John Neff
Barron's: In January you had no trouble finding lots of good companies at inexpensive prices. Is that still true?
Neff: Yes. One is the homebuilder D.R. Horton. Another is Washington Mutual. A third is a switch for me, but at a price I'll tackle almost anything. It's Tyco.
Q: At what price did you tackle Tyco? Or did Tyco tackle you?
A: My cost is $20.80, which isn't great. [The stock now trades for about $15.] About 80% of Tyco's sales and earnings come from three good areas -- health care, technology and safety and security. I know from yesteryear the operating companies that Tyco bought. They bought everything in sight.
Q: No doubt, from you.
A: Right, and they paid through the nose. The media is beating them up for buying CIT Financial for $10 billion and trying to sell it for $5 billion. But the stock they paid for it is now worth $3 billion. The new-issues market will warm up and Tyco will be able to take CIT public again. If not, they will sell it to somebody. It is a decent leveraged finance company, with collateral for almost all its loans.
Once you remove CIT, Tyco becomes an average industrial company, two-thirds equity and one-third debt. Companies in Tyco's lines of business usually sell for 20 times earnings. I've got the company earning $2.60 a share this year, and it generates about $2.5 billion in free cash flow. This is hardly a basket case. Next year it should earn $3 a share. Maybe it will sell for 10-12 times earnings, which would mean a price of $30-$36. That's pretty good alongside my $20.80, much less the current price.
John Neff
Company Symbol Recent Price
D.R. Horton DHI $26.25
Washington Mutual WM 37.89
Tyco TYC 15.35
Citibank C 40.49
Q: Alas, the market doesn't share your upbeat view, especially since the indictment of Tyco's former CEO, L. Dennis Kozlowski.
A: If he has done something wrong, why, they should get rid of him. But these things become real political footballs, and they just slay the stock. Then you raise a whole new constituency of shareholders.
Q: Value-oriented folks like you.
A: Exactly. Horton, on the other hand, which I've recommended before, has a brilliant record. It earned about $2.20 a share in the fiscal year ended last September. It will earn about $2.80 in this fiscal year, and $3.30 next year. The company supposedly was going to be done in by the recession, but with 6%-8% mortgage rates, housing is very affordable. There is a lot of babble about the bubble, but in troubled times there is something to be said for having your own castle. Relative to the stock market, housing has been a decent investment, though it's only going to grow 3%-4% a year from here. But at least a house is something you can enjoy. Horton returns about 20% on equity and will continue to make acquisitions with both cash and stock. The big builders have the ability to obtain land, and they have design centers that allow you to see in three-dimensional glory what your living room is going to look like. And they can compete for labor if they have to. Let's let our imaginations run amok: If my $3.30 is right, and they've got a six-month backlog going into the new fiscal year, and if I'm right that this is a 13%-to-15% grower, it is going to get increased recognition. If Horton can trade up to an astronomical 11-12 times earnings, it would sell for about 38, which is pretty good alongside a current 24 and change. If you took the name away from this company's 10-year record, you'd be ready to pay 32 times earnings.
Q: Washington Mutual is up 5-6 points this year. Where does it go from here?
A: I think the company can earn $4 a share this year, $4.40 next. The stock is selling for 37, or about 8.6 times earnings. I'm expecting 11%-12% growth. Retention on equity is about 17%. Each quarter the company increases the dividend. The stock yields 2.8%, pretty good these days. The only execution risk is that they've diversified away from straight home mortgages. They're trying to get more of the consumer wallet, and they've put together the biggest mortgage-servicing portfolio in the country. That can be a problem when you've got a lot of refinancings, but I think the refi bulge is mostly over. They have to hedge in the derivatives market, and investors are a little apprehensive about that, too.
Q: Have you any more picks?
A: Citigroup has been beat up, partly because of events in Argentina and insurance concerns and all the bad press about analysts at Merrill Lynch. But this is a genuine 13%-15% grower, and among the financial intermediaries, probably the best run. I expect them to earn $3.80 a share in 2003, which would imply a P/E of 11. That's a bargain as growth stocks go. The company has a magnificent return on equity of about 19%-20%. The yield has moved up to 1.7% and the dividend has been increased 75% over the past three years. Citigroup has a great capital position and controls expense neatly. And they are well positioned in emerging markets. The stock has been as high as 60, and down to 41 or thereabouts.
Q: Are you still bullish about corporate earnings?
A: I think the companies in the S&P 500 will earn $58 in 2003. That means the market's trading for 18 times earnings. In January I said $55 for this year, but I've whittled that down to $53. They laughed at me when I predicted GDP growth of 3% to 4%, but that's the consensus now. The manufacturing sector has done an awesome job on the productivity side. Wage increases have moved down, and prices are going up in old, mature industries like tires, steel and containers. Eventually we will work our way out.
Q: And they will laugh no more. Thanks.
NEFF
Price Price Percent
Company Symbol 1/7/02 6/14/02 Change
Washington Mutual WM 34.18 36.50 6.79%
Valero Energy VLO 41.44 37.36 -9.85
Salton SFP 20.80 12.55 -39.66
Highwoods Prop HIW 25.48 27.70 8.71
Short
Applied Materials AMAT 22.37 19.83 -11.35% |
