Re: I Am In The $$$MONEY$$$
Where to Invest
With uncertainty roiling the market, the big question is not, will the market go up next year, but what stocks will go up. Think Apple, Royal Dutch Shell, JPMorgan Chase, and more.
http://online.barrons.com/article/SB50001424052748703555704578163174281808756.html
SATURDAY, DECEMBER 8, 2012
By ANDREW BARY
How come we feel so bad when we've got it so good? Even after a 12% gain in the S&P 500 index this year, uncertainty about the fiscal cliff, increased taxes, and still-high unemployment continue to wear down investors. Year to date, domestic equity funds have seen $110 billion in net outflows.
The new year could bring more of the same if economic uncertainty fails to lift, making the key question for investors not which way the market is headed in 2013, but which stocks are going to go up.
For the third year in a row, Barron's is taking a crack at that question, with our 10 Favorite Stocks for 2013, including blue-chips like Apple (ticker: AAPL), JPMorgan Chase (JPM), Royal Dutch Shell (RDSA), and Novartis (NVS), and smaller companies like Barnes & Noble (BKS) and disk-drive maker Western Digital(WDC), which appear sharply undervalued.
Many of this year's picks have been the subject of bullish articles in Barron's during the past year. Apple was featured in a recent cover story, while BlackRock (BLK), Barnes & Noble, and Viacom (VIAB) were profiled in recent months.
We're coming off a good year. Our 10 stocks for 2012 outpaced the market by four percentage points, gaining an average of 17% (see accompanying table). The two big winners were disk-drive maker Seagate Technology (STX) and cable operator Comcast (CMCSA), both up more than 60%. The worst performer was
Freeport-McMoRan Copper & Gold (FCX), which declined 22%, with nearly all of that drop coming last week amid negative investor reaction to its deal to buy two energy companies for $9 billion.
No matter which way the market goes, well-run companies should be able to deliver higher revenue and profits, even in a tough environment. All of our new favorites could produce 15% to 20% total returns (including dividends) next year. Here's a closer look:
APPLE is still going strong, even as the company's shares have traded down 23%, to around $540, from a September peak of $705. None of the recent investor concerns -- lower margins, supply constraints, management changes, iPad competition, and the iPhone 5 map fiasco -- are major. It's true that Apple's earnings growth has slowed to a 23% rate from more than 100% a year ago, but that's understandable, given the company's $156 billion in annual sales.
Veteran UBS tech analyst Steve Milunovich recently wrote that it's a "good time" to add to positions in Apple before year end, with the stock trading near its lowest price/earnings ratio in five years after two disappointing quarters. He carries a price target of $780. Apple trades for only 11 times projected profit of $49 a share in its current fiscal year, ending in September 2013. Strip out Apple's huge cash holding of $128 a share, and the effective P/E is just eight.
Even after implementing a dividend -- now providing a 1.9% yield -- and a modest buyback program, Apple should build cash at a rate of $40 billion annually. There's room for a higher dividend and a more aggressive share-repurchase program in 2013. Both could play well with investors.
BARNES & NOBLE'S bookstore division dominates the field, and the company's Nook e-reader unit is holding its own against Amazon.com (AMZN) and Apple. These achievements aren't reflected in Barnes & Noble's depressed stock price, which is flat this year at around $14. The stores now control almost two-thirds of the country's retail shelf space for books and are expected to generate more than $300 million of pretax cash flow in the fiscal year ending in April. The stores could be worth the entire current stock price -- Barnes & Noble has an equity value of just $880 million.
The Nook division is losing money, but that reflects a market-share grab, as Barnes & Noble seeks to get its e-readers into the hands of as many consumers as possible and then sell them profitable digital content, including books and magazine subscriptions. Microsoft (MSFT) likes Nook, having invested $300 million this year for a 17.6% stake in the division. That implies that Barnes & Noble's 82.4% of Nook is worth $1.4 billion, or $24 a share. While this calculation likely overstates Nook's value, the division probably is worth a good deal more than its implied price of zero. One fan is media magnate John Malone, whose Liberty Media (LMCA) owns about $200 million of Barnes & Noble convertible preferred stock.
BLACKROCK received a big vote of confidence this fall when director James Grosfeld purchased nearly 500,000 shares of the investment manager in the open market for $94 million, one of the largest insider purchases in the past decade. Grosfeld, a former CEO of Pulte Homes, wouldn't comment, but he clearly sees value in BlackRock shares, which have lagged behind those of its peers this year.
BlackRock, at $193, is valued at 13 times projected 2013 profit of $15 a share, a slight discount to its rivals; it yields 3.1%. BlackRock is the No. 1 investment manager, overseeing $3.7 trillion in assets. Its iShares is the leading provider of exchange-traded funds, with half of the market.
The three main concerns about BlackRock are that it's too big to grow, that competitive pressure in ETFs from Vanguard will push down fees, and that longtime CEO Larry Fink, viewed as one of his industry's best executives, might leave for the top job at the U.S. Treasury Department. (See Feature "Madame Treasury Secretary?".)
Bulls such as Morgan Stanley analyst Matthew Kelley see double-digit earnings growth next year, driven by iShares. Fink has dismissed talk that he wants to succeed soon-to-retire Treasury Secretary Timothy Geithner. "I'm not leaving this job," Fink said last week. "I will be at BlackRock as long as my board wants me here."
GENERAL DYNAMICS is best known as a defense contractor, but unlike its peers, it has a valuable nondefense business that isn't reflected in its share price. Gulfstream, a leading maker of corporate jets, produces almost 30% of General Dynamics' profits, and that percentage should rise in the next few years, with deliveries of Gulfstream's new top-of-the-line plane, the G650, which sells for $60 million and can fly nonstop from New York to Tokyo.
General Dynamics, at around $67, looks inexpensive, trading under 10 times projected 2013 profits of $7.32 a share. Gulfstream is expected to generate more than $2 a share of that. Put a P/E multiple of 14 on that contribution, and the private-jet business could be worth $30 per General Dynamics share. This suggests that the defense business -- including tanks, other armored vehicles, and nuclear submarines -- is valued at just seven times forward earnings. Defense contractors face tighter Pentagon appropriations, but the industry probably will avoid draconian reductions in spending, assuming Congress and the president reach a budget deal.
Barclays analyst Carter Copeland argues that General Dynamics could be the only major defense contractor to show higher operating profits through 2015. Incoming CEO Phebe Novakovic, who takes the top job on Jan. 1, could be a positive catalyst. What could be in store? A higher dividend, more aggressive share buybacks, or even a Gulfstream spinoff. The company has rejected the spinoff idea, but some investors think Novakovic might reconsider. Copeland's price target: $87.
JPMORGAN CHASE is a best-in-class bank, trading at a below-average price. At around $42, its shares fetch just eight times projected 2013 profit of $5.31 a share. That's one of the lowest price/earnings ratios among major banks.
JPMorgan is strong in all of its major businesses, including trading and investment banking, asset management, private and consumer banking, credit cards, and processing services. While rivals like Citigroup (C) and Bank of America (BAC) had to worry about survival during the financial crisis, JPMorgan invested to bolster key areas. It was embarrassed by $6 billion of trading losses this year caused by the "London Whale," but CEO Jamie Dimon is determined that a similar event won't occur.
Ross Margolies of Stelliam Investment Management recommended JPMorgan in a recent Barron's interview ("How to Play the Economic Recovery," Dec. 3), saying it should benefit from market-share gains at the expense of weaker European banks. The stock trades at only a small premium to tangible book value. JPMorgan yields 2.9%.
MARATHON PETROLEUM is a leader among independent oil refiners, one of the strongest industry groups in the stock market during 2012. Now trading at about $60, the stock could hit $82, according to Morgan Stanley energy analyst Evan Calio. Refiners have benefited from the boom in oil production in the central U.S. and western Canada, which has enabled them to buy crude at a discount to world prices, bolstering profit margins. That favorable price gap is expected to remain in place next year.
Even with its runup, Marathon commands less than seven times projected 2013 profits of $8.77 a share. In October, it agreed to purchase, at what appears to be a very favorable price, a huge Gulf Coast refinery from BP that will boost its capacity by 38%. A big plus for Marathon is its ability to transfer pipeline and other assets at high prices to a newly created master limited partnership, MPLX (MPLX). Marathon's dividend, now 2.4%, probably will rise in 2013.
NOVARTIS combines one of the pharmaceutical industry's best profit outlooks with an overlooked sum-of-the-parts story. At $62 -- 12 times projected 2013 profits -- the giant Swiss drug maker trades in line with its global peers. Its shares yield 3.4%. Profits at Novartis are expected to be down this year, in part because of the loss of U.S. patent protection for the blockbuster blood-pressure drug Diovan. But earnings are likely to rise next year.
Key drivers include Gilenya, a new drug for multiple sclerosis. Novartis also owns Alcon, a leading eye-care outfit, and Sandoz, one of the world's top generic-drug makers. Novartis doesn't get much credit for Alcon, which it bought in 2011 in a deal that valued Alcon at about $55 billion. Bernstein drug analyst Tim Anderson writes that Novartis "has one of the best revenue and EPS-growth profiles through 2016." He carries an Outperform rating and a $71 price target.
Breakups have been a big industry story, as Abbott Labs (ABT), Pfizer (PFE). And Bristol-Myers Squibb (BMY) have shed key units or split up entirely in moves that have played well on Wall Street. Novartis is cool to the idea, but it probably would gain more from a split than any other major pharma company.
ROYAL DUTCH SHELL has trailed Chevron (CVX) and ExxonMobil (XOM), its "supermajor" peers, in the stock market this year, with a decline of 8%, to $67. The shares look inexpensive, given the dividend yield of 4.4% and a 2013 P/E ratio below eight.
Headquartered in The Hague, Royal Dutch has bet big on huge liquefied-natural-gas projects in Australia and elsewhere; it now gets about half of its energy output from gas. That exposure worries investors for two reasons: First, the cost of massive LNG projects is rising, running into tens of billions of dollars; and second, the current link of LNG prices to oil could weaken. However, prices for internationally traded gas -- which mostly goes to the Asian market -- are much higher than those in the U.S.
The LNG concerns seem overdone, and Royal Dutch has the wherewithal to complete existing projects, even if oil prices fall moderately. Royal Dutch looks like a low-risk way to play the energy market.
VIACOM is an outlier in the hot media sector. Shares of the owner of the MTV, Nickelodeon, and Comedy Central cable networks, and the Paramount movie studio, are up 15% this year to $52, while Disney (DIS), Time Warner (TWX), CBS (CBS), andNews Corp. (NWSA, the publisher of Barron's) all have gained about 30%. Viacom fetches 11 times projected 2013 profit, a sharp discount to its peers' average 13.
The shares have been hurt by persistent rating declines at the cable networks, mainly Nickelodeon. The bull case is that Viacom is steadily going private through one of the media industry's most aggressive share-buyback programs. That could lift the stock in 2013. Viacom repurchased more than 10% of its stock in its fiscal year ended in September, and a comparable buyback is expected in fiscal 2013.
Viacom could fetch a sizable premium in a takeover, thanks to its valuable cable assets. The company is controlled by Sumner Redstone, 90. While Redstone plans to pass on his stake to his grandchildren, unexpected things can happen after the death of a controlling shareholder. Analysts at Gabelli have put Viacom's private-market value at $86 a share in 2014.
WESTERN DIGITAL and rival disk-drive maker Seagate have languished amid worries about the future of the PC market. The two major players trade at single-digit price/earnings ratios. Our preference now is for Western Digital, which has badly trailed Seagate this year. At $37, the shares trade for less than five times projected profits of $7.65 a share.
The disk-drive market remains substantial, with annual sales of more than 500 million storage devices. While PC sales aren't growing, demand for storage is, and other forms of memory are too costly for storing massive amounts of data. And since Seagate and Western Digital control more than 80% of the market, pricing pressures are unlikely. Western Digital has a strong balance sheet, with $1.4 billion, or $5 per share, in net cash. Given that and its earnings power, a leveraged buyout of the company is possible.
The company has pledged to earmark half of its free cash flow for stock buybacks and dividends, and there's room to boost the payout, which at 2.7% is just half of Seagate's. Needham analyst Richard Kugele has a Strong Buy rating on Western Digital and a $46 price target.
