Archie MacAllaster
Barron's: How does the world look to you, Archie?
MacAllaster: We have a recovery going. It's a very gentle one. Earnings will be better in the third and fourth quarters, but the market is pretty high in terms of price/earnings multiples. By the end of the year, I expect the Dow and the S&P 500 and the Nasdaq will all be lower, with the possible exception of the Nasdaq. Quite often technology stocks have done very well in the late summer and fall. If that were to happen this year, the Nasdaq could end the year above its current level, around 1500. All that said, there are a lot of stocks that are not selling at 28 times earnings, and probably are a decent buy. Some of the banks are selling for only 11-12 times earnings.
Q: Do you see much hope for the broad market in 2003?
A: At some point when the averages are lower the market will have a pretty good chance. I think we'll do all right in '03 because short-term interest rates will be somewhat higher by the end of the year, but long rates won't change much at all. They will pretty much be stable, possibly even a little lower, and that will help stocks a bit.
Q: The financial companies you recommended in January -- Wells Fargo, Community Bank System, Old Republic -- have all done well. What are you recommending now?
A: State Auto Financial, an insurance holding company based in Columbus, Ohio, sells for about $16.80 a share. The range has been 12½ to 17¾. The company pays an annual dividend of 13 cents a share. State Auto is controlled by State Automobile Mutual Insurance, a property and casualty insurer. The two companies split their premiums according to a specified formula. Until last year State Auto wrote 53% of the business and the mutual company wrote 47%. Then State Auto bought a company called Meridian Mutual, based in Indianapolis, which was about half its size. This year the ratio was rearranged such that State Auto Financial is now writing 80% of the total business of the mutual. In the first quarter premiums were up 95%. The problem is that Meridian had a very high combined ratio of around 110, while State Auto's combined ratio in the four years prior was around 96%. [A combined ratio, which measures the profitability of an insurer's operations, is derived by dividing incurred losses and underwriting expenses by earned premiums.] In this business, 96% is very good. There are very few companies that are under 100. In the second half of last year, State Auto and Meridian together had a combined ratio of well over 100. They had to take write-offs to get the business in shape.
Archie MacAllister
Company Symbol Recent Price
State Auto Finance STFC $16.20
Flextronics Intl FLEX 8.07
Q: What was the attraction of Meridian?
A: They figured they could buy the company at a reasonable price, and align it with State Auto's operations by bringing the combined ratio down to 95% or 96%. Now, the verdict is not in yet, but so far they've made progress. State Auto made 36 cents in the first quarter of this year. Given another year or year and a half, they'll bring the combined ratio down. By the end of this year, State Auto will have earnings power of about $1.60 a share. Next year they might earn $1.80. There's a little twist: They were hit by some heavy storms in the Mid-Atlantic states, as were a lot of insurance companies. So they took a really good bath. In the second quarter, the company will be lucky if it breaks even. You could probably buy the stock cheaper a month from today, but it's going to sell a lot higher in a year and a half.
Q: What else do you like?
A: I made customers an enormous amount of money in Flextronics International going back about three or four years. I recommended it three straight times at the Roundtable. The stock has fallen from a high of $40 in the last year and a half to a low of $7.94. It is probably the only contract manufacturer in the technology business that still has not lost sales. I haven't got any idea why. They managed to buy some other companies along the way -- in fact, they're in the midst of buying two right now. The company earned 61 cents a share in the year that ended in March 2002. First-quarter estimates are 5-8 cents, and it looks like they might earn about 35 cents for the year ending March 2003.
Q: Can you see beyond that?
A: The next year, '04, they will earn perhaps as much as 65-70 cents, and by the end of the year will be earning at a rate of a dollar a share. Flextronics sells for about book value. The rest of the industry sells for 1.9 times book, on average. The company sells for 40% of sales, less than half the average for the rest of the industry. The stock is extremely cheap, and the company has had one of the best records over the years. It has a good balance sheet, too, and has saved money by moving most of its manufacturing out of the U.S. and over to the Far East and Europe. The customers squeeze on suppliers as much as they can, but you've got a great chance here. In a year or two the stock could be $20.
Q: Is that all for now, Archie?
A: You forgot to ask me about the stocks I picked last June. I had a couple of great stocks last year.
Q: Okay, tell us about the great stocks you picked last June.
A: Hanmi Financial, a Korean bank in California, did particularly well. I recommended it around 17 and it is now 17 and change, but they paid a 9% stock dividend, and there was a 3-for-2 split. So the stock is up about 70%. They just keep steaming ahead, and will make more than a dollar a share this year. I think it's in good shape. I own some of it.
The other company I talked about was Alfa, an insurance company in Alabama. Like State Auto, it's controlled by a mutual company. Last June it was 21, and two weeks ago it was 31. Now it's at 13.61, after a 2-for-1 stock split. It's a very good company. Nonetheless, this year I'm recommending State Auto.
Q: Duly noted, and thank you.
MacALLASTER
Price Price Percent
Company Symbol 1/7/02 6/14/02 Change
Wells Fargo WFC 43.78 49.83 13.82%
Commun Bank Sys CBU 26.65 30.55 14.63
Old Republic ORI 27.90 30.79 10.36
PartnersRe PRE 50.80 48.57 -4.39
Frontier Oil FTO 16.90 15.15 -10.36
ADC Telecom ADCT 5.68 2.59 -54.40
Radian RDN 41.25 49.33 19.59
Honeywell HON 34.69 35.60 2.62
Albertson's ABS 31.30 29.95 -4.31 |
