Print this

Email this

Submit a Question

American International Group (AIG)

AIG is currently being investigated by federal regulators for selling financial products designed to mislead investors, engaging in bid-rigging scams with insurance brokers, and manipulating the stock price before a major acquisition. In addition, the company remains in the penalty box after surprising investors in early 2003 with a $2.8 billion charge to boost its insurance reserves. And finally, investors continue to be concerned about management succession plans since CEO Hank Greenberg is in his late 70s and has run the company for 35 years.

Nevertheless, the current stock price looks like an excellent entry point given: 1) the company's competitive position in a diverse group of financial businesses (P&C insurance, life insurance, retirement services, consumer & commercial finance, and asset management); 2) the funding advantage created by its AAA-rated balance sheet; 3) its unparalleled presence and opportunity in high-growth international markets; and 4) its long history of generating solid and consistent growth in operating earnings and book value. Trading at 12.3x the 2005 consensus earnings-per-share estimate and 2.3x book value, investors can acquire AIG well below the market multiple that these shares have historically commanded.

Several near-term challenges have created an opportunity in shares of Wendy's International. These challenges include a sharp increase in beef prices, unsustainable discounting by competitors, difficult sales comparisons to a very strong 2H03, the recent hurricanes in the Southeast, and greater-than-anticipated weakness at Baja Fresh. We believe investors will increasingly look past these short-term issues and focus on a best-in-class operator with a proven track record of quality and innovation. Perhaps more importantly, we believe the Tim Horton's franchise, which accounts for nearly 50 percent of company operating income, is significantly underappreciated by investors. Tim Horton's, Canada's no. 1 quick-service restaurant (QSR) chain serving coffee, pastries, soups and sandwiches, has consistently posted impressive sales increases in its Canadian store base. Now, management is expanding this proven platform into the United States, with an expected 500 restaurants by the end of 2007 (compared to 233 today). We believe this portion of the Wendy's business should be valued at a significantly higher multiple than the more mature QSRs, such as Yum Brands and McDonalds.

First Data is the largest player in the payment processing industry. As such, the company engages in electronic money transfer services (through its Western Union unit), transaction processing services for merchants, and outsourcing services for credit and debit card issuers. We believe these business lines provide an excellent opportunity to participate in the trends toward electronic payment transactions (versus cash and checks), increased immigration, and higher immigrant income levels. Profitability in each of FDC's business lines is driven by scale and efficiency, global reach, and the depth of customer relationships. Long-term contracts provide above-average visibility into future earnings power. In the near term, the stock has been held back due to issues related to the integration of Concord EFS, as well as the threat of increasing competition from the large banks. While we concede that these issues cause us some concern, we also believe that FDC's unprecedented global presence and strong management team place the company in a great position to benefit from the very powerful macro trends listed above.

Citigroup (C)

Investors in Citigroup have been plagued with numerous issues over the past couple of years, from the retirement of legendary CEO Sandy Weill to the seemingly unending regulatory investigations. These issues have taken a toll on the stock price, but they have not hindered the company's ability to continue posting record-setting levels of net income. Citigroup's strength lies in its unparalleled global presence. The company is continuously entering new markets and increasing its presence in existing markets of opportunity. This geographic diversity, along with strong product diversity, enables Citigroup to opportunistically allocate capital as the market environment changes. Recent divestitures of low-return insurance businesses and acquisitions of high-return consumer businesses offer evidence of this strategy. The valuation is very attractive at 10.2x the consensus 2005 estimate and 2.3x book value. The stock also offers a very attractive dividend yield of 3.6 percent.

The entire branded pharmaceutical industry faces numerous challenges, including increased generic competition, weak new product pipelines, potential lawsuits, and potential pricing pressures. Pfizer also has to deal with questions about its widely used arthritis drug Celebrex, following the company's announcement that one study shows increased cardiovascular risks related to drug. At this point, these issues are well known by most investors and have caused the entire group to dramatically underperform the overall market over the past few years, despite very favorable demographic trends in the United States. We believe that Pfizer, as the industry leader and one of the most financially sound companies in the group, is the best way to participate in an eventual market revelation that these companies are likely to find ways to grow earnings faster than the overall market. Pfizer currently trades at 11.8x calendar 2005 estimated earnings-per-share, representing a 15 percent discount to the overall drug group and a 30 percent discount to the overall market. These discounts are virtually unprecedented for Pfizer, a company that has historically traded at a premium to both its peer group and the market. Though Pfizer is likely to lose a large portion of its sales to generic competition over the next three to four years, we believe that it is likely that Pfizer will use its enormous free cash flow ($15+ billion per year) to restock its pipeline. Finally, the current stock price indicates that the market believes that Pfizer will only grow profits at 2 percent per year over the next decade, a growth rate that we believe will prove to be too pessimistic. We find the risk/reward proposition very attractive at current levels.

Medtronic (MDT)

Medtronic is the industry leader in the rapidly growing medical device business. The company is best known for the devices that it produces for heart patients, but it also holds commanding market positions in such high growth areas as diabetes and spinal products. We believe that investors in the medical device business will continue to benefit from an aging U.S. population, without facing the numerous negative issues that the branded pharmaceutical firms face. Medtronic recently reported fairly weak quarterly results which led many short-term focused investors to sell their shares of Medtronic. Though we are always mindful of short-term results, we see no real change in Medtronic's long-term prospects. The company continues to target long-term earnings-per-share growth of 15 percent, a goal which seems achievable given the company's leadership position across a diverse line of high growth medical device segments. We believe that the current valuation (23x calendar 2005 estimated earnings-per-share) offers long-term investors an attractive risk/reward trade-off. For perspective, Medtronic currently trades at the same price that it did nearly five years ago, despite doubling its earnings-per-share over this time period!

Education Management (EDMC)

EDMC is a leading provider of for-profit post-secondary education services in the U.S. and Canada. The Company is the second largest publicly traded for-profit provider in terms of revenue. We believe top line growth at EDMC will be driven by positive secular growth trends within education market. These trends include increasing enrollment at both for-profit and traditional non-profit post secondary education schools. In addition, favorable pricing dynamics that have allowed for-profit schools to increase their tuition levels by 5 percent per annum are not expected to abate. Last, the for-profit post-secondary educations companies currently have only a 6 percent market share of the total student enrollment in the U.S. Industry experts expect market share to more than double in next seven years. We believe these top line growth drivers, coupled with better expense management and improved capital efficiency, will result in high double-digit earnings-per-share growth over the next five years.

CVS (CVS)

CVS is the nation's second-largest drug store operator by sales. The Company operates 4,206 stores in 31 states and the District of Columbia. CVS is a company that should continue to generate above market earnings growth in coming years. Above market earnings growth will come from favorable demographic trends. Aging baby boomers should ensure continued demand for retail pharmacy locations. Growth will also come from market share opportunities in high growth geographic locations. The acquisition of 1,260 Eckerd's stores located in Florida, Texas, Louisiana, Oklahoma, Mississippi, Arizona, Missouri, Kansas and Alabama (the majority of the stores are located in Florida and Texas) coupled with new store openings in other high growth markets such as Southern California, Chicago, Las Vegas and Minneapolis, should allow CVS to take share away from independent third party pharmacies as well Walgreen's. We have been impressed with management's ability to continue to expand margins over the past several years through a combination of increased front-end store sales and significantly improved inventory management. Further, we are pleased with the speed and efficiency management has exhibited in integrating the acquired Eckerd stores. We think favorable demographic trends and focused expense management will propel earnings per share growth in the low double digits.

Colgate-Palmolive (CL)

Colgate-Palmolive is a leading global consumer products company that focuses on five core businesses: oral care, personal care, household surface care, fabric care and pet nutrition. The company is the world's largest producer of oral care products and a major supplier of personal care products. Colgate-Palmolive is the most geographically diversified consumer company with 70 percent of revenue and 75 percent of profit come from outside the United States. Colgate-Palmolive is currently trading at the second lowest price/earnings multiple for our consumer staple peer group and its calender 2005 price/earnings is 17 percent below its 10-year annual average. The valuation discount is the result of what we believe is the markets overreaction to management's decision to lower second-half 2004 growth estimates. Growth estimates were revised down because of the impact a combination of higher raw materials and rising marketing expenses are having on profit margins. We believe once raw materials prices subside and management refocuses its attention on core brands, earnings growth will rebound to high single digits. At its current valuation level we believe Colgate-Palmolive has a favorable risk/reward proposition.

Pepsico Incorporated (PEP)

PepsiCo is a leading global snack and beverage company. The company manufactures, markets and sells a variety of salty, convenient, sweet and grain-based snacks, carbonated and noncarbonated beverages and foods. The Company has a very strong portfolio of leading businesses led by Frito-Lay North America which is arguably the best-run food company in the world. PepsiCo has leadership positions in non-carb and sports drink segments with their Aquafina and Gatorade products. Looking forward, we expect the Company's international division, which represents 33 percent of total revenue and 22 percent of operating profit, to be a significant growth engine. We believe PepsiCo stock offers investors a very attractive blend of value and growth.