential pullback in funding is expected going into 2012 in the medical diagnostics arena due to reimbursement changes or health care reform, says Brian Weinstein, CFA, an Analyst at William Blair & Company, L.L.C.
“What we are seeing is the more forward-thinking hospitals at this point are actually thinking about costs in a holistic way. If I spend money in my lab to bring on a test using a system that I have to pay for, do I therefore accrue savings outside of the lab and make things more profitable for the hospital?” Weinstein said.
Weinstein recommends Cepheid (CPHD), a medical diagnostics company which designed a system for savings in hospital capital spending outside of the lab. CPHD was put down as the best idea for 2011, and he says it offers best-in-class technology, which has led to a significant installed base, and the company is moving into profitability.
“We are seeing good gross margin expansion. That, we think, is going to allow the company to get to 65% to 70% gross margins, which would be kind of a normal diagnostic margin, with 30% operating margins over the next couple of years. You are starting to see some significant profitability that we think will start to come through for these guys,” Weinstein said.
The resolution of the European sovereign debt crises would result in upside in the technology, industrials, energy and materials sectors, although staples and utilities are expected to be the best performers in a widespread global recession, says Leon H. Loewenstine, CPA, Managing Director and Chief Investment Strategist at RiverPoint Capital Management.
“In our opinion, we think the probability is that the year will end in positive territory, as long as Europe does not blow up. I don’t know that we’re going to see a 2010 15% kind of return, but I think we could go from where we are at negative 8% to negative 10% to positive territory,” he said.
Loewenstine says Marvell Technology Group Ltd. (MRVL), a computer chip company, is a top pick at 10.4 times earnings with a historical growth rate of 40% and a projected growth rate of 16%. Loewenstine says MRVL reports that it expects to earn a $1.44 this year, and the stock is at $15.
“Marvell normally trades at 29 times trailing earnings. If we ignore that and we say what we think fair value is 15 times earnings, the stock offers 50% upside,” he said. “If you can buy a stock at one time its growth rate, and we think Marvell can grow at 15% to 16% a year, and I can buy that stock at 10 times earnings right now, I’ve got a great stock, and I’m going to make a lot of money.”
Global urbanization fuels infrastructure investment, especially in higher-growth emerging markets, as the number of people living in urban centers has grown threefold since 1960 to 3.5 billion and is projected to grow to 60% of the world’s total population by 2015, says Joshua Duitz, Portfolio Manager at Alpine Woods Capital Investors, LLC.
“The reason [companies] need to invest in infrastructure is because it helps facilitate the growth of the economic infrastructure. We think there are great opportunities globally to invest in the owners of infrastructure, especially in emerging markets where there is much higher growth rates than here in developed markets,” Duitz said.
Duitz says Brazil has deadlines for infrastructure build because of the upcoming 2014 World Cup and the 2016 Summer Olympics in Rio de Janeiro, providing investors with clear-cut investment thematics. Brazil also provides infrastructure companies inflation adjustments and minimum guarantees, and allows rates to raise with inflation.
“CCR (CCR03.SA) and EcoRodovias Infraestrutura e Logistica (ECOR03.SA) are my two favorites in Brazil,” Duitz said. “The valuations are inexpensive, and they both should have earnings growth above 20% because they have had traffic growth between 7% to 11% this year, and they’ve had toll increases of 9.7% because of inflation in Brazil.”
Demand is on the rise for cybersecurity solutions as the IT environment evolves and moves toward the cloud, and key verticals like the U.S. government and the payment card industry (PCI) are forced to buy cybersecurity solutions in an ever-changing threat environment, says Jonathan Ho, Analyst at William Blair & Company, L.L.C.
“We are seeing things like virtualization, cloud computing, the advent of smart mobile devices and other factors that are basically creating a lot more vulnerabilities with which the bad guys can potentially penetrate networks,” Ho said. “This will create new growth opportunities for a lot of the companies in the space.”
Ho points to Sourcefire (FIRE) as his top name in the cybersecurity space. He says FIRE has recently expanded its distribution opportunity, with the potential to double the number of value-added resellers available. Ho says Sourcefire is also expanding its product offerings, and has a track record of creating innovate cybersecurity solutions.
“Sourcefire overall has some pretty exciting opportunities ahead of it. In the fourth quarter, the company plans to launch two new products in two brand new areas: the next-generation firewall space and the antivirus space. I think both of those have the potential to shift the way the market looks at the technologies,” Ho said.
Utility equities are expected to increase in value in the next few years, as investors get past the current near-trough in valuation. The inflection point is expected to come after investors get clarity regarding EPA regulations and macroeconomic performance, says Ali Agha, Managing Director of SunTrust Robinson Humphrey.
“One area of interest would be companies that currently have less of a commodity exposure, but have a stronger regulatory presence following the theme that growth in rate-base investment through the capital expenditure program will ultimately lead to growth in earnings, coupled with decent dividend yields,” Agha said.
Agha recommends Edison International (EIX), a generator/distributor of electric power and an investor in infrastructure and energy assets. He says he likes EIX because it is a hybrid utility with a strong growth profile for its regulated utility arm, and on their merchant power side, some restructuring opportunities that may create value.
“From a valuation perspective, if you assume that in this market environment the merchant power operation is worth zero, and that’s the value that we assigned to it because that’s the worst case scenario in our view, then the regulated utility is trading at about a 17% to 18% discount to other regulated utilities,” Agha said.
