Will they or won’t they? The ongoing speculation of whether the Fed will cut interest rates later this year has helped fuel recent market volatility. But the likelihood of such a cut seems to have dimmed, and that’s cast a shadow on several sectors. It’s also made the job of Standard & Poor’s senior equity analyst Tuna Amobi that much harder. Based in New York City, Amobi covers a number of industries that fall within the “consumer discretionary” sector. The group spans a wide range and includes companies such as home builders, automobile manufacturers, cable television operators, and motion picture studios. Essentially, the sector puts out goods and services that people don’t necessarily need to get by but will certainly use when they have the chance–and enough disposable income. S&P is currently lukewarm on the sector but Amobi says a bit of hunting can unearth some very attractive values.
What qualities help stocks stand out in the current market?
Several things. First, look for premium brands. They are widely recognized and help companies create additional value. It is good for a company to operate in a niche market it can dominate. Sound finances are critical, and a strong balance sheet gives management the flexibility to leverage their current assets to boost earnings. Additionally, a stock’s valuation is important: A company that is undervalued relative to its peer group has a certain attraction. Finally, it is important that management demonstrate confidence to execute its vision, even in the face of challenging times. Finding good consumer discretionary stocks may seem like searching for a needle in a haystack, but the best names will certainly share some of these qualities.
Your firm isn’t very bullish on the consumer discretionary sector, is it?
We currently recommend underweighting the industry group. Standard & Poor’s says real gross domestic product growth is on course to drop to 2.2% this year from 3.3% in 2006, which will affect demand. Individual industries have their own problems as well. Homeowners are finding it more difficult to bank on the equity they’ve paid into their mortgages. As a result, we think they will cut back on consumption and expenditures on cars and furniture. High interest rates will probably also cut into consumer spending for the foreseeable future.
Is the news all bleak?
No. There are niches that are doing well. Filmed entertainment is on a roll. Major studios should enjoy a relatively strong summer season. Luxury goods have man aged well. Cable companies with their “triple-run” packages of cable, Internet, and telephone service are another bright spot.
august 2007 : BLACK ENTERPRISE : blackenterprise.com : Photograph by GERARD H. GASKIN
Price 52-week price range 2007 2007
Company (Ticker) ( ) Low High Est. EPS P/E Ratio Comment
Group 1 Automotive Inc. $41.07 $39 $61 $3.88 10.6 Aggressive growth of the Houston-based automotive (GPI) retailer bodes well for future performance.
Tempur-Pedic International $26.31 $13 $29 $1.56 16.9 Shares of the Lexington, Kentucky-based mattress
Inc. (TPX) company are attractively priced relative to its peers.
The Walt Disney Co. (DIS) $33.79 $28 $37 $1.88 18.0 The Burbank, California-based entertainment giant is
data as of 6/14/07 Source: Yahoo! Finance
How do your three picks stand out?
All three exhibit several–if not all–of the attributes I spelled out. First, there’s The Walt Disney Co. (DIS), which is composed of strong brands: ESPN, ABC, Disney, its world-famous theme parks, and Pixar. It’s reaping the benefit of titles such as Cars and Pirates of the Caribbean. Under the direction of CEO Robert Iger, Disney has been very aggressive at capitalizing on new media platforms.
What about Disney’s finances?
Disney is in top-notch financial shape. Management is disciplined and the company’s debt is low. Disney’s price-to-earnings ratio of around 17 to 18 is in line with the market and a stock buyback program should help push shares to our 12-month target of $45.
Why choose Group 1 Automotive Inc. in a sluggish auto market? What’s the catalyst?
Group 1 (GPI) owns car retailers–luxury and import dealers that happen to be positioned in a niche that is currently doing well. Demographics help, too: Baby boomers are spending more and more on high-end vehicles.
Group 1 has been on an aggressive acquisition spree and we expect it to keep that up at a pace of about $500 million a year. That helps to cut costs from consolidation. Shares are trading at around 10 times our 2007 earnings estimate, a 10% to 15% discount to the group, which currently trades at 11 or 12 times the coming year’s profits.
What do you like about Tempur-Pedic International Inc.?
Tempur-Pedic (TPX) has landed upon a niche market in a slow growth area. The outlook for home furnishings is slow, just like that of the housing and automobile markets. Additionally, the bedding and innerspring mattress industry is a very mature business with the likes of Sealy, Serta, and Simmons fighting it out. Tempur-Pedic, meanwhile, has found a niche in the production of elastic foam mattresses and pillows–a high-end segment of the market that has produced 33% compounded annual sales growth for the company over the last four years. That’s extraordinary. What’s more, low inflation and low unemployment help keep demand steady. A weak U.S. dollar helps because the company generates one-third of its sales overseas.
What about Tempur-Pedic’s valuation?
Tempur-Pedic trades at about 17 times our 2007 earnings estimate, while peers such as Ethan Allen and Leggett & Platt are in the 20 to 21 range. We think the stock is a good value in light of our average annual sales growth estimate in the low teens for the next few years.