Demand for carrier-neutral colocation remains strong across the board, in an environment in which the entire segment posted quarterly earnings pointing toward healthy fundamentals, says Todd C. Weller, Managing Director at Stifel, Nicolaus & Co., Inc.
“A lot of the drivers for the carrier-neutral segment have been secular growth of the Internet, everything from cloud computing to Internet gaming to software as a service. That’s fueling demand for carrier-neutral data centers. So we’ve seen solid demand in that segment,” Weller said.
Weller points to Equinix (EQIX) as his top name in the space. He says EQIX is the only global provider of carrier-neutral colocation services, and the company reported strong bookings in all of its geographies. He also says that although valuation decreased recently, there is still room for upside.
“The last few weeks have been devastating to Equinix‘s share prices, as well as any other stock on my screen because they reported very solid results as I mentioned, and you saw the stock up to $105, and now we’re sitting here in the low $80s,” Weller said. “We think that the estimates are conservative for the back half, and there’s room for upside there.”
Cost has emerged as the key differentiating factor among solar energy manufacturers, as the technologies do not vary drastically from one manufacturer to the other and subsidies are declining in leading European markets, says Angelo Zino, Analyst at Standard & Poor’s.
“You don’t really see much differentiation in the industry when it comes to product type,” Zino said. “We think low cost is going to set these players apart, and it’s really not going to be based necessarily on the more advanced technologies that are out there in our opinion.”
Zino points to First Solar (FSLR) as one of his top “buy”-rated stocks in the solar energy space. He says the thin-film producer has a strong pipeline and funding from the Department of Energy for the next couple years, and the company has recently won projects and has high exposure to the U.S. market.
“[FSLR] has a larger scale and much better balance sheet versus other so they can help meet financing needs. Not to mention, all said, they’re the low-cost industry producer, benefiting from the first-mover advantage, so it’s a lot of factors that we see favorably,” Zino said.
Data centers are expected to grow in the 15% to 20% range a year and maintain solid recurring revenue, driven by the coupling of a strong secular trend toward the digitization of the economy and the reduction of infrastructure-related costs through outsourcing, says Clayton Moran, Senior Analyst at The Benchmark Company, LLC.
“E-commerce, online video distribution, cloud computing, algorithmic financial trading, mobile data — all these developing sectors have strong secular growth outlooks and utilize Internet Protocol and Internet infrastructure. IP traffic is forecast by Cisco to grow 30% to 40% per year,” Moran said.
Moran points to Internap Network Services Corp. (INAP) as a compelling “buy”-rated, small-cap stock in the data center industry. He says INAP‘s stock has recently dropped 40%, and he sees it as an opportunity, with the stock currently priced at $5.18 and a target price of $8 per share.
“One, Internap operates defensive telecom businesses with solid growth prospects. Two, Internap has no net debt with ample credit. Three, data center industry growth has accelerated. Four, there is a powerful industry consolidation trend, and Internap is an acquisition candidate,” Moran said.
Energy equities in oil and gas offer value on price/earnings multiple terms as markets are expected to continue to slowly recover and the U.S. economy avoids a double-dip recession, says Tim Guinness, Chairman and Chief Investment Officer of Guinness Asset Management Ltd. and Guinness Atkinson Asset Management Inc.
“There’s also the standout dividend yield of a number of the super majors, and you’ve got the services sector, which was beaten down in 2009 and 2010, but began to recover in the second half of 2010, actually beating to quite a different drum to much of the rest of the economy,” Guinness said. “There’s a very distinct uptick now in the oil and gas service company business cycle.”
Guinness says although he does not favor offshore drillers who have been adversely affected by the Gulf of Mexico Macondo spill, he does like BP plc (BP) among the European super-major oil companies. He believes BP is a standout in value terms despite the negative publicity it has had on Macondo and Russia.
“We have a big bias toward investing in companies that have got production, have got decent oil and gas reserves, as well as those service companies that are big solid businesses making profits and so on,” Guinness said. “So when you look at our portfolio, you will find that the vast majority of the companies we own are established businesses just now often on a price/earnings multiple of below 10.”
Managed services demand is growing steadily in the data hosting and storage sector as companies increase IT spending in terms of dollars at a steady pace, says James D. Breen, CFA, Analyst at William Blair & Company, L.L.C.
“It’s going to be a pretty steady climb each year,” Breen said. “So whereas maybe 10% or 15% of IT dollars are outsourced today, it maybe another incremental 5% or 10% each year for the next 10 years.”
Breen likes Rackspace Hosting (RAX), a provider of managed hosting and cloud computing services. He says Rackspace is focusing on growth and trying to gain market share as the curve toward IT outsourcing and managed services improves.
“Rackspace showed year-over-year growth that accelerated to around 32% from 29%, maintained margins in the low-30% range and talked about those margins remaining stable as they continue to grow,” Breen said. “They’re seeing continued solid growth within their existing business.”
Regulated utility stocks, with a 4.5% to 5% dividend yield and 2% to 3% annual dividend growth, are fully competitive with the broader market right now given the context of slowing economic growth and contained inflation, says Hugh Wynne, Senior Research Analyst at Sanford C. Bernstein & Co., LLC.
“There is a compelling case to be made for holding a market weight or above market weight in regulated utility stocks,” Wynne said. “Given the 5% dividend yields available on some of the competitive names, these investors feel they’re getting paid to wait until the cycle turns and earnings power is restored.”
Wynne recommends looking at PG & E Corp. (PCG), an energy-based holding company headquartered in San Francisco, because the stock is undervalued after the San Bruno pipeline explosion and subsequent regulatory review to determine the appropriate fine and resulting capital expenditures for PCG.
“Until that’s resolved, a lot of investors have backed away. As a result you have a company which in the end probably represents one of the superior utility franchises in the nation trading at 15% discount to its long-term value. So I think that’s an opportunity for those that have a stomach for the risk,” Wynne said.
Data centers are expected to continue growing as demand grows for bandwidth-heavy online content and online data traffic flow grows more robust, causing stable pricing even as data centers continue to expand geographically, says Ilya Grozovsky, a Managing Director at Morgan Joseph TriArtisan LLC.
“Pricing is stable in essentially all geographic regions. Companies are willing to sign long-term contracts with built-in price escalation. The users continue to feel like they need to lock in the current prices. And expansions continue in the facilities,” Grozovsky said.
Grozovsky has a “buy” rating on Equinix (EQIX), a global operator of retail data centers. He says EQIX can fund its own growth despite selling $750 million of senior notes to refinance debt and build out its facilities, and he says the company offers a good value play that doesn’t have a takeout premium yet.
“Equinix, we feel, is putting up very strong results and has essentially the same trends that its peers do and yet trades at a discount,” Grozovsky said. “We think that it has very strong fundamentals and is trading at a discount to its peers, and that tells me it’s a good buy.”
Lower-cost manufacturers are emerging as market leaders in the solar energy space, as short-term overcapacity, pricing pressure stemming from Chinese competition and a move toward reduced subsidies creates a need for more efficient businesses, says Chris Kettenmann, Analyst at Miller Tabak + Co.
“Costs continue to decline and the cost leaders in the space have consistently outperformed peers. That’s where we’re putting our money now,” Kettenmann said. “Companies … that have a differential technological edge and cost profile versus their competitors will succeed. That’s where we’re really telling investors to concentrate right now.”
Kettenmann points to First Solar (FSLR) as his favorite name in the space. He says FSLR has the strongest balance sheet in the sector and the lowest cost structure, and Kettenmann says the company is expected to continue reducing its costs for its equipment to reach grid parity levels by 2015.
“We believe that [First Solar] will retain their cost advantage and be able to lower cost faster than the market is discounting,” Kettenmann said. “For value players who want to go at the highest-quality name in the group, we push them towards First Solar as it trades below 12 times our 2012 EPS estimate.”
Data storage drive pricing remains steady as inventories remain low compared to historical levels for this time of the year, and consistent Asian demand and pending consolidations offset softening of demand from the U.S. and Europe, says Mark Miller, Senior Research Analyst at Noble Financial Group, Inc.
“There are several mitigating factors that can compensate for softer demand. You can actually grow units in a declining market,” Miller said. “The distribution channel inventory levels are low, and we actually have seen some channel pricing increases. Things aren’t as bad as some people are pretending it to be.”
Miller says Seagate Technology (STX) represents a good buy after its valuation dropped 40%, because he says the market overreacted to headlines about the softening of Western demand. Moreover, he says STX has a pending merger, and last quarter the company hit record shipment levels by posting a 7% increase in units.
“Seagate is actually paying a 6.6% dividend. There are not a lot of stocks out there paying a 7% dividend right now, and Seagate has a very healthy free cash flow, $221 million per quarter in average free cash flow over the last three years, and the dividend payment hits Seagate for $80 million a quarter,” Miller said.
The megaplex movie theater industry continues to outflank competition from online streaming and DVD vending machines by adding further social elements to the movie-viewing experience, creating a new generational change in the industry, says David M. Brain, President, CEO & Trustee of Entertainment Properties Trust (EPR).
“There is an old song in Hollywood that says as long there are kids that want to get away from parents and parents that want to get away from kids, you’re going to have a healthy movie industry,” Brain said. “People have kitchens, but they still go out to eat. Just because you can do something at home doesn’t mean you do it at home. People want to go out.”
EPR invests in the megaplex movie theater experience through triple net leases that are 15 to 25 years long. Brain says his REIT is currently investing in the multiclass movie theater experience, with a new trend toward luxury theaters offering full bars and in-theater dining.
“That’s the beauty of net lease investing: You have these very reliable income streams that grow over time,” Brain said. “Generally about 5% of revenues is our total expense ratio, and to manage some $3.25 billion in assets, we only have about 30 employees. We’re able to do that in a net lease structure, where you don’t have a lot of moving parts.”
