When The Best Offense...Is Finding A Safe Haven
It's mid-1999, and the market tanks. Are you ready? If you're Seeking stocks to weather any storm, don't be surprised if your choices are painfully limited. Equities at bargain prices are about as easy to find as liquidity in Russia.
It wasn't long ago that utilities were obvious choices: They were cheap and provided a steady flow of cash dividends. But deregulation has taken those boring utilities and given them sex appeal. They are no longer cheap.
So where should one look? The answer is in stocks that make the best of a bad situation. These are what the pros call safe haven or defensive stocks--companies whose success is not dependent on underLying economic conditions. Sean N. McDaniel and Cappy R. McGarr, partners at McGarr Capital Management, a hedge fund based in Dallas, look for stocks that will outperform the market even in a market downturn. Typical defensive candidates are products such as food, razors, or soft drinks with strong brand names. "You want to find things people will need if the world falls apart tomorrow," McGarr says.
KILLER WEED KILLER. Two of the firm's top defensive choices are Monsanto Co. and Playtex Products Inc. Feminine care products, which make up 30% of Playtex' overall revenues, are in demand no matter what the state of the economy. The company's other divisions, infant care and suncare, are also stable growers. And with Playtex in a buying mood, McDaniel expects earnings to increase 25% for 1999.
As for Monsanto, its two biggest businesses are drugs and agricultural products. "In a recession, I don't know if people will want to buy Pentium chips, but I figure people will still need medicine and need to eat," says McDaniel.
Monsanto's agricultural products include strains of seeds to improve crop yields, as well as the world's leading weed killer, RoundUp. Products like that are a necessity for more efficient farming, which becomes especially important during times of weak commodity prices, says McGarr. On the pharmaceutical side, Monsanto's newest drug is called Celebrex, which just received Federal Drug Administration approval for treating arthritic pain. "The pharmaceutical side of Monsanto has the best cash flow and earnings growth potential of any drug company," says McGarr, who expects the stock to reach $65 next year.
SAVING GRACE. Drug stocks, in fact, are traditional defensive plays. Bear, Stearns & Co. Senior Managing Director Robert S. Reitzes, a co-manager of the company's hedge fund, New Castle Partners, says his best defensive pick is Genentech Inc., a biotech company with a novel twist. The $2 billion market cap company offers excellent drugs, according to Reitzes, including Herceptin, a late-stage breast cancer drug that prolongs a patient's life. The drug just recently received FDA approval.
But the main reason Reitzes loves this stock as a defensive play is that Roche Holding, which currently owns over half of Genentech's shares, has the right to buy the remainder of the shares on June 30, 1999, at 821/2. The stock currently trades at $70 a share. If Roche declines to go through with the purchase, there's a saving grace to the investor: Should Genentech fall to 60, Roche is obligated to buy the remainder of the outstanding shares, giving modest downside risk to the owners of this stock, says Reitzes.
Bart Blout, a portfolio manager with Sawtooth Capital management, a Santa Monica (Calif.) hedge fund, says he's always on the lookout for defensive stocks because as a small-cap money manager who takes big positions, "Once I get in a room with fire, there's no exits."
While McGarr Capital looks at food from a wholesale level, Blout likes the retail level. Blout is a big fan of the fast-food chain Taco Cabana. The average check is only $5.60. Cash flow from operations for 1999 should produce about $1.70 per share in a $7 stock. "A company that can generate its own internal cash is the definition of a defensive company," says Blout. And the chain has the highest unit volume of any quick-service restaurant in the U.S., including McDonald's. Taco Cabana is preparing to roll out its franchise nationwide.
PEZ POTENTIAL. Blout also believes that Mexican cuisine will become increasingly popular. "Salsa and hot sauce are replacing ketchup as the condiment of choice," says Blout. "As the cultures of the world come together, modern quick service and spicy food will be the choice of preference. I see McDonald's' burgers as old-fashioned food."
Another safe harbor pick is The Topps Company Inc., an old-line baseball-trading-card company with a market cap of $200 million. Says Blout: "This is an industry that went to hell in a handbasket. There's too many entrants, too much duplication." But with new strategies, the company has repositioned into the candy business, with "tons of new products," Blout says.
Bazooka bubblegum is one of the products the company is known for. But it is now launching lots of new candy as well. Blout says the company can generate cash in the neighborhood of 10% to 12% of sales. A couple of new candy products can generate a lot of money," he says.
Blout is a big fan of the company's candy diamond ring. Like the real rock, it doesn't cost much to produce, but it commands fat prices. "If they keep bringing novelty products that capture kids' imagination, you get the candy company for a good price and the trading-card company for free," he says.
Mark Strome, president of Strome Susskind & Co., another Santa Monica hedge fund, has a defensive stock that even his grandmother owns: Plains All American Pipeline LP, a $391 million market-cap oil-transportation company. Part of its appeal is its structure: It is a master limited partnership that acts like a real estate investment trust, which means it pays out 95% of its income in tax-deferrable dividends. Its current yield is 91/4%--more like 12%, since the majority of the dividend is tax-deferred.
Plains All American, which transports oil from California to Oklahoma, has no competition on its routes and is not sensitive to the price of crude oil. "Plus, there's big upside potential for the stock, because the company can buy assets that will be sold off in big oil mergers, like with Exxon Corp. and Mobil Corp.," says Strome. These purchases can instantly accrete to Plains All American because of its nontaxpaying structure. The yield distributions are expected to grow by about 10% a year. "Plus, this is the best-managed company on the face of the earth," says Strome.
CARS AND FLICKS. Bill Scovin, an entertainment analyst at Ladenberg, Thalmann & Co. in New York, is a big believer in stock-car racing as a defensive play, because the sport's fans are loyal regardless of economic conditions. NASCAR sports racing has become one of the most popular televised sports. Throw in high barriers to entry--meaning it's difficult
to build new tracks near major metropolitan areas--and fat margins, and you have a compelling story. International Speedway Corp. and Speedway Motorsports Inc. are two compAnies where Scovin expects 15% to 20% growth in revenues and earnings over the next few years.
If all else fails, there's always the movies: 3-D movies, to be specific. Imax Corp., a Canadian company, is the maker of movie screens and projectors for IMAX films. Imax, which developed the concept of 3-D movies on large screens more than two decades ago, helps movie houses construct specialized theaters. Fueling the growth is a new generation of IMAX movies that are more character- and plot-driven.
"As more IMAX movies are developed with more popular content, they will create more of a bUzz in the entertainment world," says Scovin.
IMAX has another plus: If the market really does tank next year, plenty of people may go to the movies to forget their battered portfolios. If that doesn't appease their sorrows, at least they'll be crying in the dark.
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