By Kenneth Shea, Steve Biggar, and Robert Gold On Sept. 30, Standard & Poor's Equity Research Group made changes to the S&P Top Ten Portfolio -- those stocks it considers those stocks it considers to be the best candidates for capital gains over the next 6 to 12 months. We at S&P added natural gas company Oneok (OKE) to the portfolio, replacing homebuilder Lennar (LEN). We also added beverage and snack food giant PepsiCo (PEP) to the portfolio, replacing racetrack operator International Speedway (ISCA).
Like all the stocks in the portfolio, Oneok carries Standard & Poor's highest investment ranking of 5 STARS (strong buy). Oneok is an integrated natural gas company with an expanding energy marketing and trading business. In our opinion, Oneok will benefit from rising commodity prices and a sharp focus on its highly profitable natural gas gathering and processing business. In the midst of growing merger activity that we see in the utilities sector, we think Oneok's share price does not fully reflect the underlying value of its natural gas and natural gas liquids assets. Our 12-month target price for Oneok is $42.
PepsiCo was also added to the portfolio. In our view, PepsiCo is well positioned to capture market share in the global beverage segment, generate margin expansion, and sustain low double-digit free cash flow and earnings per share growth over the coming five years. Our 12-month target price is $68, based on relative p-e and discounted cash flow (DCF) valuation metrics.
Lennar was removed from the Top 10 portfolio on Sept. 30, after S&P equity analyst William Mack downgraded the shares to 3 STARS (hold) from 5 STARS. Excluding acquisition amounts from reported backlog, we estimate organic unit growth of only 7% in the August quarter, compared with an 11% total backlog rise. We see transparency as a greater concern, since acquisition amounts that gave rise to wide difference between organic and reported unit volumes were not previously announced. On the higher risk profile we see, our target price drops $4, to $72, using peer-average p-e of about 7.8.
International Speedway was also kicked out of the portfolio after S&P equity analyst Gary McDaniel downgraded the stock to 3 STARS from 5 STARS. We are increasingly concerned about the strategic focus of International Speedway's management. We view the planned purchase of a Colorado racetrack as lackluster. This comes on the heels of the company's agreement to acquire Action Performance (ATN), an unimpressive operator, in our view, in a business we see as risky and tangential. The Action Performance deal is subject to approvals and expected to close by yearend. With a heightened risk profile we see, we are cutting our target price to $57 from $68, blending our DCF model with peer and historical analyses.
A dynamic model portfolio concept, the S&P Top Ten was launched on Dec. 31, 2001. From inception through Sept. 30, 2005, it has gained 21.13%, vs. 14.23% for the S&P 500 index (on a total return basis). For all of 2004, the S&P Top Ten rose 19.2%, vs. a gain of 10.9% for the S&P 500. Year-to-date through Sept. 30, the portfolio rose 0.50%, vs. 1.39% for the index.
Here's the S&P Top Ten list:
S&P TOP TEN PORTFOLIO
Price (10/4/05 close)
Bank of America
Attractive risk/return profile
Strong market share, rising shipping volume
Expected improvements in several end-markets
Capturing market share, expanding margins
Highly profitable natural gas business
Projections for higher EPS and gross margin
St. Jude Medical
Positive ICD market data
Shea is director of Global Equity Research, Biggar is director of U.S. Equity Research and Gold is senior portfolio group analyst, for Standard & Poor's Equity Research