Monday, February 25, 2013

Consumer Cyclical Buy Long Stock Picks

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3 Consumer Cyclical Names at Bargain Prices

Morningstar Investment Research reports despite headwinds from the payroll tax-cut expiration, the sky isn't falling on consumer spending, and these firms look undervalued.

Wal-Mart Stores (WMT), and consumer spending, has been in the spotlight the last few weeks. Earlier this month, Bloomberg News published internal emails from the retail giant which described early February sales as a "total disaster." And Wal-Mart's earnings released this week seem to confirm that the firm's core customers are under a fair amount of pressure at the moment. Morningstar's Michael Keara thinks the biggest culprit is the expiration of the payroll tax cut at the beginning of this year that is hitting lower - and fixed-income households the hardest. Is this a sign that consumer spending is about to be hit and that consumer cyclical stocks as whole look unattractive? We think not.

As Morningstar economist Bob Johnson has pointed out, some of Wal-Mart's short-term issues are idiosyncratic and the firm's anemic forecast is likely not the canary in the coal mine of consumer spending. Looking at the broader retail landscape, Johnson sees a murky picture, but one that appears to show the consumer soldiering on. Yes, the payroll tax increase, high gas prices, and delayed tax refunds are headwinds, but other factors, such as increased minimum wages in some states and higher Social Security payments, are helping mitigate the pain. To be sure, the consumer may very well come under increased pressure in the months to come, but the sky does not appear to be falling.

Against this consumer-spending backdrop, are there any values in the consumer cyclical sector? On the whole, the sector looks fairly valued today. The median price/fair value ratio is 1.04 compared with the median of 1.00 for the market as a whole. But there are still a number of values, particularly among the automakers and auto-parts suppliers. To find these values, we used Morningstar's

General Motors (GM)

We think GM's car models are of the best quality and design in decades. The company is already a leader in truck models, so a competitive lineup in all segments, combined with a much smaller cost base, leads us to think that GM will be printing money as vehicle demand recovers. We think GM's earnings potential is excellent because it finally has a healthy North American unit and can focus its U.S. marketing efforts on just four brands instead of eight. Dramatically better pricing has helped GM to be profitable at volume levels that would have meant billions in losses a few years ago.

Weight Watchers International (WTW)

Weight Watchers has a reputable and differentiated product in an industry that is rife with false claims. The company benefits from a wide economic moat because we believe it would be extremely difficult for a competitor to replicate the brand recognition, comprehensive weight management approach, and sizable meeting infrastructure to compete with Weight Watchers in a significant way.

Kohl's (KSS)

Kohl's has had great success with its conveniently located stores that cater to consumers in search of brand-name goods at value prices. Although the department store retailer was not immune to the slowdown in consumer spending during the recession of 2009, we think it has gained share as smaller competitors have been forced to close their doors and as consumers seek the convenience of Kohl's off-mall locations. We think Kohl's strong balance sheet, assortment of brands, and hard-to-replicate cost structure will enable it to outperform peers during the 10 years of our forecast period. Recently, the company has been able to hold gross margins and sales even as prices increased, suggesting some pricing power.