4 Stocks With Drivers On Wednesday: 2 With Upside Potential And 2 Facing More Weakness

Includes: AA, FCX, MDLZ, TSN
by: Efficient Alpha

Two of the most important economic reports of the week will be released before market open on Wednesday. Investors will be closely watching inflationary pressures in the Consumer Price Index for how much flexibility the Fed has at its meeting in September. Subdued pricing pressures in other sectors should help food processors pass costs on to customers, good news for large companies like Kraft (KFT) though high feed costs could hold back meat producers like Tyson Foods (NYSE:TSN).

The report on industrial production has been volatile over the last couple of months and in sharp contrast to the more negative tone set by the ISM manufacturing index. Investors may want to watch out for shares of metal miners as another negative print on industrial production would hit them harder than most.

No Worries for the Fed on Price Stability …

The consumer price index is set for release at 8:30 am and is expected to post a benign increase of 0.2% over the last month. Pricing pressures are up just 1.7% over the last year and should not give monetary authorities much argument against further stimulus measures. The Federal Reserve's dual mandate of a stable price environment and full employment means the group must balance any further easing against the potential for inflation. The Fed has set an inflation target of 2% this year in its first ever long-run goals and policy strategy statement.

Energy has been the biggest drag on prices lately reporting a decline in prices for three consecutive months. Softness in fuel and transportation prices have helped to offset increases in food, apparel and medical costs over the last few months.

A report by the Kansas City Federal Reserve Bank warned of higher inflation risks this year as an historic drought cuts yields to 17-year lows and pushes crop prices skyward. The report said that higher meat and dairy prices would most likely not be felt until next year and should have only a muted effect on overall prices. One interesting, and possibly tradable, idea from the report was that pricing pressures for meat products may actually fall for the remainder of the year as farmers sell off animals in the face of high feed costs. While the price of meat and dairy products is expected to rebound next year after the supply of producing animals is cut, a short-term price decrease would be good news for food processors.

Tyson Foods missed estimates for the second quarter with earnings of $0.50 per share, 8.7% higher than the same period last year. Revenue also gained 0.7% from the year before but the company's operating margin fell to 2.0%, well below the 3.2% average over the last four quarters. The company still has a stock repurchase program in place, though high feed costs may impair repurchases this year. Low consumer price pressures in other categories could help the company pass on some higher costs and help stabilize margins but revenue will still be under pressure.

Tyson obtained a $1 billion credit facility recently to help reduce its annual interest expense and strengthen its balance sheet. In the short-term, possible weakness in poultry prices and higher feed costs could put pressure on the shares and investors may want to hedge any positions with put options. The shares trade at 9.6 times trailing earnings and pay a 1.02% dividend yield.

Kraft Foods reported earnings roughly in-line with expectations though revenue fell to $13.29 billion in the second quarter, missing analyst estimates. The $72.8 billion packaged food producer left full year guidance at 5% revenue growth and said that its grocery business spinoff would occur in October. While revenue growth is relatively slow in the industry, the spinoff should help the two resulting companies focus on core products. The snacks business has better long-term growth prospects and can benefit from higher investment while the grocer segment should continue to be a stable dividend payer. Sentiment leading up to the spinoff could help boost shares already at their 52-week high. Shares trade for 17.1 times trailing earnings and pay a 2.83% dividend yield.

Another low print on the inflation report will be good news for food processors where margins are razor thin. Investors should look for names with long-term drivers like Kraft and avoid companies facing short-term headwinds like Tyson Foods.

Full Employment and Economic Growth is a Different Story

Industrial production is also due out before the opening bell with expectations of a 0.4% gain in July and little revision to the 0.4% gain reported in June. The June report was a welcome rebound from the disappointing 0.2% decline in May's initial estimate largely on weakness in manufacturing.

Manufacturing and mining both rebounded in June against weakness in the previous month, while utilities fell sharply after two months of strong gains.

Strength in industrial production data is at odds with recent weakness in the ISM manufacturing index which unexpectedly contracted in June for second consecutive month. New orders, production and exports all dropped to three-year lows and may foretell weakness in the rest of the economy.

Capacity utilization increased in June to 78.9% though it is still 1.4% below the long-term average. Manufacturing activity increased by 1.4% in the second quarter, well off the 9.8% pace set in the first quarter.

Freeport McMoRan (NYSE:FCX) reported that its second quarter net income fell by almost 50% to $0.74 per share on a 22.9% revenue decline and one-time charges of $53 million. Copper which accounts for the majority of sales, fell to a price of $3.53 per pound in the quarter against $4.22 per pound in the same period last year. The company also lowered its estimates for sales over the rest of the year. Shares trade for 10.1 times trailing earnings, slightly below the industry average, and pay a 3.52% dividend yield. The stock's relatively low valuation, high dividend and exposure to gold prices makes it a good choice against peers.

Alcoa (NYSE:AA) beat estimates for second quarter growth on higher demand from auto manufacturers though revenue slipped 9.4% in the quarter. The company lost $2 million in the second quarter versus a gain of $322 million in the same period last year. Management's estimate of strong growth in industrial inputs this year may be tough to meet if industrial production does not show consistent gains for the next few months. The shares trade for an expensive 31.5 times trailing earnings and pay a 1.36% dividend yield. Aluminum prices continue to slip and the support from the auto industry may be short-lived as economic growth moderates in the United States.

A weak report in industrial production could send shares of mining companies down sharply. Investors may want to hedge their exposure to the sector through covered calls or protective puts. Additionally, shares of relatively stronger names like Freeport McMoRan should withstand headline risks better than weaker names like Alcoa.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.