1 Stock and 1 Sector for Generating Alpha in This Market

Includes: AGU, BAX, CF, MDT, MOS, POT, ZBH
by: The Analyst Hub

One Stock with opportunity to generate alpha returns: Covidien Plc. (COV)

Covidien is a healthcare conglomerate that operates in four segments: Medical Devices, Imaging, Pharmaceuticals, and Medical Supplies. It gained in Thursday’s trading after announcing up to $2bn in share buy backs. Morgan Stanley, Bank of America and Goldman Sachs have recently released reports recommending buying Covidien for alpha returns. The stock has also seen major fund buying recently. BlackRock, PNC Financial Services, JP Morgan Chase & Co and AllianceBernstein have all taken big position in the stock in last quarter. Here is why you should buy it:

Accelerating Organic Revenue Growth: In its recent earnings release Covidien reported organic, constant currency top line growth in Q3 in the 4-5% range up from 3.5% last quarter and 1- 2% growth in the preceding quarters. Revenues from the vascular business more than doubled YoY to $368 mn buoyed by eV3 acquisition. The company benefited from several successful new product launches and from market share gains, and this trend is likely to continue going forward.

Beatable consensus numbers: Current consensus estimates for Q4 EPS and FY2012 are $1.04 and $4.28 respectively – both of which are too low. COV reported $1.01 EPS for Q3 and it has 12% more selling days in Q4 implying even without assuming any QoQ acceleration it can beat the consensus EPS estimate. Similarly for 2012, buyback activity alone could drive 10% EPS growth implying $4.28 consensus EPS estimate is low.

Low Multiple: Covidien is currently trading at a discount to broader medtech space while it should actually trade at a premium given the upcoming product launches and accelerating business momentum. In a recent research note Goldman mentioned medical-supplies companies like drug-infusion pump maker Baxter International Inc. (NYSE:BAX) and hospital product maker Covidien PLC are more attractive stocks than medical-device makers like Medtronic Inc. (NYSE:MDT) and Zimmer Holdings Inc. (ZMH) because of their stable unit growth and lower exposure to price cuts.

The stock is likely to rise going forward and its FY2012 guidance on September 8 (analyst day) is likely to serve as a major catalyst.

One Sector with opportunity to generate alpha returns: Fertilizers

Fertilizer stocks gained in Thursday’s trade as prices for corn, wheat, soybean and other commodities shot higher. I would recommend buying fertilizer stocks despite of the broader macro concerns. During the last downturn in 2008, excess inventory in the supply chain coupled with anticipation of decline in fertilizers prices by farmers caused fertilizer producers and retailers to take a hit. However, present situation is different. Due to the hit fertilizer retailers had taken in 2008, they were cautious this time and have not overstocked fertilizer inventories. Thus, supply chain remains very tight. Further, grain prices corrected very sharply along with other commodities during the last downturn. Thus, farmers anticipated that fertilizer prices will come down as well.

I don't see a similar commodity correction this time given the excess amount of money supply which has entered the system thanks to bailouts, quantitative easing and stimulus. In particular, when we talk of food grains where demand is inelastic, the trend is likely headed up in the mid-long term even if we consider a prolonged recession scenario. Fertilizer prices are usually correlated with food prices and I believe fertilizer companies like Potash (NYSE:POT), Mosaic (NYSE:MOS), CF Industries (NYSE:CF) and Agrium (NYSE:AGU) are the best bet in the long term to hedge one's portfolio against inflation in these recessionary times.

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

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