Fortune Investor 12.21.98 Ten Safe-Harbor Stocks
MTC's not included, but PFE is, partly because of Celebrex, so read on...
Excerpts:
Think of stocks that can handle
any economic condition, and
you'll think of blue chips with
solid, sustainable top- and
bottom-line growth. In other
words, stocks just like these.
Mine the data beneath our picks
in Safe-Harbor Stocks: Details
and build your own large-cap
searches.
Nelson D. Schwartz
If there is one thing investors could use
right now, it's a safe harbor. This year will
go down as one of the stormiest in Wall
Street history, with all the swells and
surges of a December nor'easter. Even the
market's remarkable autumn rally hasn't
really calmed the waters; underneath the
relief there's still an undertow of unease.
The confusion is shared even by the best
brains on the Street. Some, like Morgan
Stanley's Byron Wien, believe earnings
growth will pick up next year, helping stock
prices to move higher. Others, like Merrill
Lynch strategist and self-described bear
Rich Bernstein, foresee prolonged earnings
weakness for the first time since the early
1990s.
What are ordinary investors supposed to do
if even the big domes can't get a handle on
things? The prudent course is to seek out
what we call "safe harbor"
stocks--companies that seem likely to hold
their own regardless of what happens next.
To help us find these rare vessels, we
talked to strategists such as Bernstein,
Wien, and Lehman Bros.' Jeff Applegate.
We also surveyed top-ranked money
managers like John Hancock Funds' James
Schmidt. Finally, we ran our picks by top
analysts like telecom expert Kevin Moore of
BT Alex. Brown and Carl Seiden, who
follows the pharmaceuticals industry for
J.P. Morgan. (See the boxes later in the
story for these two analysts' outlooks on
their respective industries.)
We decided first that we would stick with
large-cap names. Although they currently
trade at higher valuations than their
small-cap brethren, large-company stocks
in general hold up better in market hiccups,
as they did during the recent
unpleasantness. While the large-cap S&P
500 fell nearly 20% between mid-July and
early October, the small-cap Russell 2000
fell 33%. What's more, as of Thanksgiving
the blue-chip Dow Jones average and S&P
500 had both surpassed their old records,
while the Russell was still well below its
April high.
The first attribute we looked for in our
blue-chip universe was consistent earnings
performance. Jeff Applegate points out that
steady growers are especially valuable
when overall earnings growth is running out
of wind--which is where we seem to be
now. "If profits get scarce, people are
going to pay up for earnings predictability
and stability," he says.
At the same time, we wanted to make sure
the earnings growth was sustainable. So
we avoided companies in industries tied to
unpredictable commodities like paper or oil.
Even in groups we liked, such as
pharmaceuticals, we were careful to steer
clear of companies that are overly
dependent on one product. That's why we
shied away from strong growers like Eli Lilly,
for example, whose income hinges heavily
on sales of Prozac.
As a final backup we insisted on highly
reliable revenue growth. That way future
profits won't depend on cost cuts--a
strategy that can take you only so far--or
worse, on Hail-Mary passes from corporate
accounting. Companies with weak revenue
growth, such as Coke and Gillette, were
among the hardest hit in the summer
correction, which underscores the
importance of a healthy top line.
In this market, though, fast growers don't
come cheap. Some of our picks have
relatively high P/Es, but that doesn't
necessarily mean they are overvalued. It all
depends on whether they will deliver the
growth the market expects of them. We
think they will. Wharton School finance
professor Jeremy Siegel, who has studied
the performance of U.S. stocks since 1802,
concludes, "Over time, companies with
above-average growth will do well even if
they look expensive right now."
That doesn't mean our picks can't go down.
They can. In a steep downturn, even the
best merchandise gets marked down. But
our sources are confident that these
stocks offer a close-to-ideal mix of upside
potential and downside protection. Now on
to the picks:
Say yes to drugs
In stressful markets, veteran Wall Streeters
tend to acquire a drug habit. Who
wouldn't? Pharmaceuticals companies are
almost unique in their ability to generate
strong earnings growth in any economic
climate. So no matter which way the
economy goes, drug stocks have you
covered.
Which brings us to Pfizer. You already know
the company's hottest product, Viagra. The
drug's boffo launch earlier this year made it
the most successful new drug in history. In
recent months, though, sales have faded a
bit, and Pfizer's stock gave up some of the
gains it made earlier in 1998. What's been
overlooked amid the hoopla is that Pfizer
has plenty of other potential hits in the
pipeline. "I don't think there's much doubt
that Pfizer is the best company in the
industry," says J.P. Morgan analyst Carl
Seiden. "They've got a series of
blockbusters coming out in the next few
years. It's almost an embarrassment of
riches."
The most important of these new medicines
is Celebrex, a revolutionary painkiller
developed by Monsanto that's safer than
conventional remedies like aspirin or
ibuprofen. For example, Celebrex doesn't
carry side effects of long-term aspirin use,
such as stomach bleeding.
Pfizer and Monsanto have formed a
partnership to market Celebrex, which
Deutsche Bank Securities analyst Mariola
Haggar predicts will gain final FDA approval
by the end of January. She estimates that
by 2004, Celebrex's total sales could equal
$2 billion. Pfizer's share: 40% to 50% of the
profits. Haggar adds that Pfizer will launch
several potential blockbusters from its own
labs in 1999, including migraine-remedy
Relpax and Tikosyn, a treatment for cardiac
arrhythmia. And while Viagra may be off the
front pages, it hasn't gone away. Pfizer
recently unleashed the little blue pills on
Europe and is set to do so in Japan in late
1999.
Altogether, says Seiden, Pfizer's earnings
should grow by roughly 20% annually for
the next few years, well above the drug
industry average of 15% to 16%. Revenues
are also growing by about 20% annually, he
says, and the company is taking excess
cash and plowing it into research to
maintain its supply of future blockbusters.
"Pfizer is investing now so it can grow by
20% forever," he says. "In the long run,
that's going to be great for investors." Over
the next 12 months, Seiden says Pfizer
could rise 25% from its current level of
$111 a share.
Our second pick in this group, Pharmacia &
Upjohn, used to be the drug stock Wall
Street loved to hate. The 1995 merger
between Swedish pharmaceuticals giant
Pharmacia and U.S.-based Upjohn got off
to an awkward start, with executive offices
in four countries and constant turf wars.
That all changed when Fred Hassan took
over as CEO in the spring of 1997. A
well-regarded industry veteran, Hassan
streamlined the company's sprawling
bureaucracy and installed a new
management team that's finally earning the
company respect on Wall Street.
"Hassan has really made a difference," says
Michael Kagan, manager of the $1.7 billion
Salomon Brothers Fund, which owns about
$25 million of PNU. "This company had been
an utter disaster." The turnaround hasn't
gone unnoticed: Pharmacia & Upjohn shares
are up more than 20% since this past June.
But Kagan, along with analysts Haggar and
Seiden, argues that PNU still has plenty of
upside left. Kagan notes that the
company's P/E multiple is 10% below that
of the typical drug company, while earnings
are expected to grow by 14% in 1999.
At the same time, analysts are excited
about new drugs from PNU like Detrol, an
eight-month-old incontinence remedy that
has already grabbed a big share of the
market. Incontinence affects more than 30
million people worldwide, and Detrol doesn't
cause the severe dry mouth that patients
experience with other treatments. By 2002
it could generate $800 million in worldwide
sales. Haggar estimates that drugs like
Detrol could help drive PNU shares to $65
by the end of 1999, for a gain of 22%.
If our final pick in this group, American
Home Products, seems familiar, that's
because we recommended it this past
August in our annual Retirement Guide.
Since then AHP has gone through some
tribulations--most notably the collapse of
its planned merger with Monsanto in
October. The breakup of the deal sent AHP
shares skidding, and it's now well off its
52-week high of $59.
But even without the union with Monsanto,
AHP is still a good long-term pick. That's
especially true for bargain-minded investors
who have been scared off by the drug
sector's sky-high P/Es. AHP's 1999 P/E of
27 makes it the cheapest of the major drug
stocks by far, says Haggar. Meanwhile the
company is quietly preparing a bevy of
potential hits, including Sonata, a sleep aid
due out in April that doesn't have the side
effects of existing drugs.
Haggar warns that the next quarter or two
could prove tricky as AHP finds its way
after the busted merger. But over the long
term, she predicts that AHP will see
revenue growth of 10% annually and profit
growth of more than 13%. That's a pretty
compelling proposition, given AHP's
below-average valuation. "This is a cheap
stock," says Haggar. "Your downside is
limited. I have a target price of $65 to $70,
so you're looking at a potential gain of more
than 20%."
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