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Re: Safe Harbor for Forward Looking Statements
Chapman, Spira & Carson - Disscusion

From: Fortune Investor Analysis
Date: 4/11/99
Time: 5:42:12 PM
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Safe Harbor has any number of definitions, another that is commonly used means stocks that will act well under any conditions. Naturally when the market is really going down the drain, everything goes with it, but your safe harbor stocks should rebound faster than the market in general.

Fortune did a great piece, written by Nelson Schwartz about their picks for 1999. We can't find fault with and pass them along for your perusal.

Ten Safe-Harbor Stocks

Think of stocks that can handle any economic condition, and you'll think of blue chips with solid, sustainable top- and bottom-line growth. In other words, stocks just like these. Mine the data beneath our picks in Safe-Harbor Stocks: Details and build your own large-cap searches.

Nelson D. Schwartz

If there is one thing investors could use right now, it's a safe harbor. This year will go down as one of the stormiest in Wall Street history, with all the swells and surges of a December nor'easter. Even the market's remarkable autumn rally hasn't really calmed the waters; underneath the relief there's still an undertow of unease.

The confusion is shared even by the best brains on the Street. Some, like Morgan Stanley's Byron Wien, believe earnings growth will pick up next year, helping stock prices to move higher. Others, like Merrill Lynch strategist and self-described bear Rich Bernstein, foresee prolonged earnings weakness for the first time since the early 1990s.

What are ordinary investors supposed to do if even the big domes can't get a handle on things? The prudent course is to seek out what we call "safe harbor" stocks--companies that seem likely to hold their own regardless of what happens next. To help us find these rare vessels, we talked to strategists such as Bernstein, Wien, and Lehman Bros.' Jeff Applegate. We also surveyed top-ranked money managers like John Hancock Funds' James Schmidt. Finally, we ran our picks by top analysts like telecom expert Kevin Moore of BT Alex. Brown and Carl Seiden, who follows the pharmaceuticals industry for J.P. Morgan. (See the boxes later in the story for these two analysts' outlooks on their respective industries.)

We decided first that we would stick with large-cap names. Although they currently trade at higher valuations than their small-cap brethren, large-company stocks in general hold up better in market hiccups, as they did during the recent unpleasantness. While the large-cap S&P 500 fell nearly 20% between mid-July and early October, the small-cap Russell 2000 fell 33%. What's more, as of Thanksgiving the blue-chip Dow Jones average and S&P 500 had both surpassed their old records, while the Russell was still well below its April high.

The first attribute we looked for in our blue-chip universe was consistent earnings performance. Jeff Applegate points out that steady growers are especially valuable when overall earnings growth is running out of wind--which is where we seem to be now. "If profits get scarce, people are going to pay up for earnings predictability and stability," he says.

At the same time, we wanted to make sure the earnings growth was sustainable. So we avoided companies in industries tied to unpredictable commodities like paper or oil. Even in groups we liked, such as pharmaceuticals, we were careful to steer clear of companies that are overly dependent on one product. That's why we shied away from strong growers like Eli Lilly, for example, whose income hinges heavily on sales of Prozac.

As a final backup we insisted on highly reliable revenue growth. That way future profits won't depend on cost cuts--a strategy that can take you only so far--or worse, on Hail-Mary passes from corporate accounting. Companies with weak revenue growth, such as Coke and Gillette, were among the hardest hit in the summer correction, which underscores the importance of a healthy top line.

In this market, though, fast growers don't come cheap. Some of our picks have relatively high P/Es, but that doesn't necessarily mean they are overvalued. It all depends on whether they will deliver the growth the market expects of them. We think they will. Wharton School finance professor Jeremy Siegel, who has studied the performance of U.S. stocks since 1802, concludes, "Over time, companies with above-average growth will do well even if they look expensive right now."

That doesn't mean our picks can't go down. They can. In a steep downturn, even the best merchandise gets marked down. But our sources are confident that these stocks offer a close-to-ideal mix of upside potential and downside protection. Now on to the picks:

Say yes to drugs

In stressful markets, veteran Wall Streeters tend to acquire a drug habit. Who wouldn't? Pharmaceuticals companies are almost unique in their ability to generate strong earnings growth in any economic climate. So no matter which way the economy goes, drug stocks have you covered.

Which brings us to Pfizer. You already know the company's hottest product, Viagra. The drug's boffo launch earlier this year made it the most successful new drug in history. In recent months, though, sales have faded a bit, and Pfizer's stock gave up some of the gains it made earlier in 1998. What's been overlooked amid the hoopla is that Pfizer has plenty of other potential hits in the pipeline. "I don't think there's much doubt that Pfizer is the best company in the industry," says J.P. Morgan analyst Carl Seiden. "They've got a series of blockbusters coming out in the next few years. It's almost an embarrassment of riches."

The most important of these new medicines is Celebrex, a revolutionary painkiller developed by Monsanto that's safer than conventional remedies like aspirin or ibuprofen. For example, Celebrex doesn't carry side effects of long-term aspirin use, such as stomach bleeding.

Pfizer and Monsanto have formed a partnership to market Celebrex, which Deutsche Bank Securities analyst Mariola Haggar predicts will gain final FDA approval by the end of January. She estimates that by 2004, Celebrex's total sales could equal $2 billion. Pfizer's share: 40% to 50% of the profits. Haggar adds that Pfizer will launch several potential blockbusters from its own labs in 1999, including migraine-remedy Relpax and Tikosyn, a treatment for cardiac arrhythmia. And while Viagra may be off the front pages, it hasn't gone away. Pfizer recently unleashed the little blue pills on Europe and is set to do so in Japan in late 1999.

Altogether, says Seiden, Pfizer's earnings should grow by roughly 20% annually for the next few years, well above the drug industry average of 15% to 16%. Revenues are also growing by about 20% annually, he says, and the company is taking excess cash and plowing it into research to maintain its supply of future blockbusters. "Pfizer is investing now so it can grow by 20% forever," he says. "In the long run, that's going to be great for investors." Over the next 12 months, Seiden says Pfizer could rise 25% from its current level of $111 a share.

Our second pick in this group, Pharmacia & Upjohn, used to be the drug stock Wall Street loved to hate. The 1995 merger between Swedish pharmaceuticals giant Pharmacia and U.S.-based Upjohn got off to an awkward start, with executive offices in four countries and constant turf wars.

That all changed when Fred Hassan took over as CEO in the spring of 1997. A well-regarded industry veteran, Hassan streamlined the company's sprawling bureaucracy and installed a new management team that's finally earning the company respect on Wall Street.

"Hassan has really made a difference," says Michael Kagan, manager of the $1.7 billion Salomon Brothers Fund, which owns about $25 million of PNU. "This company had been an utter disaster." The turnaround hasn't gone unnoticed: Pharmacia & Upjohn shares are up more than 20% since this past June. But Kagan, along with analysts Haggar and Seiden, argues that PNU still has plenty of upside left. Kagan notes that the company's P/E multiple is 10% below that of the typical drug company, while earnings are expected to grow by 14% in 1999.

At the same time, analysts are excited about new drugs from PNU like Detrol, an eight-month-old incontinence remedy that has already grabbed a big share of the market. Incontinence affects more than 30 million people worldwide, and Detrol doesn't cause the severe dry mouth that patients experience with other treatments. By 2002 it could generate $800 million in worldwide sales. Haggar estimates that drugs like Detrol could help drive PNU shares to $65 by the end of 1999, for a gain of 22%.

If our final pick in this group, American Home Products, seems familiar, that's because we recommended it this past August in our annual Retirement Guide. Since then AHP has gone through some tribulations--most notably the collapse of its planned merger with Monsanto in October. The breakup of the deal sent AHP shares skidding, and it's now well off its 52-week high of $59.

But even without the union with Monsanto, AHP is still a good long-term pick. That's especially true for bargain-minded investors who have been scared off by the drug sector's sky-high P/Es. AHP's 1999 P/E of 27 makes it the cheapest of the major drug stocks by far, says Haggar. Meanwhile the company is quietly preparing a bevy of potential hits, including Sonata, a sleep aid due out in April that doesn't have the side effects of existing drugs.

Haggar warns that the next quarter or two could prove tricky as AHP finds its way after the busted merger. But over the long term, she predicts that AHP will see revenue growth of 10% annually and profit growth of more than 13%. That's a pretty compelling proposition, given AHP's below-average valuation. "This is a cheap stock," says Haggar. "Your downside is limited. I have a target price of $65 to $70, so you're looking at a potential gain of more than 20%."

Phone it in

If drug companies are the No. 1 safe-harbor stocks, phone companies are a close second. True, the advent of deregulation made telephone shares a lot less predictable: Just look at the recent volatility in AT&T. Nonetheless, they remain a reasonably safe choice--as long as you go with stocks that are profiting from the new trends in telecom, not fighting them.

No company fits that description better than MCI WorldCom. WorldCom CEO Bernie Ebbers stunned the telecom establishment when his company bid for long-distance giant MCI last year. With the completion of the merger this past September, it seems that the synergies Ebbers has long talked about will come to fruition. WorldCom now has the world's largest Internet-services business. It is also the nation's second-largest long-distance company, as well as a major player in everything from local phone service to high-speed data communications. The company's scale and potential make Salomon Smith Barney's top-ranked telecom analyst Jack Grubman almost rapturous. "There are few, if any, companies anywhere in the S&P 500 that are as large as WCOM, that have WCOM's growth potential--and more importantly, that have the visibility that WCOM has for continued top-line growth," he says. "This company remains the must-own large-cap growth stock for anyone's portfolio."

It's hard to argue with him. Revenues are expected to hit $41.8 billion in 2000, a 17% increase from the 1999 level. (Microsoft's 2000 revenues, by contrast, are expected to equal $20.7 billion.) Profits, meanwhile, should jump 48%, to $5.5 billion. Even better, the company's already capacious profit margins should widen even more as the famously cheap Ebbers trims the fat left over from MCI. Analysts are convinced that the company could see $2.5 billion in cost savings in 1999, and Grubman believes the stock could be at $80 to $90 by the end of 1999, up from $59 now.

BellSouth, our other telecom pick, has also succeeded by focusing on high-growth businesses while keeping costs low and margins wide. Not only does it have the fastest revenue growth of any of the Baby Bells, says BT Alex. Brown analyst Kevin Moore, but it's also the most efficient. BellSouth generates revenues of $271,000 per employee, putting it well ahead of competitors like Bell Atlantic, which generates sales of $226,000 per employee. Plus, says Moore, BellSouth's high-margin businesses like data and digital services, along with wireless communications, are growing by over 30% a year.

It doesn't hurt that BellSouth enjoys a commanding presence in one of the country's fastest-growing regions. "Economically and demographically, the South is one of the top places to be for a Baby Bell," says Moore. BellSouth has also made some shrewd overseas moves, such as building a major cellular business in Latin America. In the third quarter BellSouth's Latin American wireless revenues jumped from $206 million to $442 million, a 114% rise.

The efficient, steadily growing domestic business and the new opportunities abroad should help BellSouth's profits increase by 12% annually over the next few years, Moore estimates. "We see this stock in the $95 to $100 range in about 12 months, a 20% gain. That's pretty good upside for a Baby Bell." Or any other stock, for that matter.

Safe techs

Unlike the drugs or Baby Bells, tech companies aren't often thought of as safe-harbor stocks. However, it would be a big mistake for risk-averse investors to avoid this group, especially because of the long-term growth opportunities that the Internet and other new technologies offer.

The trick is to find tech stocks that combine rapid growth with proven staying power. That's why we prefer two of the biggest names in this sector: Microsoft and Lucent. Their size, wide range of products, and record of consistent growth all make them safer bets than smaller competitors. And while Lucent and Microsoft may not promise overnight riches like an eBay or Amazon.com, we're happy to leave those two high-fliers to day traders and other gamblers.

Our picks do have some well-publicized risks of their own, however, especially Microsoft. As everyone knows, the colossus of Redmond is embroiled in the antitrust trial of the decade with the only other entity in its weight class, the U.S. government. To top it off, the stock has surged 40% since June.

So is this the right time to be buying Microsoft? Lehman Bros. software analyst Mike Stanek says he's frequently asked that question. His answer: "The market is open from 9:30 a.m. to 4 p.m., five days a week," says Stanek. "Anytime during those hours is a good opportunity to buy Microsoft."

What makes Stanek so confident? "This company is entering the most lucrative product cycle in its history," he explains. "Between Windows 98 right now, the Microsoft Office upgrade in 1999, and Windows NT in 2000, you're looking at annual earnings growth of 25% at a minimum."

It's Windows NT that has analysts like Stanek especially excited. While Microsoft dominates the market for desktop software, it isn't yet a player in the $40 billion-to-$50 billion market for enterprise software, the heavy-duty programs that run on big servers and workstations. Once the new version of Windows NT comes out in early 2000, Microsoft could siphon market share from enterprise software sellers like IBM, Sun, and Oracle.

"Over the next five years, Windows NT will help sustain the company's annual earnings growth at 25%," says Stanek. "And you've still got growth in the high teens or low 20s from its other products." Moreover, the licensing fees big corporate customers pay for Windows NT and Microsoft Office give Microsoft's profits a predictability that few companies--tech or otherwise--can match.

But isn't the government's antitrust suit a real worry? In the short term, yes. Over the long term, though, Microsoft's stock price will be determined by the company's earnings power, and there is no evidence that the current legal battle poses any real threat to that. Even a worst-case scenario--a government breakup of Microsoft--would likely prove a boon to investors. Just ask anyone who held on to the Baby Bells when AT&T split in 1984.

Stanek doesn't see anything so drastic as that. He predicts Microsoft could hit $140 before the end of 1999, a nice gain from its current level of $120.

Our other pick in this group, Lucent Technologies, is already one of the tech legends of the 1990s. Since its 1996 spinoff from AT&T, this maker of communications hardware has risen more than 500%, and there's nothing to suggest that the glory days are over.

For starters, the $200 billion market for communications gear is growing by 12% to 14% annually, spurred by massive infrastructure investment by companies like MCI WorldCom and AT&T. The recent wave of telecom deregulation in Europe has only heightened demand for Lucent's products, as giants like Deutsche Telekom modernize their aging phone networks. Finally, the explosion in Internet traffic practically guarantees strong growth for years to come.

What's more, Lucent is taking market share from rivals like Nortel and Siemens. "As General Electric is to the industrial economy,

Lucent is to the Information Age," says Jim Parmelee, an analyst with CS First Boston. "It's already clear that Lucent is one of the long-term winners out there."

Indeed, Lucent scored the Wall Street version of a hat trick when it recently announced its latest results, beating estimates for earnings, revenues, and profit margins. Parmelee, who predicts long-term growth of 20% to 25%, says Lucent could rise from its current $89 to $110 over the next 12 months.

Bank on earnings growth

Our next two picks, First Union and Bank One, may not seem to have much in common with tech superstars like Microsoft and Lucent. But what these two superregional banks lack in sex appeal they more than make up for in steady earnings growth and very reasonable valuations.

Take First Union. Powered by smart deals like this year's acquisition of Pennsylvania's CoreStates Financial, this North Carolina-based bank should see its profits jump by more than 15% in fiscal 1999. Over the next three years, says Sanford Bernstein analyst Moshe Orenbuch, the company should easily maintain a growth rate of about 12%. Despite that potential, First Union is trading at 14 times next year's earnings, a 15% discount to the banking group and a whopping 40% less than the typical S&P 500 stock.

Plus, First Union is way ahead of its peers in creating the kind of integrated banking giant that Wall Street has been talking about for years. While John Reed and Sandy Weill struggle to meld Travelers and Citicorp into the new Citigroup, First Union CEO Ed Crutchfield has been quietly building a genuine financial supermarket. "Crutchfield understands Wall Street, and he's been able to bring together areas like money management and capital markets with more traditional parts of the bank," says James Schmidt, manager of the John Hancock Regional Bank fund.

What's more, Crutchfield promised Wall Street last summer that he's no longer interested in the kind of expensive acquisitions that weighed down First Union's stock in the past. Assuming Crutchfield keeps his promise and doesn't break the bank, as it were, with any big purchases, Orenbuch predicts First Union could hit $80 within 12 months. Throw in a yield of nearly 2.6%, and you're looking at a total return of almost 30%.

Bank One is another superregional with a below-average valuation. Formed by the merger of Columbus, Ohio-based BancOne with First Chicago NBD in October, it dominates the Midwest, with retail operations in 14 states.

Strong growth in its core markets and over $400 million in cost cuts related to the merger should give Bank One's earnings a 19% pop in 1999, says Orenbuch, and lead to 14% annual growth over the next three to five years. That puts Bank One among the fastest growers in the industry, despite a low 1999 P/E of 13.

That's among the reasons Bank One offers one of the best risk/reward profiles of any major bank stock. "Given the relatively low P/E and the signs that the merger is working," says Orenbuch, "this is a great buying opportunity." He predicts Bank One could hit $70 within 12 months, a gain of 30%.

Wall Street loves Wal-Mart

A couple of years ago, some investors began to wonder whether Wal-Mart could continue to churn out the remarkably steady growth it had become famous for. At one point in early 1996, earnings actually fell.

In the past year, though, Wal-Mart has rebounded. The stock is up 87% in 1998, driven by strong gains from the company's new domestic supercenters as well as from its overseas stores, where 1998 profits are on track to more than double last year's results. "There are other companies that are good at certain segments of retailing," says Don Spindel, an analyst with A.G. Edwards, "but there's no one that does it as well across the board as Wal-Mart. They don't have any weak links." For example, Wal-Mart is quickly becoming a powerhouse in the $400 billion market for groceries. Spindel believes that Wal-Mart's grocery sales could easily double to $80 billion over the next five years.

He predicts 1999 overall sales will top $150 billion and that earnings will continue rising 12% to 15% annually for the next three years. By the end of 1999, he figures, the stock could be trading at around $90, up from $75 now. "It's ingrained in Wal-Mart's culture to constantly go after what customers want," he says. In these uncertain times, that's a good way to provide what investors want too.

Issue date: December 21, 1998


Last changed: March 17, 2000