While we seem to have skipped past the debt ceiling issue, it is quite possible we will see continued turbulence ahead. Given the high valuations (23x cyclically adjusted P/E for S&P; 16.5x TTM and 23x TTM for Russell 2000), weak economic conditions, and political uncertainty in the US and abroad investors need to be extra careful when allocating new funds to the stock market. What stocks hold up best in a tough market? Generally large-cap companies with 1) leading market positions (2) strong competitive advantages (3) large amounts of recurring revenue which will hold up even if the economy turns south and (4) strong balance sheets (net debt < 2x EBITDA). These companies are likely to show profits which hold up well in tough conditions - in fact, the companies featured in this article saw profit declines of no more than 10% in the great recession and saw a quick rebound thereafter (all have consistently achieved new record results in each 2010, 2011, and 2012). Based on these criteria, here are three stocks which should perform well even if things get ugly:
Domiciled in Sweden, Assa Abloy (OTCPK:ASAZY) is the largest lock maker in the world with a global market share of nearly 12%. While the construction market has been difficult since the financial crisis, Assa has continued to increase revenue and operating profit every year since 2010 and is on track to do so again in 2013. While commercial construction has been subdued, the aftermarket (which represents ~70% of the total lock market) is driven by changes in tenancy, renovation, and extensions have not been very cyclical and provides the company with a steady stream of profits. Assa has been cobbled together through 150+ acquisitions since the early 1990s and while management has done a good job of rationalizing facilities, there remain opportunities to increase manufacturing efficiencies. Similarly, the company's back office is still running dozens of IT systems (as a result of acquisitions) but management plans to consolidate these over the next few years. Further, Assa remains an active consolidator of the locks industry - it should be able to add 5% per year to sales via acquisitions (as an aside, those interested in micro-caps should have a look at Securidev in France which trades at less than half the private market value Assa has paid for lock makers on average over the past decade). Having the highest margins in the industry, Assa is able to achieve significant synergies on acquired businesses and earn good returns on capital for its shareholders through M&A. Thus even in a difficult economy, we expect Assa will continue to grow its operating profit given its steady after market revenue, opportunity to improve results through cost cutting, and through value accretive M&A. While its shares are not cheap, at 19x earnings, shares could offer investors with a five year holding period and an 8-10% annualized return.
SAP (SAP), the German ERP software leader has underperformed the broader market in 2013 as investors have cast aside large software companies in favor of cloud pure plays. While the stock has been a bore recently, there are many things to like about SAP. First, it has a leading position in complex ERP systems for large corporations. These systems are incredibly sticky (99% retention). Companies spend tens, and in some cases hundreds of millions of dollars and 3-5 years to implement these systems and almost never rip them out. In addition to getting paid a fee for the initial sale of the system, SAP receives a maintenance fee of 20-22% of the initial sales price every year. These revenues represent over half the company's revenue (and a greater % of profit). This provides a very stable revenue and profit stream for the company - even in a weak macro environment (despite the economy falling off a cliff between 2008 and 2009, SAP reported less than a 10% decline in operating profit). Similarly the company has exciting growth opportunities with its HANA in-memory database which, when coupled with other product cross selling opportunities should allow the company to grow its operating profit in excess of 10% annually (comprised of high single digit revenue growth and some operating leverage). Trading at just over 15x earnings, shares look to have 30% upside.
Wal-Mart (WMT), the world's largest retailer's shares are on sale. Investors were disappointed with first half results and sold off the shares. While the retail environment is difficult (both in developed and developing markets - Wal-Mart's Mexican business reported a nasty October same store sales decline), Wal-Mart remains one of the best retailers in the world. It sells primarily necessities and should hold up well in a tough environment (operating profit increased 5% between 2008 and 2009 despite the huge economic headwind). With numerous competitive advantages including: unparalleled purchasing power, a valuable brand that customers trust, and world class logistics. Nobody buys cheaper and Wal-Mart is able to offer customers a great value while earning a nice margin for itself - an advantage which becomes more pronounced in a difficult economy. The company still has exciting growth opportunities ahead of it both domestically where it will roll out more Neighborhood Market grocery stores (just over 300 today but room for up to 1100) and expanding online sales (which are just a fraction of Amazon's). The company generates in excess of $13 billion of free cash flow annually - virtually all of which is being returned to shareholders via dividends and share repurchases. Selling at less than 13x earnings, Wal-Mart looks to have 20% upside even if the economy takes a tumble.
While we may be in for a rocky road ahead, I expect the shares of these companies to outperform the broader market over a 3-5 year horizon.