8 Stocks You Need To Own In 2014 With 25%+ Upside

by: David Ristau

Top 8 Picks for 2014

Each year, we like to select our top stocks for the year. This year, we are going with 8 core names from different sectors along with two honorable mentions. The top eight this year are the following:

Apparel - Quiksilver (NYSE:ZQK) and VF Corp (NYSE:VFC)

Beverages - Reed (NASDAQ:REED)

Chemicals - PolyOne (NYSE:POL)

Discount Retail - Dollar General (NYSE:DG)

Restaurants - Yum! Brands (NYSE:YUM)

Technology - Stratasys (NASDAQ:SSYS) and Equinix (NASDAQ:EQIX)

Automotive - Ford (NYSE:F) Honorable Mention

International - Netease (NASDAQ:NTES) Honorable Mention

This year, we have picked these eight companies for their combination of growth with value as well. We like these names to all appreciate 20% or more this year with limited risk in each name. For each, we will discuss the company's main catalysts, and how to price the company.


Main Catalyst

The company is in the midst of a major overhaul to restore profitability and grow sales again. The company has not had positive EPS since 2004. The plan of action is very well laid out by the company on their website already here. The key ideology by the overhaul was to cleanse the company of unprofitable segments, reduce SG&A costs, streamline the business, and refocus on the company's core business. Quiksilver has three main brands: Quiksilver, Roxy, and DC. The three brands market to three different aspects of the action sports industry. Quiksilver is a surf and surf lifestyle brand. Roxy is a general female action sport line, and DC is a skateboarding-based brand.

ZQK's most important plan has been to rededicate these brands to their core and original success. Since new CEO Mooney came into office, the company still has not seen a dramatic benefit to their brand. The problem for the company is that designs for the brands were already out through several seasons, and the company would not be able to see dramatic improvements to the lines until the fall of 2014. The company hopes to create more brand strength by divesting their non-core products, globalizing product design (so that products are similar across all regions), and licensing secondary and peripheral products. By creating brand strength, the company believes that they can create better growth and redefine what Quiksilver stands for.

Prior to Mooney, there were 30,000 SKUs that were being produced with many differences from country-to-country as each acted as a separate entity (with only around 4000 of these SKUs actually creating a profit). The company has appointed Eric Kergolot as a global leader for retail stores and Nicolas Foulet as the global leader for e-commerce. By appointing these global leaders along with others, the company is globalizing their brand.

We believe that 2014 will start to see fruits of their labor making a major impact.

Price Target

For 2014, we are projecting the following:

Revenue: The company believes they will see a CAGR rate of revenue at 2.5% by 2016. The company has not grown revenue in five years, and they will continue to see a dip through 2014 as the company continues to reinvest in the brands, loses certain lines, and closes down stores. Yet, in 2015, we should start to see the turnaround in revenue. By 2017, we could see 5-10% growth in revenue again, putting the company at approximately, $2.1B - $2.2B by 2017. Revenue will likely drop to $1.9B in 2014 based on the cuts and start to build again in 2015.

Margins: Income, though, is a place where the company can likely start to see better margins more quickly. In fact, the company already started to see better margins in the latest quarter. The company is focusing in on several initiatives that will create better profits like cutting down on SKUs that are unprofitable, globalizing the business that is fragmented by country divisions, and closing unprofitable stores. The company believes they can get EBITDA to 13% of revenue by 2016. Currently, that level sits at 11%. The company has not seen their labor pay off yet, but it's still early in the game. With these calculations, however, the company should likely see EBITDA at around $280M by 2017.

Capital Expenditures: These should likely decline as the company wants to cut costs and bring down expenses, but we may start to see them cycle back up in 2016-2017.

We used these numbers in a discounted cash flow analysis model and were able to come up with a price target of $12. The company has significant upside still left. While investors are still wary about this company's turnaround, they seem to be taking every move the right way to take their company back to where it needs to be.

2014 Price Target: $12

Potential Price Appreciation: 33% Potential

VF Corp

Main Catalyst

VF is one of our favorite companies because they have very strong brand lines that people will continue to buy - North Face, Vans, and Timberland. The company is very enticing with a current five-year plan that is positioning the company for sales growth and margin expansion. Under this five-year growth plan, the company will do the following:

· Drive cash flow, increase dividends, and share repurchases

· Expected to grow revenue to over $17B by 2017 (CAGR 10% per year)

· EPS to grow to 18.00 by 2017

· Outdoor and Action Sports will see revenue grow to $11.1B by 2017 to 64% of the company's total revenue (expects 11% CAGR per year)

· Jeanswear growth at 4% per year

· Sportswear growth of 8% per year

· Online and direct-to-consumer growth to 14% per year

· Open 645 stores in the next five years

In the company's latest quarter, they saw revenue up 5%, Outdoor and Action Sports revenue up 6%, International up 7%, and Direct-to-Consumer up 14%. The company announced a 4-to-1 stock split as well, and they drove their dividend up over 20%. So far, the company is still coming up a bit light on their five-year plans, but these plans were for five-year rates, and they are only a few months into it.

We believe that this five-year plan even if not executed completely is still not valued correctly. Two signs of this are their 20 future PE as well as PEG at 1.9. For a company that is growing at a strong rate with great profitability, we believe that VFC has a lot of promise.

Price Target

For 2014, we are projecting the following:

Revenue: The company looks like they will see another strong year of growth with continue upside in their core business with CAGR at 10%, reaching $17B by 2017. The company should be looking at $11.5B - $12B in sales in 2014, but those sales will accelerate more quickly in 2015-2017 as the company opens more stores and increases online branding.

Margins: After the latest earnings our expectations are for 2017 operating income to be at $2.64B versus our previous expectation at $2.55B, as operating margin looks likely to be at around 15.5% in 2017, slightly higher than our original expectation. The company is increasing margins at a slightly faster rate than we had expected.

With these changes and the strong execution, our model now prices VFC at $85 price target, meaning there is a ton of upside left in shares over the next twelve months.

2014 Price Target: $85

Potential Price Appreciation: 37% Potential


Main Catalyst

For Reed's, the catalyst for this company is fermented tea - kombucha. Most of the potential upside in shares comes from the opportunity that the company has in kombucha. Kombucha is simple. It is fermented tea that has a carbonated taste with hints of alcohol. The company started selling kombucha under their Culture Club logo in 2012, and the upside is tremendous. The company sold 750K bottles in 2012 and expects to sell 7.5M in 2013. The company is seeing a lot of success at picking up distributors, and they have probably one of the brightest stars in the industry given their strong distribution network and established business lines already from their Reeds Ginger beverages. Being able to work with clientele that they already have and bring this high growth and wanted beverage into those locations is causing a lot of early success that we see continuing on a multi-year trend.

In the company's latest quarter, they saw 75% increase in volumes for kombucha sales year/year, and the company is really just getting started a little over one year into the industry. In fact, the company is having so much success with the product that their current production appears unable to meet demand, and they are starting to look for some third party companies to help production. According to Nelson data, kombucha will grow 70% in 2013, and the main reason is that kombucha is making the move from the natural foods market to the mainstream market.

Some of the recent developments for the company suggest a similar action. In the past three months, the company has announced their Culture Club will be sold in 176 stores in the Midwest through Jewel-Osco stores, 81 stores in Wegmans, and 1000 stores of Kroger (NYSE:KR). The company has gained access to 1500 stores in Q2 of 2013 and 1200 stores in Q3 of 2013. What is great is to see is that the company is also going into these new markets despite the fact that the company is new to the market. The current leader GT's has been around for years, but REED is using their success with their other products to propel themselves into the kombucha industry and gain shelf space. Many of these companies are moving into kombucha for the first time and working with REED right off the bat.

Moving forward, the potential for kombucha trends are amazing. Two things are going to develop for REED - growth of kombucha and growth of the production capabilities of REED. The company spoke many times in their latest quarterly report of production issues causing them to not reach their maximum potential. They also mentioned that they are spending a lot of money to improve efficiencies. The kombucha is only produced in REED's West Coast facility currently, but they are looking to expand it to their East Coast facility and move some simpler products out to allow for larger kombucha production. As the production issues become less intrusive, margins should grow as well as volumes.

Price Target

For 2014, we are projecting the following:

Revenue - From 2013 to 2017, we see growth at $38M to $81M with a CAGR of just 23%. The company is growing well above these rates currently, and kombucha appears ready to explode over the next 1-2 years at a much higher rate. In our model, we saw around 30% growth in 2014 and 2015 with growth decreasing into 2016 and 2017 as comps become larger and kombucha likely sees its growth start to diminish.

Margins - Margins should continue to expand. We believe costs of goods will stay fairly constant but gross margins will expand as the company produces more bottles for each production line and can likely start to see COGS-to-revenue decrease. SG&A will start to take a smaller part as production increases and operating margins should expand at a faster rate than gross margin. We see no operating income in 2013 but it bouncing to $6M in 2014 up to $11M in 2017. The company has noted a lot of upfront costs hurt operating income in 2013 due to marketing and sales team growth.

Capital Expenditures - For now, we expect these will stay relatively in tandem and neutralize each other as far as cash flow. The company should see both rise as their production facilities depreciate and the company increases capex to likely acquire new facilities or do some share repurchasing.

2014 Price Target: $10

Potential Price Appreciation: 25%


Main Catalyst

The main catalyst for PolyOne is their acquisition of Spartech. Not because of what it adds to the company in the sense of revenue, but what PolyOne can do with Spartech's business and create significant growth off of it. PolyOne uses a four-pillar strategy to every part of their business that includes specialization, globalization, commercial, and operational excellence.

Spartech's acquisition helped the company increase specialization first off. With Spartech, the company was able to add Spartech Custom Sheet & Rollstock, packaging solutions, and specialty compounds. The three working together are very interesting. First off, PolyOne before this did not have any exposure to custom engineered solutions or packaging. With this acquisition, The company now offers significantly more in packaging with consumer and medical packaging as well as gets into aerospace and security products. The acquisition has already done well to add the specialty exposure that the company wants. What PolyOne wants to do with the company though is improving operational excellence as well as globalize the company.

When PolyOne acquired Spartech, the company was operating with about a 1% operating margin. In 2011, POL's operating margin was 8%, dropped to 6% after acquiring Spartech, but the company is already starting to add that operational excellence that the company is so keen on and believes is part of their success. In the latest quarter, the company got $264M of revenue from the company, but it was able to turn that into $16M in operating income for a 6.1% operating margin. The company has started to overhaul the Spartech system with North American asset realignment, which is expected to improve quality and operational execution as far as delivery times. Further, the company is improving product quality and safety at plants.

The realignment plans are a big part of why we believe that the Spartech deal is not only going to provide about $1.2B - $1.4B in sales this year, but the company will also see margins improve (as is already being seen). In July, the company announced that it was going to work on realigning assets by closing six legacy Spartech facilities, train staff, and work on getting the Spartech staff up to speed with PolyOne four pillars. The company noted that they would be able to save $25M per year by 2015 in pretax income. What does that mean for the company? The operating margin on Spartech products will continue to move higher, which could add about 2% to operating margin, bringing it to around 8%. The operational efficiency of POL is such an important part of this business.

Price Target

For 2014, we project the following:

Revenue - Expectations are pretty set for $3.8B and $4.2B in the next two years. The 2015 target likely can only happen if the company has another acquisition, but they do still seem set to do that. So, on the high end we will use $5B. On the low side, we will use $4.5B. From there, we will use 7-8% growth on the upside, which is more consistent with organic growth that is expected versus 4-5% on the industry averages.

Margins - This area is likely the hardest part to estimate. The company is sitting at 6% in operating right now, and we used a 6.5% high side for both models to allow ourselves the ability to price in some of the risk factors we discussed above.

Capital Expenditures: The company is expecting Capex to rise to around $110M in 2014, and it should stay up around that same level in 2015 as we anticipate an acquisition in that arena. If not, then they will have to aggressively expand business overseas as well.

2014 Price Target: $52

Potential Price Appreciation: 45%

Dollar General

Main Catalyst

Management has outlined a few trends to increase shareholder value. The plan is to drive sales growth by increasing shopper frequency and transaction amount. They want to do this by improving merchandise in-stock levels, testing larger store formats (including adding perishable foods), and by offering tobacco products this year. The company also plans on increasing gross profits by expanding private label selection, increasing foreign sourcing, and maximizing transportation and distribution efficiencies. Another item that will improve margins will be new efforts in improving the pricing model for markdowns.

Not all catalysts have been good however. In recent years, sales growth in consumables, which generally have lower gross profit than non-consumables, has outpaced that in non-consumables. This is mostly due to economic challenges faced by customers, but this also presents an opportunity later discussed in the "Economic Moat" section.

Another catalyst for DG includes store management. DG's store openings have been flat YoY, but remodeling and relocating stores are up about 9%. This indicates that management is selective in their store selection process and is careful of saturation. During 2012, DG opened 479 new stores and remodeled or relocated 591 stores. During 2011, DG opened 482 new stores and remodeled or relocated 544 stores. The company opened 650 stores in 2013, and they plan to open 700 stores.

Price Target

For 2014, we are projecting the following:

Revenue - The company is expected to grow revenue to over $17B with another 10% revenue growth. The company will mostly be powered by continued store building. The company is expected to grow sales through another 700 stores in 2014, but we believe that will start to taper in 2015 - 2018 back to 200-300 in the later part of those years.

Margins - Margins seem to be topping out in the 31-32% in gross and 10% in operating due to the fact that the company has adopted a lot of their margin expansion ideas like adding tobacco and more consumables. At some point, discount retail is hindered by its ability to grow margins much more unless it redefines its business again. We anticipate these margins staying fairly stagnant.

Capital Expenditure - These should stay elevated for the next couple years before a cycle of less expansion, and they drop back to the $250M - $350M range, which is more normal.

When we use these numbers for our 2014 model, we come up with a price target of $90

2014 Price Target: $90

Potential Price Appreciation: 48% Potential

Yum! Brands

Main Catalyst

2014 is the year of the comeback for Yum! After the company looked poised for a major breakout with strength in Asia, Taco Bell gaining strength, and the company axing struggling Long John Silver, issues with China's growth and chicken hurt the company significantly. Yet, shares have a future PE of 20 with PE at 31, showing not a lot of belief in future earnings as well as a fairly neutral 2.6 price/sales ratio. The company has started to show signs of a recovery in China, and we like that the company has some easy comps to work from in the new year.

The company has promised to redefine their KFC brand in China in 2014 with menu changes and new marketing campaign, and we believe that the company has such easy comps that a rebound in 2014 will be easily successful. The company has already noted in their latest December results that SSS were back on the rise.

Additionally, we like that the company is pushing for strong unit growth in China mostly with a push for Pizza Huts there. The company has already noted that they will see 20% EPS growth in 2014, and they expect double-digit revenue/income growth for years to come. The company is appealing growth name, but they are priced much cheaper than they should be, mostly due to the problems in 2013. We like this timeframe at early 2014 as a place to enter the name. Finally, the company plans to kickoff a national campaign for Wing Street for the first time in 2014, and we believe that this investment will start to pay off in the coming year.

Price Target

For 2014, we are projecting the following:

Revenue - The company is expected to grow revenue to over $14B with another 11% revenue growth. Continued store building and a rebound in same-store sales will mostly power the company. From there, we continue to anticipate 8-10% growth in 2015-2016 followed by 6-8% growth in sales in 2017-2018. We anticipate $19.5B - $20B in sales by 2018.

Margins - Margins will definitely bounce back in 2014 with refranchising in the USA as well as a bounce back in China, and we should see operating margins back in the 16-17% region. We believe these can continue to increase as the company focuses on franchising and will be able to see fixed costs of expansion take a more limited hit on margins.

Capital Expenditure - These should stay elevated for the next few years with slight increases, as the company remains very focused on unit growth. We anticipate a $1.2-$1.3B Capex in 2014 that should top out around $1.5B over the next couple years.

When we use these numbers for our 2014 model, we come up with a price target of $93.

2014 Price Target: $93

Potential Price Appreciation: 25% Potential


Main Catalyst

The main catalyst moving forward for SSYS is their ability to leverage and execute on the opportunity in the consumer market. Advanced manufacturing will always have a major part of this industry, but there are billions more consumers. Some of the issues that will occur are the breadth of what can be printed, the cost of the printer, and the maintenance of margins. Right now, SSYS operates with very solid, premium margins. Can that be maintained in their push into the consumer market?

Stratasys already made the first proper move by closing a deal with MakerBot, a consumer-based 3D printing manufacturer, back in August. Here is some more on that deal. 3D Systems (NYSE:DDD), the main competitor for SSYS, is also pushing into this space. The company has launched its Cube printing system, starting at $1299. The company wants to focus on printing household items, jewelry, and more. SSYS, however, is taking a slightly different approach. DDD wants consumers to buy their product. SSYS is starting by partnering with UPS (NYSE:UPS) to provide 3D printers in-store. In this way, consumers can print a product at the store and ship it right away. It is similar to the old style of printing and copying at Kinko's, which was a great stepping-stone for in-home printers. SSYS will build its brand name and get more users using the product in this way than DDD will be able to by selling products at such a lofty price tag.

How is the company doing so far on this push?

In the company's latest earnings report, consumables are doing well. The company noted that it had seen a 30% increase in revenue compared to last year. Customer usage and growing install base has helped them. Yet, the company also noted that they are still not marketing directly to the everyday consumer yet as they continue to still wait for the consumer to catch up: We think we have very aggressive marketing regardless of the time of the year. But again, I think that MakerBot today is targeting, like you said, I think correctly, low-end professional markets and multiple consumers which are individuals that have some technical capabilities are obvious, and we're having to market to them aggressively within the whole year and especially during the holidays.

Overall, the company has a lot of potential here to take part of this market share. DDD is in the lead at getting in the homes, but we prefer SSYS's route of working with clients that have a lot of use for the products, marketing through partnerships, allowing other users to try the printer first hand, and will eventually push into that area.

Price Target

For 2014, we are projecting the following

Revenue - The company is expecting to continue to grow by 20% or more per year for the next several years. We are expecting revenue to come in around $480M for this FY with growth to around $650M in 2014. From there, we expect growth rates to taper to around 20% per year like the company has predicted.

Margins - The company wants operating margins to push to 15-20% over the next several years. Right now, operating income will come in negative for the year due to merger costs with MakerBot, but that should come back down. We would expect operating margin to improve pretty quickly to around 15% by 2016 and closer to 20% by 2017.

Capital Expenditures - The company will likely continue to see capital expenditures grow and likely move to around 5-6% of revenue as the company continues to dedicate to a major expansion plan over the next several years. Depreciation should move up at a similar rate.

For 2014, we are seeing shares are worth around $165.

2014 Price Target: $165

Potential Price Appreciation: 20%


Main Catalyst

For Equinix, the company has two main catalysts - growth of cloud-hybrid offerings as well as conversion into a REIT. The company is working to take advantage of the REIT. As the company has noted in their latest quarterly call, cloud traffic will grow 35% CAGR through 2017 when 2/3 of global data center traffic will be based in the cloud. As a more classic data center company, these statistics threaten EQIX's future for sure. So, the company is undergoing two major transformations of their business.

Let's take a look at the REIT status first. The company, since it owns and installs its data centers with products (servers), considers itself a real estate location and can therefore come under the tax shield of the REIT-status. What exactly could the REIT status do for Equinix? The REIT tax shield is estimated to save EQIX around $312M in taxes in 2015 and 2016 and would have a very low tax rate. The company would then return about 90% of its income to shareholders through lofty dividends. The advantages of the REIT-status will be fleshed out further in the pricing/valuation section. Overall, though, this move would allow EQIX to save a lot of money as they have 100s of sprawling data centers that have become much more of investments in real estate.

The issue, though, is on the other end that Equinix in many ways is a more old-school data center provider. The company is a more basic data center storage company, but they realize pushing into the cloud is going to be essential for their future. Yet, the drawback of moving into a hybrid cloud is that it means less large deals. With hybrid clouds, the combination of servers and software for IT and standard colocation both springing up, it has created a decision for most companies. The company is benefiting from the cloud because it is an integral part of the cloud and additionally colocation. The issue is that the length of deals now takes longer as the hybrid cloud is more complex. With the trends towards a multi-tiered architecture to IT and data storage, the company is following the trend:

The company has noted that a lot of cloud companies are using them to leverage data storage. In the latest quarter, the company had 1200 cloud company customers. Additionally, the company made a great move in partnering with Microsoft's (NASDAQ:MSFT) Azure. Customers can now connect directly into Azure with a private connection provided by EQIX. The company, further, will build 10 new cloud hubs in 2014 to continue to develop its hybrid offerings.

Price Target

For 2014, we are projecting the following:

Revenue - The company expects to be making $3B by 2015 with about $2.4B in 2014. A 10-12% growth rate still looks solid for this company as they do have a lot of potential in the cloud moving forward. In our model, we will use a 2017 revenue projection of $3.6B.

Operating margin - What will end up happening is that margins will likely move down some as the hybrid structures will not be worth as much. The sales will take more work to get, and the crowded space creates competition. We would expect a drop back to around 18-20% in margins.

Capital Expenditure - These will stay high at 25-30% of revenue because of the nature of the high expenditure business that EQIX operates within. It costs them a lot to buy servers, buildings, and continue to expand to incorporate networks to stay ahead of the curve.

With this updated model, we came up with a price target of $225. While we have decreased some overall estimates, we have also seen the discount rate drop with lower beta and better cash. Additionally, we are more confident in the REIT structure passing. Without the REIT structure, though, shares are worth around $115 in our model, so the decision there is crucial.

2014 Price Target: $225

Potential Price Appreciation: 23%

We also like Ford and Netease a lot, but we worry about automotive stocks and China in 2014 in a macro sense. Car companies have been doing amazingly well over the past couple years, and we are concerned about those stocks ability to make progress over comps from 2013 that are becoming strong. We still see Ford as very overvalued, and it is our favorite name in the space. For China, we are likely going to see a weak start to 2014, which will hurt all names in the space. NTES is our favorite name in that space. NTES has the sole license to operate some of Blizzard's most popular titles in China. Legendary games that have been around for more than a decade like StarCraft and Warcraft have drawn millions of users worldwide. World of Warcraft has played an essential role in topline growth for NetEase in the last few years. However, according to the last two quarters, revenue generated by Warcraft has decreased, signaling that popularity for this title has possibly peaked. And that's okay with us.

That does it for 2014! Look for these names to outperform and be some of the best this year.

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

Business relationship disclosure: I have no business relationship with any company whose stock is mentioned in this article. The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

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