Markets & Finance

Stocks: Should You Ride the Cyclicals?


S&P's latest list turns up 34 attractive names from the energy, materials, industrials, and information technology sectors

From Standard & Poor's Equity ResearchFor the first time in three years, stocks in cyclical industries (i.e., those that are sensitive to business cycles and whose performance is tied to the overall economy), have a higher net margin, on average, than noncyclicals, according to Massimo Santicchia, a director of portfolio services at Standard & Poor's. (Net margins are a company's net profit divided by net revenues, often expressed as a percentage.)

While this phenomenon may indicate the top of a cycle, it may also indicate further growth for cyclical stocks. With that in mind, we screened for five-STARS stocks—those perceived by our analysts to have the highest upside potential in the next 12 months—in four sectors typically thought of as cyclical: energy, materials, industrials, and information technology.

Thirty-four stocks made the cut, and are listed in the table below. Following the table, we spotlight S&P analyst opinions on one name from each sector:

Company

Ticker

Airgas

ARG

Baker Hughes

BHI

Carlisle

CSL

Commvault

CVLT

Corning

GLW

eBay

EBAY

EMC

EMC

ExxonMobil

XOM

Fastenal

FAST

FedEx

FDX

FMC

FMC

Glatfelter

GLT

Goodrich

GR

Harsco

HSC

Ingram Micro

IM

International Business Machines

IBM

Jacobs Engineering

JEC

Kinder Morgan Energy Partners

KMP

Logitech

LOGI

Manitowoc

MTW

Mariner Energy

ME

MEMC Electronic Materials

WFR

Microsoft

MSFT

Noble

NE

Oracle

ORCL

Rockwell Collins

COL

Seagate Technology

STX

Shanda Interactive Entertainment

SNDA

Statoil

STO

Superior Energy Services

SPN

Swift Energy

SFY

Teradyne

TER

Terex

TEX

Total

TOT

Energy

Baker Hughes

With 58% of 2007 total oil-field revenues generated from the faster-growing Eastern Hemisphere, we see strong growth prospects for Baker Hughes. In addition, unlike most of its peers, Baker Hughes does not offer pressure pumping services, the one service offering we think is most likely to suffer from pricing weakness in 2008, given relatively large additions to market capacity.

We expect earnings of $5.24 a share for 2008, up 10.8% from the $4.73 reported for 2007.

Risks to our recommendation and target price include higher-than-expected cost inflation.

Based on our view of slightly below-average return on invested capital in 2008, we think a modest discount to the peer valuation is warranted. Factoring in a multiple of 11.5 times estimated 2008 cash flow (a slight discount to peers), and blending with our discounted cash-flow model, we arrive at a 12-month target price of $90.

Information Technology

EBay

We see eBay as the clear leader in online auctions, a mainstream Internet retail destination, a major facilitator of large transactions involving cars and real estate, a growing international presence, and the owner of the world's leading purely online payment platform.

We are optimistic about its international and payment segments, and believe the new management team can reignite growth at the marketplaces unit. EBay also has been building a global online classifieds business and is increasingly focusing on Internet advertising.

Despite what we consider strong brands, durable businesses, and a solid balance sheet, eBay recently traded at only 17 times our 2008 earnings estimate of $1.62 (which excludes certain noncash items) and had a p-e-to-growth ratio of below 1.0. These multiples were notably lower than those of eBay's peers, as well as where the stock historically has been valued. EBay posted earnings of 89¢ in 2006 and $1.36 in 2007.

Our 12-month target price is $44, or 27 times our current year forecast. Risks to our recommendation and target price include a slowdown in consumer spending.

Industrials

FedEx

Despite the U.S. economic slowdown, we expect FedEx to post revenue and earnings growth in fiscal 2008 (ending May), aided by strong international shipping activity in China and Asia overall.

We see revenues up 7% in 2008, but we expect operating margins to be pressured by higher energy costs and a less profitable mix of business. We see earnings growth of only 3% in fiscal 2008, to $6.55 a share. However, growth should accelerate in fiscal 2009, and our forecast is for a 13.7% increase in earnings, to $7.45.

We think the shares are attractively valued, recently trading at 13.6 times our fiscal 2008 earnings estimate and 11.9 times our fiscal 2009 estimate. These p-e's are below those of the overall S&P 500. Our target price of $140 values the shares at 18.8 times our fiscal 2009 estimate, slightly above the S&P 500.

Risks to our recommendation and target price include increased price competition and ongoing litigation involving the classification of workers as independent contractors, which could lead to higher labor costs.

Materials

Glatfelter

We believe the maker of specialty papers is poised for a sustained period of profitability growth, given the acquisitions the company has made over the past two years, and its focus on relatively small, technically demanding niche markets.

We are encouraged by the recent trend of higher prices for paper. Also, Glatfelter plans to sell as much as 60,000 acres of its land over the next three to five years, which should generate proceeds of around $200 million that will be used to reduce debt.

Our earnings estimate for 2008 is $1.15 a share, a 40% increase from the 81¢ reported for 2007. Our 12-month target price of $18 is derived by applying a peer p-e of 13.9 to our 2008 earnings estimate and blending that with our discounted cash-flow valuation.

Risks to our recommendation and target price include further escalation of raw material and energy costs and an unexpected downturn in demand and pricing for paper.


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