By Matthew Smith
Concerned that the expected economic recovery won’t occur in 2012, triggering another market sell off? Then I share your concern as many analysts are giving conflicting information about the direction of the market and the economy. Many have expressed a cautiously optimistic view that the market will perform better in 2012. The Federal Reserve Bank of Philadelphia found in a recent report that; “on average economic forecasters predicted real GDP growth in 2012 of 2.4 percent and unemployment to be around 8.8 percent.” The key driver of this increasingly gloomy outlook for 2012 is the European sovereign debt crisis, which many analysts believe will drag out for longer than expected and will have an impact on the US economy.
So if you too are concerned about renewed recessionary fears then it is important to consider adding some defensive stocks that provide opportunities for both growth and income. After an exhaustive analysis I have found five stocks that I believe are low risk as they have betas of less than 1 and a PE of less than 15. In this article I will provide you with my unique fundamental analysis of five of these stocks to determine whether they are worthwhile defensive additions to your portfolio. Please use my research as a starting point for your own due diligence as more in depth analysis should be utilized to come to a final investment decision.
British American Tobacco Plc (BTI)
British American Tobacco is the second largest tobacco maker in the world, witha market cap of $92 billion. It operates worldwide, with operations in the Asia-Pacific, the Americas, Eastern and Western Europe, Africa, and the Middle East. It recently increased its presence in South America through the acquisition of Colombia’s second largest cigarette manufacturer Protabaco. Its 52 week trading range is $72.59 to $96, and it is currently trading close to its 52 weeks peak at around $93, with a price to earnings ratio of 18. It has quarterly revenue growth of 2%, a return on equity of 39% and pays a dividend with a yield of around 3%.
The sluggish global economy, negative consumer sentiment and increasing regulatory pressures have been applying a lot of pressure to tobacco companies directly impacting their earnings and it is no different for British American Tobacco. Under British accounting laws it is not required to report on a quarterly basis but on a semi-annual basis. It reported first half 2011 earnings of $7.4 billion, a 2% decrease from second half 2010 earnings of $7.6 billion. However, through management driving increased cost cutting and operational efficiencies, the company increased net income by 39% for the first half 2011 reporting $1.9 billion, up from $1.4 billion for the second half 2010. However, its balance sheet has weakened with cash and cash equivalents dropping by 25% to $2 billion for the first half 2011, a decrease from $2.5 billion in the second half 2010.
British American Tobacco does not compare well to its competitors. It is being outperformed by Philip Morris International Inc (PM), which has a market cap of $135 billion and is currently trading at around $78, with a price to earnings ratio of 17. It pays a dividend with a yield of 4%. Its quarterly revenue growth of 26% is greater than British American Tobacco’s 2% and its return on equity of 179%, is substantially greater than British American Tobacco’s 39%. British American Tobacco is also underperforming many of its industry competitors with quarterly revenue growth of 2%, versus an industry average of 6%, and a return on equity of 39%, versus an industry average of 57%.
All told though, I believe that British American Tobacco remains a solid defensive investment, thanks primarily to its size, global presence and ongoing cost reduction initiatives, which should see an improvement in margins. In addition, not only does it pay an attractive dividend with a yield of 2.5%, but it has posted solid results over the past several quarters, despite the difficult economic environment across much of the world.
It currently has a profit margin of 20% and earnings per share of $3.57, both of which are the highest in the tobacco industry. From a pricing perspective it is a relatively stable stock, with a beta of less than 1. However, long-term investors should be cautious as the risk of regulatory concerns will persist and in the long-term this will eventually have a direct impact on earnings and profitability. I wouldn’t be fixated on buying the stock for value alone but rather for its strong profit margin and earnings. British American Tobacco warrants further investigation as a defensive addition to your investment portfolio.
Reed Elsevier NV Plc (RUK)
Reed Elsevier provides information solutions in the areas of science, medical, legal, risk, and business sectors primarily in North America and Europe. The company appears to be a little too dull for its own good not attracting the interest from analysts that its performance justifies. It has a market cap of $9.5 billion and a 52 week trading range of $29.32 to $37.91. At the time of writing it is trading at around $32, with a price to earnings ratio of 17. It has a return on equity of 38% and pays a dividend with a yield of 2%.
Overall the numbers for Reed Elsevier are solid, especially when considering the difficult economic environment. It reported a 6% drop in first half 2011 earnings, which were $1.5 billion compared to second half 2010 earnings of $1.6 billion. First half 2011 net income rose by 15% to $199 million, from $173 million for the second half 2010.
Reed Elsevier compares very favorably to its industry competitors, outperforming Meredith Corp (MDP), which has a market cap of $1.5 billion and is trading at around $33, with a price to earnings ratio of 12. Meredith has quarterly revenue growth of -4.3%, a return on equity of 17% and pays a dividend of 5%, all of which are lower than Reed Elsevier. Reed Elsevier also compares quite favorably to it industry, with no quarterly revenue growth, versus an industry average of 14% and a return on equity of 38%, versus an industry average of 26%.
Reed Elsevier presents as a solid defensive stock, with low price volatility having a beta of less than 1 and pays a dividend with a yield of 2%. The company is delivering a solid return on equity of 38% and a profit margin of 12%, both of which are the highest in its industry. For all of these reasons I would have no hesitation utilizing Reed Elsevier as a defensive play and it is a good candidate for further research.
Psychemedics Corp (PMD)
Psychemedics Corporation provides testing services for detecting abused substances through the analysis of hair samples primarily in the United States. The key markets for the company’s services are employers for applicant and employee testing, as well as physicians, treatment professionals, law enforcement agencies and school administrators. In a sluggish economy with high unemployment, which is currently at 8.6% and with companies reducing or even freezing recruitment as part of cost cutting initiatives Psychemedics is likely to experience a decrease in earnings. It has a market cap of $48 million and a 52 week trading range of $6.85 to $11.12. It is currently trading at around $9, with a price to earnings ratio of 14. It has quarterly revenue growth of 24%, a return on equity of 33% and pays a dividend with a yield of 6%.
In the third quarter 2011 it reported a 1.4% increase in earnings, reporting $6.3 million, an increase from second quarter earnings of $6.2 million. It also reported a 1% increase in net income for the third quarter of $1.1 million, an increase from the second quarter net income of $1 million. Psychemedics has strengthened its balance sheet increasing its cash and cash equivalents by 34% to $3.5 million in the third quarter 2011, from $2.6 million in the second quarter.
Psychemedics also stacks up well against its competitors. One of its competitors is Bio-Reference Laboratories Inc (BRLI), which has a market cap of $377 million and is trading at around $13.50, with a price to earnings ratio of 11. It has quarterly revenue growth of 22% and a return on equity of 21%, both of which are less than Psychemedics. It is also performing quite well when considered in comparison to its industry. Its quarterly revenue growth of 24%, versus an industry average of 16%, and a return on equity of 33%, versus an industry average of 1.5%, indicates that it is out performing many of its competitors.
When we dive deeper into the numbers, Psychemedics becomes an even more compelling investment. It has solid earnings per share of 26 cents, which is the ninth highest for its industry segment, along with a healthy profit margin of 17%, which is the fourth highest in its industry segment. Its solid return on equity of 33% is the highest for its industry. I also believe that Psychemedics is relatively cheap when its earnings yield of 8% is compared to the current ten year bond yield. For all of these reasons I think that Psychemedics is a solid defensive buy which offers low price volatility, having a beta of less than 1, a solid balance sheet with no debt and a very attractive dividend yield of 5%. This makes the company a strong candidate for further in-depth research.
Pacific Gas & Energy Corp (PCG)
Pacific Gas operates as a public utility company in northern and central California, operating in the fields of electricity and natural gas distribution, electricity generation, electricity transmission and natural gas procurement, transportation, and storage. It has a market cap of $17 billion and a 52 week trading range of $36.84 to $48.54. It is currently trading at around $41, with a price to earnings ratio of 16. It has quarterly revenue growth of 10%; a return on equity is 9% and pays a dividend with a yield of 5%.
Pacific Gas increased third quarter earnings by 5%, to $3.9 billion, from $3.7 billion for the second quarter. However, third quarter net income decreased by 45% to $200 million, from $362 million in the second quarter. Pacific Gas’ balance sheet has also weakened in the third quarter with cash and cash equivalents dropping by 6.6% to $670 million, from $717 million in the second quarter.
The company stacks up well when compared to its competitors outperforming Edison International (EIX), which has a market cap of $13 billion and is trading at around $41, with a price to earnings ratio of 14. Its quarterly revenue growth of 5%, return on equity of 8% and dividend yield of 3% are less than Pacific Gas. When compared to the overall performance of its industry, Pacific Gas is performing quite strongly. Its quarterly revenue growth of 10%, versus an industry average of 6% and a return on equity of 9%, versus an industry average of 11%, all of which show that it is generating stronger revenue growth than many of its competitors but is lagging on return on equity.
When we dive deeper into the numbers, Pacific Gas becomes even more compelling as an investment. The company is currently trading at a price that is marginally higher than its book value per share of $30.36, which is the fourth highest in its industry. The company has earnings per share of 50 cents and a solid return on equity of 9%, which is the fourth highest in its industry segment. I also believe that Pacific Gas is relatively cheap when compared to current ten year bond yields, with an earnings yield of 6%. The company’s stock price is very steady and is not volatile with a beta of less than 0.5. When all of this is considered, it is clear that Pacific Gas is a solid defensive stock especially when the handy dividend of $1.82 per share, which is an attractive yield of 5%, is considered. Based on the numbers and performance indicators discussed above I’d normally have no hesitation suggesting that this stock is a worthwhile addition to any portfolio. However, in early December 2011 the company accepted liability for the fatal San Bruno Pipeline blast and as it has yet to clearly quantify that liability, I believe it is best to wait until this has been disclosed to the market. Therefore, I prefer a wait and see approach with this company.
Universal Corporation (UVV)
Universal Corporation is a leaf tobacco merchant and processor primarily in North America, South America, Africa, Europe, and Asia. It selects, buys, processes, packs, stores, supplies, ships, and finances leaf tobacco. It has a market cap of $1 billion; a 52 week trading range is $35.02 to $47.70 and is currently trading at around $46, with a price to earnings ratio of 15. It has a return on equity of 8%, quarterly revenue growth of -3.5% and pays a dividend with a yield of 4%.
The company has reported a 34% increase in earnings with third quarter 2011 earnings of $641 million, an increase $479 million for the second quarter. It reported a 151% decrease in third quarter net income to -$8 billion, from $16 billion for the second quarter. Universal Corporation’s balance sheet also weakened in the third quarter, with cash and cash equivalents decreasing by 51% to $45.5 million, from $94 million in the second quarter
When compared to its competitors Universal Corporation is performing quite strongly outperforming Alliance One International Inc (AOI). Alliance One has a market cap of $245 billion and currently trades at around $3. It has quarterly revenue growth of -8% and a return on equity of -30%, all of which are lower than the respective performance indicators for Universal Corporation. Universal Corporation is also performing better than many of its other industry competitors with quarterly revenue growth of 2%, versus an industry average of 0%, and a return on equity of 12%, versus an industry average of 8%.
On a deeper analysis of the numbers, Universal Corporation becomes an even more favorable defensive investment. It has a healthy debt to equity ratio of 0.51 and a solid return on equity of 26%, which is the fourth highest for its sector. I also believe that Universal Corporation at current prices is relatively cheap when compared to ten year bond yields, with an earnings yield of 6% and it is also trading only slightly higher than its book value per share of $41.12. I also like Universal Corporation’s stronger balance sheet as it has decreased long-term debt in the third quarter 2011 by 6.7% to $300 million, from 322 million in the second quarter, leaving it with an impressive debt to equity ratio of 0.51. I believe this firmly places the company in a position to grow earnings in a difficult economic environment, as well as being a good indicator that it can maintain its handy dividend payment of 1.96 cents, which is an attractive yield of 5%. For all of these reasons I believe that Universal Corporation is a solid defensive investment and that it is worthy of additional consideration.