With consumer spending expected to grow more slowly this year, stocks in the consumer-discretionary sector have been lagging the broad market -- but as Thomas Graves, Standard & Poor's group head for consumer-discretionary stocks, puts it, "We do see some attractive opportunities among individual stocks."
Other than the fact that all are companies making products that consumers can postpone buying, there's no broad theme among the stocks Graves sees as strong buys. There are currently 17 in his sector, including restaurant outfits McDonald's (MCD ), Red Robin Gourmet Burgers (RRGB ), and Steak 'n Shake (SNS ). He also reports a high rating on housing stock Lennar (LEN ) and on retailers Bed, Bath & Beyond (BBBY ), Best Buy (BBY ), Coach (COH ), and Payless ShoeSource (PSS ).
Graves says S&P at this point sees the best possibilities for investors in three other sectors: consumer staples, health care, and utilities. In consumer staples, S&P has strong buys on Procter & Gamble (PG ), PepsiCo (PEP ), and Colgate-Palmolive (CL ), among others.
These were some of the points Graves made in an investing chat presented on May 31 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. AOL subscribers can find a complete transcript at aol.businessweek.com/chat
Note: Thomas Graves is an S&P Equity Research analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat, except as noted. All of the views expressed in this chat accurately reflect the analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts."
Q: Tom, how has the consumer-discretionary sector been doing, with energy prices up and a whiff of inflation?
A:It hasn't been an easy year. Stocks in this sector, through last Friday, had moderately underperformed the broader market. However, we do see some attractive opportunities among individual stocks.
Q: How closely do the stocks you cover track consumer spending? What seems to be the biggest factor affecting their movement?
A:We see a variety of factors affecting the price changes of consumer-discretionary stocks. Obviously, some factors are specific to individual issues. On a broader basis, we look at the level and direction of interest rates, growth in consumer spending, and energy prices.
Currently, we have some concern about the prospect of rising rates, the extent to which energy prices are limiting spending on other items, and the likelihood that overall consumer spending this year will grow more slowly than it did last year.
Q: What are your top picks?
A:Overall, we have a strong buy opinion on 17 stocks. Among those are Bed, Bath & Beyond, Lennar class A shares, and Fortune Brands (FO ). We also like a number of restaurant stocks, including McDonald's and Red Robin Gourmet Burgers. We also have a strong buy opinion on shares of Steak 'n Shake. We've set a 12-month target price of $24.
Q: Is there any common thread that makes the 17 strong buys?
A:Among some clusters of stocks, there's a common thread. For example, we have a strong buy opinion on three housing stocks. In part, this reflects our view that housing demand is going to remain relatively strong. However, when you look across all 17, I believe [we chose them] more on a company-by-company basis than on any one theme.
Q: Obviously a worry here -- what to do with American International Group (AIG )?
A:We have a buy opinion on shares of AIG. We aren't surprised by the suit New York Attorney General Spitzer has filed against AIG and some of its former management team. We view this latest salvo positively, since it moves the situation closer to resolution. Our 12-month target price of $64 for AIG assumes that the stock trades at a valuation that is closer to peers, based on 2005 estimates.
Q: What's your take on PetsMart (PETM )?
A:We have a buy opinion on it. We recently downgraded our recommendation from strong buy, based on valuation. Our 12-month target price is $37.
Q: Do you like Procter & Gamble (PG )? Other stocks in this sector?
A:We classify PG as a consumer-staples stock, and we have a strong buy recommendation on it. We also have a strong buy recommendation on other consumer-staple companies, including PepsiCo (PEP ), Colgate-Palmolive (CL ), and others.
Q: What stocks will be most affected by fuel prices, positively and negatively?
A:Higher fuel prices are obviously a negative for some transportation-related companies, with airlines likely to be among them. Higher fuel prices, on the other hand, could be beneficial to a number of energy companies, including those with substantial reserves.
Q: Entertainment stocks?
A:Among the ones that we follow, we have a strong buy opinion on two different types of News Corp. shares: class B (NWS ) and class A (NWS.A ). In addition, we have a buy opinion on Time Warner (TWX ) and Disney (DIS ).
Q: What's your opinion of Outback Steakhouse (OSI )?
A:We have a hold opinion on it. Our view is that the stock's valuation fairly reflects the company's growth prospects.
Q: Earlier you said S&P saw better opportunities beyond consumer discretionary -- where, specifically?
A:Our sector strategist, Sam Stovall, is recommending that on a market-capitalization basis investors overweight three sectors: consumer staples, health care, and utilities.
Q: Is there room for growth with Starbucks (SBUX )? It appears sluggish lately.
A:We aren't especially bullish on shares of Starbucks, which is reflected in our hold opinion. However, we do expect further strong earnings growth from the company. We're estimating $1.16 per share in the fiscal year ending September, 2005, followed by $1.47 in the fiscal year ending September, 2006. At its current level, we aren't recommending purchase of the stock.
Q: If you have 17 strong buys in consumer discretionary, is that a lower number than in better times?
A:The number of strong buys within the sector does vary, based on both macroeconomic factors and things that are specific to individual companies or stocks. In total, equity analysts at Standard & Poor's cover more than 1,500 stocks. There are more than 100 on which we have strong buy opinions.
Q: And can you give us some of the other names you haven't had a chance to tell us about yet?
A:Within the consumer-discretionary sector, some of our strong buy opinions include Apollo Group class A shares (APOL ), Best Buy, Guitar Center (GTRC ), and International Speedway class A shares (ISCA ).
Q: Do you recommend chicken stocks like Tyson Foods (TSN )?
A:We have a buy opinion on the class A shares of Tyson. Our 12-month target price is $21. In the fiscal year ending September, 2005, we're estimating earnings per share of $1.15, and for fiscal 2006, $1.45.
Q: Any other interesting buys among stocks in your area, Tom?
A:Strong buy opinions that we haven't mentioned yet include shares of Claire's Stores (CLE ) and Payless ShoeSource (PSS ).
Q: Going to the drugstore -- Walgreen (WAG ) vs. CVS (CVS )? Do you have a buy rating on both?
A:We have a strong buy on CVS, which includes our positive view of Eckerd being turned around. We have a 12-month target price of $61. Meanwhile, on shares of Walgreen, we have a buy opinion, and our 12-month target price is $49.
Q: Opinion on Harley-Davidson (HDI )?
A:We have a hold opinion on it. Based on our 2005 earnings estimates, we look for the stock to trade at a p-e multiple similar to that of the S&P 500. Our 12-month target price is $56.
Q: The distinction between discretionary and staples seems obvious, but can you give us your definitions?
A:We view discretionary stocks as being those of companies that produce products or services that consumers can more readily defer a purchase on. Consumer staples are more likely to be shares of companies that produce or sell day-to-day necessities such as food.
Q: Has Lowe's (LOW ) overshadowed Home Depot (HD ) ratings?
A:We have a buy opinion on both of these home improvement retail companies. For Lowe's, our 12-month target price is $65, while for Home Depot, it's $48.
Q: What about hotel stocks?
A:Within the hotel area, our favorite stocks include La Quinta (LQI ), LaSalle Hotel Properties (LHO ) and FelCor Lodging Trust (FCH ). La Quinta is considered a consumer-discretionary stock, and the shares trade as part of a unit, while LaSalle and FelCor are in the financial sector because both of them are considered to be real estate investment trusts (REITs).
Q: Do you expect consumer-discretionary stocks to stay in the shadows through the rest of the year? Except for your buys and strong buys, of course.
A:Basically, we expect the prospect of higher interest rates and other potential negative factors to cause the sector to perform less favorably than some others.
Q: Is Target (TGT ) better valued than Wal-Mart (WMT ) currently?
A:We have a strong buy opinion on shares of Wal-Mart. Our 12-month target price is $59. We have a buy opinion on shares of Target, for which our 12-month target price is $57.
Q: Are there any stocks you watch that investors should consider selling?
A:There are a number of stocks on which we have a strong sell or a sell opinion. Within the consumer-discretionary sector, they include CKE Restaurants (CKR ), Clear Channel Communications (CCU ), and General Motors (GM ).
Q: Do you favor Hershey (HSY )? They seem to beat the S&P.
A:We have a hold opinion on Hershey. The company's first-quarter earnings were slightly above our estimate. Our 12-month target price is $67. We think the shares are worth holding, based on our view of strong brand momentum and cash flow. However, we see limited near-term upside potential.
Q: What kind of retailer seems to be doing best in this environment?
A:We've seen some strength among retailers serving the high-end consumer market. However, we don't have a lot of buy recommendations directly tied to this theme. One company we like is Coach (COH ), on which we have a buy opinion. Our 12-month target price is $33.
Q: The old-line department store isn't doing well for investors?
A:In recent years we have seen them facing a squeeze from specialty retailers on one side and mass merchandisers or big-box retailers on the other. That being said, we have a hold opinion on Sears Holdings (SHLD ) and J.C. Penney (JCP ). We do have a buy opinion on Nordstrom (JWN ).