My Annual Top Ten Stock Picks For 2012: Part III

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Includes: LOCM, NCR, SDRL, VRTX
by: Chris Katje

This article marks the fourth annual year of providing a top ten list on Seeking Alpha of stocks I believe will outperform the market. This year the picks are divided into three articles as the analysis is lengthier than before. I hope you enjoy the picks and can use the information to do further research or make a winning pick for 2012. Start prices are from January 3rd, 2012. Analysts estimates and price targets are from Yahoo Finance. (Click here for Parts I and II)

Over the past three years my return has been:

2009: 10 Winners 0 Losers, +999% Total Return, Average 99.9%, Three Double Baggers
2010: 8 Winners 2 Losers, +329% Total Return, Average 32.9%, One Double Bagger
2011: 2 Winners 8 Losers, -113% Total Return, Average -11.3%

Local.com (NASDAQ:LOCM)

Industry: Internet

Start: $2.12

2012 Predicted Earnings: $.02

Price to Earnings: 106x

Price Target: $3.50

Analysts Target: $3.90 (3 Analysts)

Top Three Reasons to Buy:

1. Competes in High Growth Areas

2. Extensive Website Portfolio

3. Buyout Target

Local.com (LOCM) has been on my investing radar for over a year now. The company now trades under $3 making it affordable for a small time investor like myself to purchase a large number of shares. The company owns the local.com website along with Krillion, Spreebird, Screamin Daily Deals, and Rovion.

The company connects customers with local businesses though its collection of website properties. Local.com also owns 100,000 geo category websites to showcase the best of every city when searching the web.

Spreebird is a unique property that connects moms with deals that support their children’s schools.

The company has partnerships with Google (NASDAQ:GOOG), Yellowpages.com owned by AT&T (NYSE:T), and Yahoo (NASDAQ:YHOO). These partnerships ensure that when users search, local.com will have listing high in search results.

Along with search partners, Local.com also has contracts with many large media companies including newspapers, Disney (NYSE:DIS), and Scripps (NYSE:SNI).

The company has over $10 million in cash on the books, representing $0.46 per share. This is 22% of what shares traded for at the beginning of the year. Local.com does not pay a dividend and will not in the near term as it is focusing on growth through integrating current business segments and also acquiring similar companies. Through acquisitions, the company now competes directly with Groupon (NASDAQ:GRPN) with its Spreebird/Screamin Daily Deals segment.

The stock traded above $7 at the beginning of 2011 and I believe when investors look at the company’s segments they will see how undervalued shares are. Earnings for next year are hard to predict as only two analyst’s report earnings estimates currently on Yahoo Finance. One analyst predicts a loss of $0.39 per share and one predicts a nice profit of $0.43 per share.

As the yellow pages disappear and more people use the internet and applications on their phone to search for restaurants, attractions, and events. Local.com also has several patents which relate to location based advertising which could eventually provide the company with licensing fees and make it a large acquisition target. I don’t see a deal happening in 2012 but am thinking this company gets bought out by Yahoo, Microsoft, or Google in the next three years.

NCR Corporation (NYSE:NCR)

Industry: Information Technology

Start: $16.46

2012 Predicted Earnings: $2.18

Price to Earnings: 7.6

Price Target: $21.80

Analysts Target: $23.57 (7 Analysts)

Top Three Reasons to Buy:

1. New Reel Time Technology

2. Diversification from ATMs

3. Integration of Radiant Earnings

Over the last four quarters, NCR has beat analyst’s earnings per share expectations. Earnings surprises of 7.8%, 17.4%, 9.5%, and 12.8% have still not been rewarded by the open stock market. The shares traded as high as $20.97 in 2011 and I think shares are headed higher than that range in 2012.

NCR’s financial segment holds the number one position in banking ATMs with Wells Fargo (NYSE:WFC) and JP Morgan’s Chase (NYSE:JPM) unit among its largest customers.

The company’s new Reel Time technology platform is a great step into another segment. The technology helps movie theater companies track marketing efforts and concession sales.

A recent acquisition of Radiant Technologies in August expanded the company’s point of sale software division used by restaurants for ringing in orders, and tracking food costs and profit margins. The $1.2 billion acquisition further showed that NCR wants to branch away from just being an ATM maker and operator. Radiant was on my investing radar for a long time, as the restaurant I manage uses software from the company. The deal with Radiant brought key customers including: Exxon Mobil (NYSE:XOM), Chipotle (NYSE:CMG), Kroger (NYSE:KR), and Nordstrom (NYSE:JWN) who all use the Radiant software in their retail and hospitality operations. The company’s software holds the number one market position for casual dining restaurants.

With the acquisition NCR now is the number one player in retail self-checkout. Customers for this service also include Lowes (NYSE:LOW), Macy’s (NYSE:M), and Wal-Mart (NYSE:WMT). The hospitality segment holds McDonalds (NYSE:MCD) and Yum Brands as its two largest customers. Six of the ten fastest growing restaurant chains use Radiant’s software. The company holds the number two position in the DVD kiosk segment thanks to a large deal with Blockbuster (NASDAQ:DISH).

The airline industry relies on software from NCR for its self check-in terminals. Five of the top six airlines use the company’s products including: US Airways, Delta, and Continental.

The company’s growing diversification away from ATMs is how it landed a place on my top ten list. I think 2012’s earnings will beat expectations as the Radiant numbers finally are counted. Look for many new deals to be signed especially the new Reel Time technology platform.

Seadrill (NYSE:SDRL)

Industry: Oil

Start: $33.18

2012 Predicted Earnings: $3.22

Price to Earnings: 10.3

Price Target: $40.00

Analysts Target: $38.69 (13 Analysts)

Top Three Reasons to Buy:

1. Dividend Yield

2. Newer Rigs

3. Increased Drilling in Deepwater

Seadrill first came on my radar while running screens for dividend income. The company paid out $3.14 in dividends per share in 2011, representing a yield of almost 10% at today’s prices. In 2010 the company paid out dividends for three of the four quarters. The company has borrowed against credit lines to secure the newest fleets in the drilling business and is able to offer great units to leading oil companies. The income from the units is then returned to shareholders in the form of dividends. As long as oil stays high and demand for the company’s rigs continues, I believe this is a safe pick for 2012. I think the company has limited upside due to its debt and worries from investors but I think the dividend yield will remain and provide a nice safety to income investors.

Digging in to the company’s third quarter earnings report (November 30th, 2011) on Seadrill’s website I found the following:

Floaters ($9.3 billion backlog)

2012 – 96% contracted

2013 – 73% contracted

2014 – 52% contracted

Jack-ups ($2.5 billion backlog)

2012 – 71% contracted

2013 – 27% contracted

2014 – 26% contracted

Tender Rigs ($1.7 billion backlog)

2012 – 95% contracted

2013 – 59% contracted

2014 – 41% contracted

The company pointed out the expansion into new geographic regions as a strength and I think this is definitely the case for 2012 as oil prices rise once again. There is high demand for deepwater drilling devices to locate oil. The company has a strong backlog of contracts with major oil companies Exxon Mobil (XOM), Statoil (NYSE:STO) BP (NYSE:BP), Petrobras (NYSE:PBR), and Chevron (NYSE:CVX). All these large oil companies can afford to rent the Seadrill equipment for years to focus on locating oil.

The company had the following as of November 30th, 2011:

-17 Ultra Deepwater Units (all built since 2000)

-2 Mid-Water Semi (1 built since 2000)

-22 High Specification Jack-ups (20 built since 2000)

-20 Tender Rigs (13 built since 2000)

Seadrill also has ownership stakes in Ensco (NYSE:ESV), Asia Offshore, Archer, North Atlantic Drilling, and Sapura Crest Petroleum. The company is working with Sapura Crest Petroleum to further its expansion in Brazil and may consider splitting off its Brazilian drilling unit to shareholders to take advantage of a separate company’s leverage in Brazil.

The company competes with Diamond Offshore (NYSE:DO) and Transocean (NYSE:RIG). Both companies have a larger base of units but their drilling devices are not as modern, giving Seadrill a competitive advantage to customers around the world.

Vertex (NASDAQ:VRTX)

Industry: Biotechnology

Start: $33.21

2012 Predicted Earnings: $4.55

Price to Earnings: 7.3

Price Target: $55.00

Analysts Target: $48.53 (19 Analysts)

Top Three Reasons to Buy:

1. New Cystic Fibrosis drug

2. Full year of Incivek sales

3. Shares beaten down in 2011.

My pick in 2009 of Dendreon (NASDAQ:DNDN) was a make or break based on FDA approval. Unlike Dendreon, Vertex already has a product on the market and the FDA approval will be an added bonus. Shares will drop if not approved but it will not lead investors to question if the company can make it or their future cash burn. In April, the Food and Drug Administration is expected to make a decision on Vertex’s cystic fibrosis drug known as Kalydeco.

Kalydeco would be the first drug on the market to treat the protein defect which leads to cystic fibrosis. In December, Vertex announced that the drug had been given priority FDA review of six months rather than the typical ten month waiting and review period. Cystic fibrosis currently affects 30,000 people in the United States and 70,000 people worldwide. The drug will target a small percent of those affected likely in the 1,000s.

Gilead’s (NASDAQ:GILD) buyout of Pharmasset (VRUS) for $11 billion showed how important the Hepatitis C market is to large drug companies. After the deal, shares of Vertex fell as the competition in the Hepatitis C market became more clearly laid out. The difficulty here is that Vertex is now trading with a market capitalization of under $7 billion. Vertex has an approved potential blockbuster drug and is trading with a lower value than Pharmasset, which is where I see huge value in shares.

In an article I wrote about Gilead’s Pharmasset buyout I predicted Gilead would double its market capitalization by 2020 thanks to new hepatitis drugs. In that same article I also pointed out that Vertex would enjoy several years of leading market share in the Hepatitis C drug marketplace before the PS-7977, now owned by Gilead, hits the market assuming it is approved by the FDA. Annual sales for Incivek are predicted to be $2 to $3 billion each year until that time. There is also the potential that PS-7977 does not get approved or is delayed, which could send Vertex shares soaring. This potential is more long term for Vertex shares rather than why it was selected for the top ten stocks for 2012.

The third quarter, reported for Vertex in October, saw sales of Incivek at $420 million. This was the first full quarter for sales of the drug. The second quarter saw sales of $75 million during a short period of approval. During that same quarter the company announced the approval and availability of Incivek in Canada, United Kingdom, Germany, France, Sweden, and Japan.

The company has a strong drug pipeline which includes drugs aimed at Epilepsy, Rheumatoid Arthritis, and Influenza. I believe 2012 is the perfect time to get in on this growing company before it soars back to its $55 level seen in 2011.

Disclosure: I am long ATVI, F, IMAX, DNDN.