COVER STORY: Polished Performance by Michael Santoli
Highlighted companies: General Dynamics Corp. (GD), Merrill Lynch & Co. Inc. (MER), Dean Foods Co. (DF), Weatherford International Ltd. (WFT)
Summary: The DJIA is up 14.6% to 12,278 and in October hit a new all-time high. The Nasdaq Composite has gained more than 10%. Barron's interviews nine major Wall Street strategists and gets their predictions for the coming year, with a few stock picks. Some key points:
Related: Using P/E Ratios As Buy Signals, Is Stagflation on the Horizon For 2007?, Us vs. the Fed -- Who Drives the Market?, Falling Dollar: Who Stands To Gain?, Barron's Post-Election Sector Analysis, Barron's Q4 Analyst Roundtable
- Forecasters look for an average 8% gain in 2007, putting the S&P 500 at 1520 by year end. Each of the nine strategists is expecting an up-year for stocks, but the most ardent bull thinks the S&P will rise a paltry 13%.
- Goldman Sachs' Abby Joseph Cohen: "Share prices properly reflect a favorable fundamental picture for 2007. Growth is moderating, inflation pressures are abating and the [Fed] is expected to maintain a friendly stance." Henry McVey of Morgan Stanley: "Stocks look cheap relative to bonds at current levels."
- Interest rates: The bond market is betting heavily that the Fed wants to lower rates to head off a housing-induced slowdown, and assume that Bernanke's emphasis on continuing inflation threats is mere lip-service. Among the analysts, the most aggressive call for lower short-term rates is for the Fed to shave 1.25 points off today's 5.25% federal-funds rate in 2007 -- Michael Ryan of UBS and Goldman's Abby J. Cohen share this view. Tom McManus of Bank of America thinks the market is "overly confident" about the prospect of an imminent rate cut.
- Sectors: Emerging market demand may put continued pressure on commodity prices. This year 79% of earnings growth came from relatively low-multiple sectors: energy, financials, telecom, utilities and industrials. 2007 forecasts imply that 67% of growth will be generated by health care, technology and staples. Francois Trahan of Bear Stearns sees the market under pressure in early 2007 until the Fed satisfies investors' wish for a rate cut. At that point he advises buying tech and consumer-discretionary shares, typical early-cycle, bull-market leaders.
- Picks: Henry McVey of Morgan Stanley says he's hunting for companies with rising returns on equity, partly driven by greater balance-sheet leverage. With profit margins peaking, outperformers will separate from the pack. Examples given: General Dynamics (GD), Merrill Lynch (MER), Dean Foods (DF) and Weatherford International (WFT).
Scoop! Frothy News Shares by Andrew Bary
Highlighted companies: GateHouse Media Inc. (GHS) , Gannett Co. Inc. (GCI), The New York Times Co. (NYT), Tribune Co. (TRB), Dow Jones & Company Inc. (DJ), Yahoo! Inc. (YHOO), Google Inc. (GOOG), Lee Enterprises Inc. (LEE)
Summary: While other newspaper stocks head south, Gatehouse Media (GHS), an operator of small newspapers around the country entices investors with a high (6%) yield, double the payout of other big newspaper operators such as Gannett (GCI), New York Times (NYT), Tribune (TRB) and Dow Jones (DJ), pushing GHS shares up to $20.50 from an IPO price of $18. But Gatehouse's payout is misleading. GHS's P/E ratio is very high (37) compared to the rest of the industry (12-15), and its main appeal could be undermined if, say, Gannett decides to lift its dividend. With a market value of $800 million and net debt of $500 million, the highly leveraged publisher could have an even harder time dealing with the industry's twin woes of advertising and plummeting circulation. GHS's "hyperlocal" strategy of focusing on small town newspapers to avoid competing with the big national advertisers may be in jeopardy, as Yahoo! (YHOO) and Google (GOOG) start moving in on local markets. Analyst John Janedis of Wachovia gives GHS a mere 'Market Perform,' despite Fortress Investment's (who bought GHS a year ago for $10 a share) good record of taking companies public. Barron's Bottom Line: For those partial to small and mid-sized papers, Gannett and Lee Enterprises look like much better bets.
Related: A Newspaper IPO?! Gatehouse Media Bucks the Trend
A Victim of Myopia by Vito J. Racanelli
Highlighted companies: Alcon Inc. (ACL), Bausch & Lomb Inc. (BOL), Allergan Inc. (AGN), Advanced Medical Optics Inc. (EYE), Pfizer Inc. (PFE), Johnson & Johnson (JNJ)
Summary: While Alcon Inc. (ACL) is in the business of helping people see better, Wall Street's vision of its potential is suspiciously myopic: Shares are down 25% over the last year from $150 to $113 on recent earnings drops and the lack of 'new drugs.' But ACL is #1 or #2 in most of its markets, has a diversified portfolio, consistent results, and is well-managed, says Joanne Wuensch of BMO Capital Markets, who rates it "Outperform." It its favor: (1) Baby-boomers are turning 60, and cataracts, the world's leading preventable cause of blindness, occur in 1/2 of all 65-74 year-olds and about 70% of those older. (2) Size: Alcon is "the only fully integrated eye-care company, a one-stop shop," operating in pharmaceutical, surgical, and consumer products -- Tom Bridges of Geneva Investment. (3) Lens-care product recalls this year at Bausch & Lomb Inc. (BOL) and Advanced Medical Optics Inc. (EYE) spiked sales, and analysts see it holding much of it's gains. (4) A strong R&D program: It spends more than #'s 2, 3, and 4 combined (BOL, EYE and Allergan Inc. (AGN)). (5) Alcon has been showing good gains internationally, growing 18-20% in emerging markets, and 35% in Brazil, Russia and China, plus a major ramp-up in Japan. The downside: (1) Weak sales of its ReSTOR multi-focals, in which high prices have played a role. (2) Will Nestle, its 75% owner, decide to sell, dropping prices? (3) Johnson & Johnson (JNJ) recently indicated it wants to enter the contact-lens solution market, a 'formidable competitor.' On the other hand, it also indicates that JNJ feels the sector has promise. Barron's bottom line: Put Alcon's recent problems into perspective -- within two years, the company's shares, recently around 113, could be changing hands near 140.
Related: Who Gains, Who Loses From the Bausch & Lomb Recall?, JNJ: A Healthy Blue-Chip, Jim Cramer's Take on ACL
A Small Bet on Outsourcing by Tiernan Ray
Highlighted companies: Electronic Data Systems Corp. (EDS), Infosys Technologies Ltd. (INFY), Cognizant Technology Solutions Corp. (CTSH)
Summary: IT outsourcing stocks like Infosys Technologies Ltd. (INFY) and Cognizant Technology Solutions Corp. (CTSH) are flying so high this year (+35.2% and +59.7%) that it's hard to find a value exposure to the field. Now Electronic Data Systems Corp. (EDS), who has built a business on installing and maintaining computer systems for the U.S. Marines and General Motors Corp. (GM) among others, looks to be the next up-and-coming with its June $380m purchase of Mphasis, an Indian competitor of Infosys, giving it a diverse workforce of 20,000 across India, China, South America and Europe, and making it an interesting offshoring bet. While they're playing catchup with INFY and Indian firms, Eagle Global Advisors' Thomas Hunt III says Infosys has no competitive advantage EDS can't match, and that market share is Infosys' to lose; he sees net income rising from 2% to 6.5%. Outside of India, EDS boasts dozens of worldwide data centers, and thinks it can find the best skill/price combination in areas such as Eastern Europe, Latin America and Malaysia. Last month Fitch upgraded $3.1b of EDS debt from Stable to Positive, citing orders in excess of billings for the past three quarters, and a Q3 sales growth (6%) that was the highest y/y since 2002. EDS stock trades at $26.50, up 18% from recent lows, but still cheaper than a year ago. It's P/E are 19x expected 2007 earnings of $1.43, down from 23x last year. And it trades at a 36% discount to previous 12-months sales, vs. Infosys which trades at 7.5x.
Related: Accenture, EDS, Perot, Affiliated Computer: Stock Risk From Increased Outsourcing?, Electronic Data Systems Q3 2006 Earnings Call Transcript
John Malone's Dubious Deal by Mark Veverka
Highlighted companies: News Corp. (NWS), Liberty Media Capital (LCAPA), DirecTV Group Inc. (DTV)
Summary: According to rumors last week, News Corp. (NWS) will ink a deal to swap Liberty Media Capital's (LCAPA) $11b stake in NWS for News Corp.'s 38.6% stake in DirecTV Group Inc. (DTV). This leaves Veverka, an outspoken DirecTV bear, scratching his head. While it's true DTV has sharply boosted free cash flow and earnings, its documented customer service shortcomings point to a fundamental problem: satellite TV presents greater obstacles and expenses than digital cable. Subscriber growth has slowed recently because of a shortage of receiver boxes with digital video recording, causing DTV to delay dish installations and push potential customers towards cable. Liberty CEO Greg Maffei told investors last week that Liberty wanted the stake in DTV to compliment its cable content channels (QVC home shopping network and Discovery Channel), and that satellite provides a "national footprint" compared to cable's regional networks. Still, Veverka wonders, what's his boss, LCAPA Chairman John Malone -- the king of cable -- doing betting on the dish?
Related: News Corp. and Liberty Media Looking to Wiggle Out of as Much as $4.5 Billion in Taxes, News Corp-Liberty Media DirecTV Share Swap Nearly Complete, Making Sense Of The Liberty Empire: Part I, News Corp. Looks to Dump DirecTV, News Corp F1Q07 Earnings Call Transcript
The Disney-Apple Connection by Mark Veverka
Highlighted companies: Walt Disney Company (DIS), Apple Computer Inc. (AAPL)
Summary: Notwithstanding earlier rumors of a Disney/Apple merger, a recently published patent application filed by Walt Disney Company (DIS) is, "a small but tangible bit of evidence that a new era of cooperation" between the media giant and Apple Computer Inc. (AAPL) may be under way. The filing pertains to streaming-video technology for a Disney handset (flip phone?), and reads, "the systems and methods of the present disclosure may be applied to other mobile electronic devices...such as e.g. the iPod digital music player available from Apple Computer," suggesting that Apple and Disney are going to be cooperating in media ventures. Apple is expected to enter the mobile-phone market next year with its iPhone, and Disney still seems to want to pursue becoming a wireless provider through its Disney Mobile unit, leading Veverka to speculate, "Wouldn't those connected kids like to receive their High School Musical videos on a sleek new Apple iPhone?"
Related: Memo to Pixar and Dreamworks: The Animation Duopoly is Over, Forget the iTunes Store: Disney Offering Free TV Programing at ABC.com, Apple Begins Production Of iPhone, Will iTunes Lose Its Best Content?, Disney and Apple's Movie Success Means Competitors Must Get With the Program, Disney Aims to Capture iPod's 'Tween Market With New 'Mix Max', Walt Disney Company F4Q06 Earnings Call Transcript, Apple F4Q06 Earnings Call Transcript
Doctoring by BlackBerry? by Bill Alpert
Highlighted companies: Medtronic Inc. (MDT), Amgen Inc. (AMGN), Genzyme Corp. (GENZ), Wyeth (WYE), DexCom Inc. (DXCM)
Summary: Medtronic Inc. (MDT) shares are up 10% in the past two weeks on its latest quarterly sales figures, despite the fact that the increase was due to international sales (U.S. sales were down 4% y/y but up 12% q/q). CEO Art Collins says MDT can ramp up sales at a 15% pace for the next five years, doubling its present $11.3b revenues. The case: (1) Wireless telemetry which allows remote patient treatment should boost ICD (implantable cardioverter defibrillators) sales. (2) An aging population should spur sales of devices for spine, pancreas, and brain patients; MDT says biotech companies like Amgen (AMGN) and Genzyme (GENZ) are relying on Medtronic to deliver experimental drugs to targets in the heart or brain. (3) Its 57% U.S. market share is driven, according to doctors, by a strong brand loyalty. (4) Among its rivals Boston Scientific Corp. (BSX) and St. Jude Medical Inc. (STJ), only Medtronic has the cash-flow to develop/acquire the technology to detect heart-attacks before they happen. The company sees huge potential in implantable sensors that allow doctors to monitor patients without putting them in intensive care. Within two months Medtronic expects a FDA panel to review its application for 'Chronicle,' which wirelessly reports the blood pressure in the right ventricle of a patient's heart, giving doctors a week's warning to prevent heart failure by adjusting medication. VP Stephen Oesterle calls Chronicle, "the most important product we're going to release in the next five years," because it will pave the way for other wireless monitoring systems that reduce emergency room visits for patients with diseases like diabetes. "We're several years ahead of anyone on this stuff." Barron's: Shares could climb into the 60s as new products spur sales.
Related: Heartening Test Results May Pump ICD Makers -- Barron's, Medical Device Industry Breathes Sigh of Relief, Medtronic Raises Dividend for 28th Straight Year, Jim Cramer's Take on MDT
Nortel's Stronger Signal by Mark Veverka
Highlighted companies: Nortel Networks Corp. (NT), Alcatel-Lucent ADR (ALU)
Summary: Despite CEO Mike Zafirovski's exuberance, Nortel Networks Corp. (NT) shares have moved little in the last three years, and are down more than 25% in 2006. But the company, with a market value of $9.7b, may be reaching a turning point that's escaping Wall Street due to its tendency to underdetail its plans. Zafirovski's moves: 1) Settling $2b of litigation, 2) Recruiting 7 new direct reports and reducing management layers, 3) Restructuring pensions, 4) Renegotiating contracts with manufacturers on better terms -- moves Barron's terms "not glamorous but essential." Last week's reverse 10-1 stock split puts shares at $22.30, bringing them back under the radar of institutional funds. Operating margins, now at 1%, should hit 13% within five years. Also boosting shares this week was the closing of its radio-access UMTS branch sale to Alcatel-Lucent (ALU) for $320m -- analysts say the move will boost margins and earnings in 2007. Charter Equity analyst Ed Snyder says earnings next year could reach $2, and shares $30. Barron's: Bigger gains may follow.
Related: Ready To Wait For Nortel's Turnaround, Nortel May Sell Off Tomorrow On Reverse Split, Nortel May Never Recover Its Old Glory, Nortel Shareholders, Fasten Your Seatbelts, Nortel Q3 2006 Earnings Call Transcript, Jim Cramer's Take on NT
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