If you thought that 2011 was a bad year for the global economy, 2012 is starting to shape up as even worse. We are currently seeing the U.S. and Europe dealing with unprecedented debt problems, the end of China’s real estate bubble as key real estate markets cool, and the impending failure of the U.S. economic recovery. All of this is triggering further market volatility and governments worldwide to implement austerity programs.
For these reasons, many analysts are no longer predicting that 2012 will be the year of economic recovery but the one where we are headed for a double dip recession. If this does occur we will see company earnings and stock prices hit particularly hard in those industries that have the greatest exposure to declining corporate and consumer demand such as financial and retail stocks.
In order to ensure that you are able to weather such an eventuality, now is the time to start considering defensive investments, which will not only allow you to ride out the impending economic storm but continue to receive returns through dividend payments. After analyzing five stocks with betas of less than 1, price to earnings ratios of less than 15 and dividend yields of greater than 3%, I have found three that I believe are solid defensive stocks for 2012: Lockheed Martin (LMT), Eli Lilly (LLY), Terra Nitrogen (TNH) and two that aren't, GlaxoSmithKline (GSK) and H&R Block (HRB). As always, use my analysis as a starting point for conducting your own due diligence prior to making any investments.
Lockheed Martin Corporation (LMT)
Lockheed is the world’s largest defense contractor and the largest military aircraft manufacturer with a market cap of $26 billion. The company researches develops, manufactures, services and operates advanced technology systems and products in the areas of defense, space, intelligence, homeland security, and government information technology, both in the United States and internationally. It is the prime contractor on the largest ever defense contract, the $250 billion Joint Strike Fighter program.
The majority of Lockheed’s earnings are derived from U.S. Government contracts, and this has been historically high due to U.S. involvement in Iraq and Afghanistan, as well as the need to update aging and obsolescent defense equipment and systems. It has a 52 week trading range of $66.36 to $82.99 and since the start of 2011 has risen by 21% in value, to now be trading at around $81 with a price to earnings ratio of 9.
Lockheed saw a 5% rise in third quarter 2011 earnings to $12 billion from second quarter earnings of $11.6 billion, and during this period net income dropped by 6% to $700 million. However, for the same period Lockheed’s balance sheet strengthened with cash and cash equivalents rising 40% to $4.6 billion, although long-term debt rose 30% to $6.5 billion.
Lockheed stacks up well against its competitors, its return on equity of 86% is the highest in the industry, higher than both Boeing’s (BA) 85% and Northrop Grumman’s (NOC) 15%. It has revenue growth of 7%, which is higher than Boeings 4.5% and Northrop Grumman’s -6.5%. Lockheed’s dividend yield of 5% is also the highest in its industry and is greater than Boeing’s 2.4% and Northrop Grumman’s 3.4%.
With a dividend of $4 per share, which is a solid yield of around 5% combined with a history of consistently playing a rising dividend since 2003 that has increased by 590% to its current value, it is an ideal income-generating stock for investors. When this is combined with a moderately low beta of 0.86 it is an ideal defensive stock for weathering further market volatility and economic headwinds.
Despite trading at close to its 52 week peak, its earnings yield of almost 11%, which is more than triple current ten year Treasury bond yields, indicate that the stock is still undervalued at current prices. For all of these reasons I believe that at its current price the company is a solid defensive investment, which has growth potential as the economy improves, in particular if the U.S government were to increase defense and security spending.
Eli Lilly and Company (LLY)
Eli Lilly is one of the world’s largest pharmaceutical companies with a market cap of $44 billion. It develops, manufactures, and sells pharmaceutical products worldwide, distributing its products through independent wholesale distributors and directly to pharmacies. It is currently trading at around $41, having gained 24% since the start of 2011. It has a 52 week trading range of $33.46 to $42.03 with a conservative price to earnings ratio of 10.
Much of Eli Lilly’s earnings are relatively steady, although they are dependent on the company bringing newly developed drugs to market and maintaining patent protection over existing product lines. In October 2011 it lost patent protection for Zyprexa in the U.S. which will see generic competitors enter the market and erode Zyprexa’s market share, which will impact its earnings.
For the third quarter 2011 Eli Lilly reported a 2% drop in earnings to $6 billion from $6.3 billion for the second quarter and in the same period net income rose by 3% to $1.2 billion. Eli Lilly reported a stronger balance sheet in the third quarter with cash and cash equivalents rising by 8% to $6.6 billion, although long-term debt rose by 5% to $5.5 billion.
Eli Lilly stacks up well against its competitors, making it a probable Buffett stock. its return on equity of 34% is the third highest in its industry and higher than Bristol-Myers (BMY) 21% and Abbott Laboratories (ABT) 19%. The company has revenue growth of 9%, which is higher than Pfizer’s (PFE) 7.5% and GlaxoSmithKline’s (GSK) 7%. Its dividend yield of around 4.7% is the highest in its industry, equal to GlaxoSmithKline’s 4.7% and higher than Pfizer’s 3.6% and Abbott Laboratories 3.4%.
With its current dividend of $1.96 per share and solid yield of around 4.7% combined with a beta of 0.67 it is an ideal defensive stock for weathering further market volatility and economic headwinds.
It also has a strong balance sheet with a debt to equity ratio of 0.47, which bodes well for stock price and dividend stability. When this is considered in conjunction with a profit margin of 20%, which is the fourth highest in its industry, the company is generating a solid profit on sales and earnings all of which bodes well for future income growth.
Despite trading at close to its 52 week peak, its earnings yield of 10.3% is more than triple the current yield of ten year Treasury bonds, indicating that the stock is undervalued. For all of these reasons I believe that at its current trading price Eli Lilly is worthy of further investigation and analysis as a defensive investment.
GlaxoSmithKline PLC (GSK)
GlaxoSmithKline is the fourth largest pharmaceutical company in the world and it researches, develops, manufactures, and markets pharmaceutical and consumer health products worldwide. Since the start of 2011 it has increased in value by 24% to be currently trading at around $46, giving it a market cap of $228 billion. It has a 52 week trading range of $36.28 to $46.50 and an aggressive price to earnings ratio of 45.
For the third quarter 2011 GlaxoSmithKline reported a 5.7% increase in third quarter 2011 earnings to $7 billion. Net income also rose by 24% in the third quarter to $1.4 billion and the company reported a weaker balance sheet in this period with cash and cash equivalents dropping by 7% to $5.7 billion, although long-term debt remained steady at around $14 billion.
When compared to its competitors GlaxoSmithKline is performing quite strongly. Its return on equity of 35% is the second highest in its industry and substantially higher than Novartis’ (NVS) 15% and Merck’s (MRK) 7%. Its quarterly revenue growth of 9% is greater than Pfizer’s 7.5%, and Merck’s 8%.
With its current dividend of $2.17 per share, which is a solid yield of around 4.7% combined with a beta of 0.63 it appears to be an ideal defensive stock for weathering further market volatility and economic headwinds. It has a profit margin of 19%, indicating that the company is delivering a solid profit on sales and earnings, which bodes well for future income growth.
However, I am somewhat concerned by its high debt to equity ratio of 1.83, which doesn’t bode well for stock price and dividend stability.
Finally the company has an earnings yield of 4.5%, which is only marginally higher than the yield on ten year treasury bonds, indicating that at current prices GlaxoSmithKline is overvalued. While the company’s stock price is not particularly volatile and it does pay a solid dividend yield I do not feel that it is an ideal stock for a defensive play in 2012 unless its debt levels and stock price drop.
H&R Block Inc (HRB)
H&R Block provides tax preparation, retail banking, and various business advisory and consulting services primarily in the United States, Canada, and Australia. It has a market cap of $4.7 billion and since the start of 2011 has seen its stock price rise by 35% to be currently trading at around $16. It has a 52 week trading range of $12.31 to $18 and a price to earnings ratio of 15.
H&R Block’s 2011 third quarter earnings dropped by 88% to $257 million, from second quarter earnings of $2.3 billion and for the same period net income dropped by a massive 126% to -$175 million from $659 million in the second quarter. In the third quarter its balance sheet weakened with cash and cash equivalents dropping by 39% to $1 billion, although long-term debt improved, dropping by 3% to $1 billion.
When compared to its competitors H&R Block stacks up well, with quarterly revenue growth of 8%, and it also has the highest return on equity for its industry of 31% compared to an industry average around 12%.
H&R Block’s stock price is relatively stable with a beta of 0.5 and when this is combined with a dividend yield of 5% it presents as an ideal defensive stock for a volatile stock market. However, I am concerned by its high debt to equity ratio of 1.28, which when combined with a profit margin of -110% doesn’t bode well for future profit, stock price and dividend stability.
For all of these reasons, I don’t believe that H&R Block is an appropriate defensive investment due to its extremely poor profit margin and high debt to equity ratio and thus is not worthy of further research and analysis.
Terra Nitrogen Company L.P. (TNH)
Terra Nitrogen produces and sells nitrogen fertilizer products for agricultural and industrial applications. Since the start of 2011 its stock price has risen by 83% to be current trading at around $181.50, giving the company a market cap of $3.4 billion. It has a 52 week trading range of $101.21 to $199.50 and a price to earnings ratio of 13.
Terra Nitrogen, as other contributors have pointed out as a David Tepper favorite, has seen third quarter 2011 earnings rise 2.4% to $203 million and net income drop slightly by 0.4% to $128 million. Its balance sheet has weakened during this period, with a 6% drop in cash and cash equivalents to $144 million.
Terra Nitrogen stacks up well against its competitors with quarterly revenue growth of 49.5%, which is the fourth highest in the industry, and this is greater than Potash Corporation’s (POT) 47% and Monsanto’s (MON) 17.5%. Its return on equity of 182% is the highest in its industry and greater than Potash Corporation’s 39% and Monsanto’s 14.5%.
Terra Nitrogen has a solid profit margin of 63%, which is the highest in its industry, and in conjunction with its solid return on equity of 182%, indicates that it is able to cost effectively translate earnings into net income. It also has a debt free balance sheet combined with a very low beta of 0.30, which bodes well for profit and dividend stability. When this is considered in conjunction with a solid dividend yield of 9.2%, it is the perfect defensive stock that is not only well positioned to weather any further economic headwinds, but is able to deliver a solid income stream for investors, with a diminished risk of capital loss.
Finally despite trading at close to its 52 week peak the company has an earnings yield of 7.8%, which is more than triple current ten year Treasury bond yields, thus indicating that the company is undervalued even at its current price. Therefore, I believe the company is a solid candidate for additional research and analysis.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.