3 Opportunities The Arriving Bear Market Should Provide

Includes: INTC, MCD, PM
by: S.R.T.Z Investments

Recently both Mr. Bernanke and Mr. Draghi announced more steps trying to revive and strengthen the economies of the U.S. and Europe. At first the market seemed to cheer these plans; but it seems now that investors understand more pain may be on the way:

  1. The easing plans offer more liquidity to financial markets, but as we have experienced in the past - this liquidity is not translated into REAL industrial growth. Therefore, they may possibly not help economies that much.
  2. Global recovery and growth seem more fragile than ever before - with violent demonstrations where painful cuts are required.
  3. Unemployment rate trend is unstable - no clear findings of fewer people unemployed several months in a row.
  4. Inflation has not yet raised its ugly head, mainly because of global recession. But eventually, when you print that much money, it will strike.
  5. The U.S. is quickly heading for the fiscal cliff at the end of the year. I do not think it will fall off that cliff, but it will add to the volatility markets should experience.
  6. Middle East seems to be highly unstable, sending oil higher.
  7. More and more companies cut their growth and profit forecasts.

In articles I published in the past I took a bearish note and expected markets to go down. That did not happen, not yet anyway. However, today more than before I remain bearish and strongly believe the markets will head south.

With that in mind, I will present below three stocks of great companies that I strongly believe in. They all have great business models, I have no doubt they will survive a bearish cycle.

However, given their own forecast and my estimates for their markets, I expect further decline in their stock prices and will keep monitoring them looking for a pullback as an entry point.

Intel Corporation (NASDAQ:INTC): Intel is THE world leader in designing and selling computer microprocessors. It is number one when it comes to standard computers and servers, but is experiencing fierce competition in the smartphones and tablets market due to late entrance to these markets.

The close future is not that bright - Far East markets expect a decline in growth, Europe is under huge debts and the same goes for the U.S. All that means less investments by users of computers and that is before considering smartphones and tablets.

However, PCs and servers are not a dead market and Intel will see more profits, for example, when Windows 8 becomes more stable and accepted, when Mircosotft's (NASDAQ:MSFT) Surface pads penetrate the market and when Win XP support ends (should happen in 2014).

In the smartphones and tablets industry where it currently lags behind ARM Holdings plc (NASDAQ:ARMH) and others, the first signs of Intel catching up and joining the game were Microsoft's Surface running on Intel's CPU and the contract with Motorola announced recently. Could Intel completely change the picture in the next few years and have its CPUs inside Apple's iPhone and iPad? That's a remote possibility in my opinion but your guess is as good as mine.

Intel currently yields a 4% dividend that seems safe with a relatively low 36% payout ratio. Safe, of course, is a relative thing and depends on how deep will be the down cycle. Keep in mind that a blue-chip that has raised dividends 9 years in a row and paying 4% is a rare thing.

Some more data to complete the picture:

  1. Market cap is around $113 billion.
  2. Balance sheet is extremely strong with total liabilities below current assets. LT investments and fixed asset are worth $27 billion on top of that.
  3. Free cash flow in 2011 was around $10 billion. That figure is expected to be cut significantly in 2012 but may rise back in 2013.
  4. Stock price is 23% below 52-week high.

I think for the long-term current price may not be that high, but since I expect more declines in the close future on fundamentals deteriorating - I will be a buyer at $17-$20 per share.

McDonald's Corporation (NYSE:MCD): McDonald's owns and operates fast food restaurants almost all over the world. It is a world leader when it comes to fast food and recently began adding healthier options to the menu as well. With more than 33,500 restaurants worldwide, it still expects high growth thanks to aggressive penetration to markets in Asia.

Even McDonald's has felt economic pressures: with same-stores sales not rising recently as in the past few years and with commodities prices going up - profitability could be hurt. But on the other side, even in recessions, McDonald's is considered a relatively cheap food that one can allow to buy (when money is scarce - McDonald's may be chosen instead of more expensive restaurants).

McDonald's currently yields almost a 3.4% dividend (raised 10% recently) with a 51% payout ratio. Management is committed to maintaining the dividend and has raised it 36(!) years in a row.

Some more figures about McDonald's:

  1. Market cap is around $93 billion.
  2. Balance sheet is solid with total liabilities approximately $4 billion lower than current assets + LT investments and fixed assets. Current ratio sufficient at 1.25 as of June 30, 2012.
  3. Free cash flow in 2011 was almost $4.5 billion, that pace was somewhat slower in H1 2012. However, I find it more appropriate to consider Cash flows from operations less depreciation instead of regular free cash flow since most Capex was on new restaurants. These investments can be stopped in a recession without harming existing stores. If you use this figure, cash flows were at $5.7 billion for 2011 and $2.4 billion in H1 2012. Both figures (regular and "amended" free cash flows) indicate strong cash flows for the company to rely on.
  4. Stock price is 11% below 52-week high.

McDonald's case and valuation is somewhat different from INTC described above. MCD is much more of a defensive play and as such has so far decreased less in price and may decrease less in the future. Still, given global headwinds it faces (as mentioned in second-quarter results), I will wait for another pullback before I buy shares of this great company.

Philip Morris International Inc (NYSE:PM): PM manufactures and sells leading tobacco brands like Marlboro, Parliament, L&M and others. PM is active in 180 countries and is acting aggressively to increase market share in emerging markets. The company enjoys already substantial and still rising market share in most geographical areas it operates in thank to leading brand names, aggressive investments and price leadership policy. The company also enjoys the fact it sells a product that is very difficult to quit for users. However, PM will suffer from two main issues:

  1. Weak global economy and rising unemployment: when people have no jobs or when they earn low salaries, spending it on tobacco will be a low priority. In such a case, no matter how hard it is to quit smoking - people will do that. The proof of that is PM's results in Europe that have showed negative growth, mainly in the suffering countries (Greece, Portugal, Italy, Spain).
  2. Legislation aimed at reducing smoking: there is a slow but ongoing trend (currently mainly in developed economies) to try to reduce smoking by legislation - be that more taxes, plain packaging for all brands or other steps.

I believe it will take years before legislation will dramatically influence PM's results and cash flows. However, the weak economy is here and is already influencing the company's results - even if not dramatically. Since the split from Altria (NYSE:MO) in 2008, PM has paid investors over $40 billion in dividends and stock repurchases. Last August it launched another 3-year repurchase program to buy up to $18 billion more. Additionally it has grown its dividend in 67% since 2008.

PM currently yields almost a 3.8% dividend with a 61% payout ratio.

Some more figures about PM:

  1. Market cap is around $152 billion.
  2. Total liabilities approximately $15 billion higher than current assets + LT investments and fixed assets. Current ratio sufficient at 0.92 as of June 30, 2012. Checking these numbers in PM's case is not that efficient since so much cash had been paid back to customers.
  3. Free cash flow in 2011 was almost $10 billion; approximately the same pace was in H1 2012. This is a very strong cash flow for the company, personally I would have preferred it paid off some debt before performing stock repurchases.
  4. Stock price is just 4% below the 52-week high.

While I think PM is a great business heading up, I think:

  1. The stock price shot up too fast too high
  2. The near future global economic environment combined with general market volatility as well as long-term legislation will provide headwinds. I will be a buyer on pullbacks to $70-$75 per share.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.