The economic outlook is bleak, and after the recent panic, investors are very aware that we’re facing hard times. In fact, just last week my two pre-teenage daughters invented a new, credit-crunch version of Monopoly, incorporating plunging property values, distressed sellers and even loan sharks. With the bad news being this widespread, I think equities have been oversold and now offer buying opportunities for the patient investor. Here are two attractive stocks, and below, another for the brave.
A classic defensive pharma stock
Wyeth (NYSE:WYE), rated a BUY by Merrill Lynch
Wyeth is a global leader in prescription drugs (83% of sales), over-the-counter treatments (12%) and animal healthcare products (5%). In 2007, turnover rose 10% to $22.4bn. Around half was generated in America and the rest overseas. The group’s frontline drugs include anti-depressant Effexor ($3.8bn); pediatric vaccine Prevnar ($2.8bn); Enbrel for arthritis ($2.5bn); antibiotics Zosyn/Tygacil ($1.3bn); and Premarin/Prempro for menopausal symptoms ($1.1bn).
Wyeth has struggled of late for a number of reasons. There are worries over generic competition for one of its best-sellers (Protonix for heartburn) and there have been setbacks in its product pipeline. It is becoming harder to get drugs approved by the US regulator, the FDA, and on the political front there is the potential for legislative pressure in America. The group has also had to deal with currency fluctuations and litigation due to a withdrawn diet drug. Despite all this, it remains a giant in the industry, offering predictable earnings, huge economies of scale and, I believe, compelling value.
In particular, I believe its pipeline of drugs in progress ranks as one of the best of the big pharma sector. It includes vaccines, biologics and, more specifically, Lybrel (a low-dose oral contraceptive), Bazedoxifene (a next generation osteoporosis treatment), and the potential blockbuster Bapineuzumab for Alzheimer’s disease. In fact, if Bapineuzumab is successfully approved after its delayed Phase III clinical trials, it’s possible that it could become the world’s top-selling drug, since all existing Alzheimer’s treatments only ease symptoms, rather than improve a patient’s condition.
On top of this, Wyeth’s presence in biologics and vaccines, which are derived from living cells as opposed to chemical substances, provide the group with three important attractions. Firstly, due to their natural compounds, there is less risk of harmful side effects, which means that human testing tends to be quicker. Secondly, they are used not simply in treatment, but also in disease prevention, which is set to become a huge growth area as governments look to vaccinate children at an early age rather then pay the healthcare costs associated with problems later in life.
Thirdly, once off-patent, it is relatively easy for generic rivals to get copycat versions of cheap, chemical-based drugs approved by the regulators and then sold to consumers. Not so for biologics and vaccines. These are far more complex to create because they’re produced from organisms rather than test-tube reactions. This makes it harder for generics to prove that they have the same characteristics as the branded version.
On the financial side, the board expects 2008 underlying earnings per share (EPS) will be between $3.49 to $3.55. Wall Street forecast earnings should then stay broadly flat until 2010, after which profits should rise again as new compounds come on stream. What’s more, costs are being cut to improve margins, and the firm is overhauling its early-stage research by halving the number of its therapeutic areas in order to get more products to market more quickly. The dividend yield is 3.7%, while the balance sheet is ungeared.
By any measure this is not a company on its knees and simply does not warrant being rated on a miserly 9.3 times earnings. Wyeth is a classic defensive stock, which is artificially trading at depressed levels and could even become the target of a takeover bid from one of its larger rivals.
• Recommendation: long-term BUY at $34.03
A resilient way to play IT
Western Digital (NYSE: WDC), rated a BUY by Deutsche Bank
A slightly riskier option is Western Digital, the world’s second-largest maker of hard disk drives (HDD). It has a 27% share of the $35bn market, behind leader Seagate Technology on 33%. Western Digital has number-one positions in the two fastest-growing segments of the market, with its largest customer, Dell, comprising around 10% of sales.
Despite the recession and fears over future IT budgets, growth is resilient – being driven by the internet and the global demand for storing and retrieving data and video files. Western Digital’s strengths are in two key areas. It makes HDDs for laptops, a market that is worth about $8bn a year and has been expanding at 25% a year. It also makes storage drives used in PDAs, navigation systems and handheld devices that store music, books, news content and films. This segment of the business is already worth $6bn a year and is forecast to grow by 29% a year until 2010.
Yes, Western has been battling deflation, with average selling prices dropping to $53 a unit last quarter, down $6 from a year ago. But even so, overall results are holding up well, given tough conditions. In the quarter to 26 September, the company reported better than expected EPS of 93 cents. Revenues were up 19% and operating margins rose to 11% from 7.5% in the previous year. While sales are expected to be flat, and margins a little softer next quarter, chief executive John Coyne added that “HDD remains one the few areas overall that is demonstrating significant year-over-year growth”.
On the financial front, Wall Street expects turnover and underlying EPS of $8.0bn and $3.02 respectively for the year ended June 2009, rising to $8.2bn and $3.17 in 2010. That puts the stock on very undemanding p/e ratios of 5.5 and 5.2 – far too cheap, especially in light of its $700m cash pile. Sure, there are dangers to consider. The industry is highly competitive, expected growth rates may prove optimistic, and the dollar’s recent revival could also prove a headwind. Further out, the technology is migrating towards solid-state drives (SSDs) from HDDs. But SSDs are far more expensive and in the short term I suspect PC manufacturers will favour lower-cost HDDs, due to the weak economic environment. And I’m sure Western Digital will eventually enter the SSD space, given its long-term plans to serve all segments of the mass storage market.
• Recommendation: BUY at $16.39 (market cap $3.6bn)
Gamble of the week
Puricore (PURI)
When valuations have been hammered, there are always opportunities for investors willing to brave small caps – as long as one is prepared for the occasional sleepless night. One such stock is Puricore. It is a life-sciences firm that develops non-toxic and environmentally-friendly germ-killing systems (such as Sterilox) mainly for the food, dental hygiene and healthcare industries. The technology is patent protected and uses the electrolysis of salt and water to create a natural food-safe sanitiser that not only disinfects surfaces and medical instruments, but also safely extends the shelf life of fresh food sold in shops.
Even though the Sterilox systems are fairly new, around 40% of all NHS hospitals already use at least one of these units. Yet this is just part of the story – so far, $35m worth of Sterilox systems have also been installed in food retailers across America to provide a natural protection against pathogens such as Escherichia coli and Salmonella. On 24 October, the firm announced another substantial order from Safeway Inc, to implement the technology across its remaining (around 3,000) North American outlets in 2009. Yet Puricore’s market share is still only around 8% of American retailers; CEO Greg Bosch reckons this can be doubled within two years.
The big concern is that Puricore is not yet self-funding, albeit Bosch believes it should be profitable by 2010. Clearly another cash call is a risk, although there is around $13m net cash on the balance sheet after raising £8.4m at 13.25p in August. Other risks include foreign exchange, contract delays, difficulties rolling out Sterilox in Europe, tightening NHS budgets and the possibility that better technologies will be invented going forward. That said, house broker Nomura predicts revenues of $34m for 2008, and Piper Jaffray has a buy recommendation and a 26p target price. And recurring revenues, generated from rental agreements, service contracts and the sale of consumables, accounted for 44% of turnover in the first half. My guess is that as long as the firm stays on track, then by 2011 it should achieve sales of over $70m and deliver underlying operating profits (EBITA) of $10m. Assuming this was the case, I would rate the organisation on a ten-times 2011 EBITA multiple discounted back at 15%, which would give a fair value of about 18p a share.
• Recommendation: SPECULATIVE BUY at 9.88p (market capitalisation £21.4m)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.