Tuesday, November 18, 2008

From WSJ

Maybe There Is an Upside to This Mess

The market has tumbled, the financial system is wobbling, and global economies likely are in a deep
downturn.
But one big positive has emerged: The plunge in prices of all kinds of commodities, from oil and natural gas to steel and copper. These moves will ease some pressure on strapped consumers and will give a boost to a range of companies by reducing their costs and increasing demand for
some of their products.

Searching for stocks likely to be helped by tumbling commodity prices can be tricky, however, because the benefits can be offset by growing problems elsewhere. Companies in the gambling business, for instance, will be aided by falling oil prices as travel to casinos becomes cheaper. But rising unemployment, housing troubles and other issues plague their customers, even as some casinos deal with heavy debts, making these shares look risky.

Look for an Energy Lift

Analysts say the best move is to focus on companies that are helped by falling energy prices and are in relatively stable businesses -- ones that aren't dependent on consumer spending or other areas of weakness.
"Energy costs represent only one dimension to the business," notes Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "Without evaluating their overall business environment, you could get caught with the right idea but the wrong company."

Last week, the Dow Jones Industrial Average was down 5%, leaving it down 36% so far this year.

The Nasdaq Composite index was down nearly 8%, bringing its 2008 drop to 43%.

Energy prices continued to plunge, as did other commodity prices. Oil, which closed at $57.04 on Friday, now is off more than 60% from its record close of $145.29 on July 3.
Falling energy prices hurt companies in the oil patch, of course. But many others rely on energy as a key input to make their products. These companies are seeing their own costs drop sharply.

One company likely to benefit: Pactiv, the maker of Hefty trash bags, plastic containers and other products such as plastic plates, cups and cutlery. Pactiv relies on polypropylene and polyethylene, both oil-based resins. Cash flow is impressive. The shares were selling Friday for a price-earnings multiple of about 16.
Pactiv's products are relatively stable, even in a global slowdown. During the 2000-2002 downturn, the stock climbed, a sign of its defensive nature; shares are basically flat from a year ago. Pactiv has raised prices on its products in recent months, a healthy sign.

The company's third-quarter results fell compared with a year ago, in part because energy prices soared earlier this year and its products became more costly to produce. But Chairman and Chief Executive Richard L. Wambold late last month said, "As we move into the fourth quarter, this situation will change as a result of our pricing actions in the third quarter, and [because of] resin-cost decreases, which are expected in the fourth quarter."

It's in the Bag

Pactiv is a "perfect example of a company that has benefited from lower crude prices," says Harris Private Bank's Mr. Ablin.

The falling costs of commodities such as resin, diesel and other raw materials also will help consumer-products maker Clorox. Meanwhile, about one-third of Goodyear Tire & Rubber's costs of goods sold are products derived from oil. While the company could be hurt by the continuing troubles of the U.S. auto makers, sales of replacement tires -- 80% of Goodyear's business -- are tied to miles driven, which should rebound if gasoline prices fall further.
Airlines benefit from lower oil prices, and many investors rush into these shares when crude drops. These companies added fees over the summer to compensate for the higher energy costs they were dealing with at the time. Now that fuel has fallen, many carriers have simply incorporated their former fuel surcharges into ticket prices, which could lead to profits. Shares of AMR, parent of American Airlines, have almost doubled since mid-July. But airlines have deep difficulties, such as fierce competition and heavy employee-pension costs, making the area highly risky.

By contrast, companies that cater to the aerospace industry, which includes both commercial and military business, appear more attractive, according to some investors. Precision Castparts, which makes rivets and metal parts for aircraft, as well as fasteners for automobiles, could be a beneficiary of any improved airline health.

Precision shares have fallen 60% so far this year, but as the outlook for its customers improves, so will Precision's. It also will be helped by falling metal prices. The stock trades at about 12 times its expected profits for the next year, a relatively attractive multiple. An industrial-gas-turbine business is growing, even as sales of fasteners to auto makers slow. Most analysts have a "buy" rating on the stock.

Flying Higher?

Aircraft-component manufacturer TransDigm Group, down about 40% in the year to date, is trading at a P/E ratio of about 11. The company, which makes ignition systems, gear pumps, cockpit security devices and other components for commercial and military airplanes, recently authorized a stock-buyback plan, a healthy sign.
Defense spending could fall in the Obama administration, but some analysts say those concerns are overstated (see Barron's Insight).
Dean Machado, managing partner of New York hedge fund Akita Capital, says he is a fan of BE Aerospace, a maker of aircraft interiors. Its shares are down about 84% in the year to date, and it recently cut its earnings expectations for next year. But the stock now trades for just four times these estimates, getting Mr. Machado excited.

"While energy isn't a major input, the company is a major supplier to airlines and aerospace, and to the extent that airlines now are healthier ... BE shares should benefit," he says.

No comments: