As 2012 gains momentum and business sentiment regarding the performance of the U.S. economy improves, now is the time to closely examine some large and mega-cap stocks that dominate their market sectors to determine if they are worthwhile investments. After applying my unique fundamental analysis I have found three stocks, Applied Materials (AMAT), Agilent (A) and Exxon (XOM), that I believe will perform strongly in 2012, one potentially risky but profitable play, AT&T (T), and one to avoid, St. Jude (STJ). As always use my analysis as a starting point for conducting your own due diligence prior to investing.
Applied Materials Inc
Applied Materials is a global leader in the semi-conductor industry, providing manufacturing equipment, services, and software to the semiconductor, flat panel display, solar photovoltaic (PV), and related industries worldwide. It currently has a market cap of $16 billion and is now trading at around $13 with a trailing PE of 9. It has a 52-week trading range of $9.70 to $16.93.
At this price I believe the company is quite undervalued and that this is a reflection of the weak demand for semi-conductors over the last 2 years. In my opinion the company should see a major improvement in its stock price during 2012 and now I will explain why.
Based on the numbers Applied Materials' outlook isn't that great. In fourth-quarter 2011 the company saw a 22% drop in earnings to $2.2 billion and a 4% drop in net income to $455 million. However, for this quarter its balance sheet strengthened with cash and cash equivalents rising 8% to $6 billion and long-term debt remaining steady at $2 billion.
But when we start looking at the company's key performance indicators its growth potential becomes clear, and as the table below shows, it is performing stronger in many respects than its competitors.
|Lam Research (LRCX)||0.53||6%||18%|
Based on the PEG ratio, Applied Materials has strong growth prospects and this also becomes apparent when we see its solid profit margin coupled with a strong return on equity. The kicker for me when considering the long-term growth potential of Applied Materials is the company's major stake in solar fabrication. This is highly likely to continue growing over time, given the increasing global focus on developing and implementing greener energy sources.
I also like the fact that some of Applied Materials' major customers are some of the biggest semi-conductor vendors and electronics manufacturers in the world, including Intel (INTC) and Samsung (SSNLF.PK). Therefore, any increase in semi-conductor and component demand should see a direct flow-through effect for Applied Materials.
However, coming back to the key ratios, it only gets better when we consider that Applied Materials has a conservative debt-to-equity ratio of 0.22 indicating a solid balance sheet. This bodes well for net income, dividend stability and free cash flow. The company also pays a handy dividend yield of around 3%, which is a rarity for a tech company.
At current trading prices Applied Materials appears to be unfairly discounted by the market, because it has an earnings yield of 12%, which is more than triple the current risk free rate. Despite Applied Material's fourth-quarter numbers not being that attractive compared with third-quarter 2011, it still delivered a solid 2011 profit of $1.9 billion. This is more than double its 2010 profit, which continues the upward trend in profit since 2009. I expect this trend to continue into 2012, especially as the semi-conductor industry has an increasingly positive outlook for this year. Now is the best time to get in before this stock makes its move.
Agilent Technologies Inc
Agilent is one of the largest manufacturers of bio-analytical and electronic measurement solutions to the communications, electronics, life sciences and chemical analysis industries. It distributes its products worldwide. The company has a market cap of $15 billion and is trading at around $44 with a trailing PE of 16. It has a 52-week trading range of $28.67 to $55.33. At its current price I believe that Agilent is undervalued by the market due to its strong financial performance and its key performance indicators and now I will show you why.
For fourth-quarter 2011, Agilent reported a 2% rise in earnings to $1.7 billion and a 12% drop in net income to $289 million. However, the company reported a stronger balance sheet in this period with cash and cash equivalents rising by 15% to $3.6 billion and long-term debt dropping by 11% to $1.9 billion. Overall, the company reported a profit for 2011 of $1 billion, which was almost double the profit reported for 2010.
I also feel that Agilent's key performance ratios indicate that the company has solid growth prospects and I have set these out in the table below, in order to compare them with some of its major competitors.
|Roper Industries (ROP)||0.54||15%||14%|
Agilent has a very favorable PEG ratio, and when this is combined with its solid profit margin and strong return on equity, I believe the company will continue to grow net income and deliver strong investor returns throughout 2012. This is further confirmed by its conservative debt-to-equity ratio of 0.51 that indicates a strong balance sheet with company operations primarily funded by equity. This reduces the risks of any cash flow disruptions triggered by interest rate rises or breaches of lending covenants.
Another highly appealing aspect of this company is that in January 2012 it declared its first ever cash dividend of 10 cents per share, which is good news for shareholders and indicates that the company is strongly placed financially. This gives the company a forward annual dividend yield of 1% and it now yields more by way of dividend than many of its competitors including Roper, Bio-Rad, Danaher (DHR) and Teradyne (TER).
Finally with an earnings yield of 7%, I believe the company is marginally undervalued by the market as this is more than double the current risk free rate of return, which is a fair risk premium. In my opinion, now is a great time to jump on board with Agilent as it starts to hit its straps and deliver solid investor value.
Exxon Mobil Corporation
I have long been a fan of Exxon the 'King of Oil,' due to its solid management, technological sophistication and geographic diversity. It is the world's largest publicly traded energy company, with a market cap of $401 billion and it engages in the exploration, production and transportation of crude oil, natural gas and petroleum products. It has operations in the United States, Canada, South America, Europe, Africa, Asia, and Australia. Exxon has a 52-week trading range of $67.03 to $88.23, and is currently trading at around $84 with a trailing PE of 8.
The company recently announced its fourth-quarter earnings for 2011, reporting a 9% increase in earnings to $122 billion, but a 9% drop in net income to $9 billion. This saw the company report total 2011 net income of $41 billion, which is now the third year in a row that net income has risen.
Exxon's key performance ratios indicate that the company has solid growth prospects and I have set these out in the table below in order to compare them with some of its major competitors.
Exxon has a very favorable PEG ratio, and when this is combined with its solid profit margin and strong return on equity, my opinion is that the company will continue to grow net income and deliver strong investor returns throughout 2012. I like the company's extremely conservative debt-to-equity ratio of 0.1, which indicates a strong balance sheet and bodes well for net income and dividend stability. It also indicates that the company is well positioned to cope with any further economic headwinds that may arise out of the ongoing fallout from the European debt crisis or a drop in demand from China.
Overall, the 2012 outlook for Exxon can only improve as it has recently commenced a restructuring of its operations in Japan, to reduce its exposure to the highly competitive, low margin Japanese refining industry. This will free up cash for investment in more profitable sectors of its operations. This would continue to propel Exxon's strategy of distancing itself from the downstream oil business, so that it can reposition itself to adapt to the boom in exploration for hydrocarbons, like shale gas and oil sands, which are now being exploited on an unprecedented scale in Australia, the U.S and Canada.
The oil price outlook for 2012 also bodes well for Exxon as Goldman Sachs has predicted that the oil price per barrel will rally as high as $120 for Brent crude by July 2012, which is around a 7% increase in price from current prices of $114 for Brent Crude. This, combined with an increasingly positive outlook for the U.S economy in 2012, coupled with high energy demand from China, can only bode well for the earnings of an oil and natural gas producer such as Exxon.
In my opinion, Exxon is a solid long-term play. While its dividend yield of 2% is nothing to write home about, it will provide investors with a consistent return on their investment. Finally, with an earnings yield of 10%, which is more than triple the risk free rate of 10-year Treasuries, I believe that at its current price the stock is undervalued by the market. It is for these reasons that I believe we will see Exxon deliver solid investor value during 2012.
AT&T, with a market cap of $177 billion, is the largest domestic telecommunications company in the U.S. It provides both wireless and wire line telecommunication services and related equipment to business and retail consumers within the U.S. and internationally. It has a 52-week trading range of $27.20 to $31.94 and is trading at close to its 52-week peak, at around $30, with a trailing PE of 45.
A near recessionary global economy coupled with corporate cost cutting and lower consumer discretionary spending has had a direct impact on both the earnings and margins of telecommunications companies, and this is no different for AT&T. It reported a 3% increase in fourth-quarter 2011 earnings to $33 billion and a 285% fall in fourth-quarter net income of -$6.7 billion. Its balance sheet weakened in the fourth quarter with cash and cash equivalents falling by 70% to $3.2 billion, although long-term debt dropped by 2% to $61 billion. For 2011 the company's net profit was $4 billion, which is almost a fifth of its 2010 net profit of $19 billion.
AT&T's key performance indicators especially in comparison with competitors do not make the company's growth prospects look that great as the table below shows.
It is clear from the comparison above that AT&T's key ratios do not deliver a compelling investment story for the company as they do not indicate a strong potential for growth over 2012. However, on a more positive note the company has a solid balance sheet as indicated by its debt-to-equity ratio of 0.61 and I have a preference for investing in companies with low debt-to-equity ratios of less than one. But ultimately it is now necessary to dig a little deeper to see whether AT&T can deliver investor value over this year.
What that investigation shows is that AT&T activated a record number of Apple (AAPL) iPhone's during the last quarter of 2011 and sold more than twice as many Google (GOOG) Android smartphones than it did in the same quarter one year ago. AT&T also spent considerable sums of money throughout 2011 updating and improving its network, expanding network size and removing black spots to improve call and data transmission quality. It also embarked on a focused program to improve customer service. These programs to date have had an impact on improving AT&T's overall performance but will take some time to have a marked impact, although this bodes well for AT&T's performance during 2012.
Finally, AT&T has an earnings yield of 2%, which is roughly the same as the risk free yield of 10-year Treasuries and doesn't allow for a risk premium over this rate. This makes AT&T a difficult company to judge; its numbers do not present a compelling investment story yet it has been positioning itself to improve performance, customer service levels and market share in 2012. I would be willing to take a risk on AT&T, as I believe that as its internal improvement programs gain traction we will see a marked improvement in performance.
St. Jude Medical Inc
St Jude is one of the largest medical device researchers and manufacturers in the world with a market cap of $13 billion. It develops, manufactures, and distributes cardiovascular and implantable neuro-stimulation medical devices worldwide, marketing its products through a direct sales force and independent distributors. It has a 52 week trading range of $32.13 to $54.18 and is currently trading at around $42, with a trailing PE of 16.
For fourth-quarter 2011 St Jude reported a 2% rise in earnings to $1.4 billion and a 28% fall in net income to $163 million. Its balance sheet strengthened during this quarter despite cash and cash equivalents dropping by 1% to $985 million, as long-term debt dropped by 7% to $2.7 billion. Its overall net profit for 2011 was $864 million, which is 5% lower than 2010.
St Jude's key performance indicators especially in comparison to its competitors are no particularly compelling as the table below shows.
Despite St. Jude's PEG ratio being less than optimal, it does have a solid profit margin and return on equity of 19%. This indicates to me that it is able to cost effectively translate earnings into net income. In addition, these earnings should grow as the U.S. economic recovery gradually gains momentum, despite the ongoing fallout from the European debt crisis.
I also find St. Jude's debt-to-equity ratio of 0.62 appealing as this indicates it has a solid balance sheet, which bodes well for net income and dividend stability as any rise in interest rates won't see additional cash flow being allocated to managing debt. It also means the company is not only strongly positioned for future growth, but is capable of weathering any further economic headwinds should they arise.
Sales in the company's key earnings generating product line, cardiac rhythm management sales, have declined during fourth-quarter 2011. This is concerning primarily as the company gets more than half of its sales from it cardiac rhythm management business.
When this is considered in conjunction with the broader picture of increased pricing pressure from hospitals, as they attempt to cut costs while maintaining patient care standards, combined with the likelihood of more potential cuts in government healthcare spending, it does not bode well for 2012 earnings for medical equipment manufacturers such as St Jude.
Finally, with an earnings yield of 6%, the stock appears fairly valued when compared with the risk-free yield of 10-year Rreasuries, as the margin of around 4% is the minimum I would seek when investing in a stock. Overall, despite many analysts giving St. Jude a median target price of around $45, I am not comfortable with the company and feel that there are better investment opportunities for 2012.