March 17, 2008
With Bear Stearns grabbing all the headlines, the markets are taking a beating. Historically, bear markets often end with this type of fearful, obvious bad news, so doing a little (but just a little!) buying of some strong stocks around here could work out well. Overall, however, it’s still a time to be forming watch lists and holding plenty of cash on the sideline. This week’s Top Ten contains many usual suspects -- i.e., commodity stocks -- but also highlights a couple of leaders from the steel group, which is beginning a new advance.
Will Bear Mark The Bottom?
We’ve studied the characteristics of bull and bear markets going back decades, and we know that bear phases often end with big selloffs caused by scary, headline-grabbing news. The Bear Stearns debacle certainly qualifies, and this financial panic could result in a sustainable low. So if you have a huge cash position (60% or more of your account), buying a few shares here or there could work out well. Just be sure to stick with what’s working–namely oil and natural gas stocks, as well as some steel names that are acting better–and remember to cut all losses short. Overall, you should stay in a mainly defensive posture until we see real signs of improvement. Our favorite stock this week is Steel Dynamics (STLD). The company raised its earnings guidance last week and the sector as a whole seems to be gaining sponsorship. We think you can buy a little on weakness.
Why the Strength
If you’re looking for a way to play energy, but want to get into a stock that’s a little less volatile than some of the fast movers in recent Top Ten Reports, then Devon Energy, based in Oklahoma City, could be for you. The firm is a blue chip in the industry with more than $11 billion in sales, and has a good history of increasing both production and reserves; in 2007, those two rose 12% and 9%, respectively, and the company should reproduce that growth this year. Combine that with rapidly rising prices for both natural gas (which makes up about 60% of revenues) and oil, and you have a recipe for success. Like we wrote, Devon isn’t likely to be the highest flier should the energy bull market continue. But we like its great fourth-quarter numbers (sales up 32%, earnings up 83%), its reasonable valuation and its prospects for continued production growth.
DVN broke out of a double-bottom base one month ago, when it jumped above 94 on good volume. It followed through in fine fashion and is now consolidating in tight trading range, which is generally a sign that big investors are holding on to their shares. We think you could buy a little around here, and then place a tight stop in the 92-94 area.
DVN Weekly Chart
DVN Daily Chart
Why the Strength
If you’re looking for a fairly direct play on the price of oil, Encore Acquisition could be your best bet. Nearly three-quarters of the company’s production (as well as 82% of its reserves) are oil, one of the heaviest weightings in the industry. Even better, the firm’s fields–especially the North Dakota and Montana Bakken–are spinning off tremendous amounts of free cash flow and adding more to reserves. The result should be a 6% to 8% organic boost in production this year, which, combined with a 50 million share repurchase program and big price increases, should result in booming earnings. Analysts are expecting a 78% jump in the bottom line his year, on top of the big gain in the fourth quarter (see table below). Encore has hedged much of its production for ’08 and ’09, but the portion that isn’t could sell for significantly higher prices than the firm’s very conservative $80 per barrel assumption. All told, we like this company’s prospects a great deal.
EAC is making its second straight Top Ten appearance. Despite the huge swings in the market last week, this stock acted exceptionally well, advancing to new peaks on solidly above-average volume. Interestingly, its three down days last week all came on lower volume, while its two big up days saw turnover grow nicely. If you bought on last week’s recommendation, just sit tight. If you didn’t, we’ll nudge up our buy range a bit.
EAC Weekly Chart
EAC Daily Chart
Why the Strength
Herbalife sells weight management, nutritional supplement and personal care products–and makes billions of dollars doing it. The company uses a tried-and-true business model, recruiting dedicated independent distributors to market its products and build relationships with customers. With 1.7 million distributors, the company claims to be among the largest network marketing companies in the world. The business model makes for quick and easy expansion; about 80% of the company’s sales are outside the U.S. Combined with an apparently unshakeable demand for self-improvement products, that’s allowed Herbalife to rise above the economic turmoil here. In fact, U.S. sales have risen for the past six quarters, and Herbalife reported its highest sales total ever in January, up 20% from a year ago. That tells us that the accelerating earnings trend in recent quarters should continue.
Despite positive fundamentals, HLF hasn’t done much on the upside in recent years; the stock traded for 41 back in June 2006 … the same price it fetched just two weeks ago! But now it appears perception is back on an upswing–the stock has scored two straight weekly gains on good volume, the price has eked out to a new peak and the relative performance (RP) line looks great. Even in a great market, HLF isn’t likely to rocket higher, but its bullish action is intriguing. If you’re game, buy just a little.
HLF Weekly Chart
HLF Daily Chart
Why the Strength
Netflix is an innovator by nature. With Blockbuster and a host of imitators encroaching on its patent-protected turf, the company that pioneered DVDs-by-mail began finding new ways to deliver movies. “Instant Viewing” allowed paying subscribers to watch movies online, more or less instantly. It also meant even more competition from, but also for, Apple’s iTunes store and set-top Apple TV. In February, Netflix announced its intention to back the Blu-ray format for high-definition DVDs, following in the footsteps of Best Buy, the nation’s second-largest DVD retailer. Later that week, the largest, Wal-Mart, did the same, landing Netflix decisively on the right side of the technological frontier. Whether or not a rumored Netflix-Microsoft deal brings Netflix’s streaming video to the Xbox, Netflix will continue to revolutionize the way movies are delivered.
NFLX’s breakout of three weeks ago remains intact. Actually, the stock is threatening to extend its gains despite the awful headlines and fear pervading the market. On the downside, 30 appears to be the key level; any breach of that would tell you the breakout is failing. But so far, NFLX is acting terrifically, so if you bought on our prior advice, sit tight. If you didn’t, nibbling on some shares below 33 and keeping a tight stop in place seems prudent.
NFLX Weekly Chart
NFLX Daily Chart
Why the Strength
With analysts rushing to raise their forecasts for steel prices this year, it only makes sense that Nucor, one of the monsters of the steel industry, is displaying strength. The company produces a variety of steel products that are seeing higher prices because of still-strong demand overseas. Nucor makes much of its steel from recycled metals, and on that front, its recent $1.4 billion purchase of a scrap processor should provide more raw material (which is itself in short supply these days) and ensure the firm a chance to benefit from higher prices. One analyst hiked his ’08 forecast for hot-rolled steel prices to $650 per ton from $525, and Steel Dynamics (see page 9) recently hiked its own earnings estimates due to higher prices. Nucor is not going to be a long-term growth stock, but this industry has enjoyed some sharp upmoves in recent years, followed by multi-month consolidations. It appears that business is turning up, so we could be near the start of another upmove that could take the stock nicely higher.
NUE topped out last May, and spent nine months building a launching pad for a renewed advance. With materials and metals prices skyrocketing (i.e., inflation), the stock pushed through resistance around 64 during February, and followed that up with a big-volume jump to new peaks last week. Overall, NUE’s performance since the market’s late-January low has been impressive, a sign of big-cap leadership. And we like that the CGM set of funds, managed by whiz investor Ken Heebner, expanded their position in recent months. If you’re able to get shares at 66, that would be a gift; as it is, we think you can buy a little in the upper 60s.
NUE Weekly Chart
NUE Daily Chart
Why the Strength
The more we read about Silver Wheaton, the more impressed we are with its potential. The company is 100% involved in silver production, but interestingly, its production stems from stakes it has in other companies’ mines. For instance, it has a 25% stake in Goldcorp’s Penasquito mine in Mexico, which is one of the largest silver deposits in the world. All told, it has stakes in six of the top 30 silver deposits in the world, which are often owned by firms whose primary focus is other metals. Thus, they sell their future silver production on the cheap (Wheaton’s average cost is a miniscule $3.90 per ounce) and focus elsewhere. The result has been solid growth in recent years, and the best is yet to come–management expects output to jump from 13 million last year to 15 million this year, 19 million in ’09 and 25 million by ’10. Combine that with rapidly rising silver prices (every 10% jump in prices hikes SLW’s cash flow by 15%) and we see exciting upside possibilities … assuming a continued bull market in silver prices.
SLW, making its second straight Top Ten appearance, notched its third weekly gain in a row, with all three coming on above-average volume. We believe Goldcorp’s sale of its SLW stake (written about in last week’s Top Ten) has removed potential overhead, and is allowing the stock to trade in tune with silver prices. That should be a bullish event over time, yet after a move from 17 to 19 1/2 the past few days, we believe a rest period could be in order. Still, we’re bumping up our buy range from last week.
SLW Weekly Chart
SLW Daily Chart
Why the Strength
Steel stocks are a sometimes-hot, sometimes-not kind of group, even during times of inflation like now. The reason? Raw material costs (metallurgical coal and iron ore) often rise faster than steel prices, eating into margins. But not today! Steel Dynamics gave investors some good news last week when it hiked its first-quarter earnings projection to $1.25 to $1.30 per share, up about 10% from the prior estimate, thanks to rapidly rising flat-rolled steel prices as well as some efficiency gains at its plants. All told, what we like best about this story is how quickly perception can change–90 days ago, analysts were expecting $4.89 in earnings this year, but the outlook is now at $5.54, 13% higher. We feel there’s more good figures in the future as demand for steel remains robust, and inflation becomes a reality for more and more businesses. It’s not a revolutionary story, but Steel Dynamics is a leader in a sector that’s reasserting itself. We like it.
STLD has been in an uptrend for years, but there have been plenty of sharp pullbacks along the way. Still, the action of the past few months shows a stock that has wanted to move higher … but every time it reached new-high territory (late October and December) the market yanked it down. But the third time is often the charm in the market, and STLD busted to new highs on big volume last week, thanks to the earnings guidance. It’s extended right now, so if you’re game, buy a little on a pullback into the mid 60s.
STLD Weekly Chart
STLD Daily Chart
Why the Strength
Another week, another metal seeing a stunning price increase that’s benefiting miners of the metal. In this case, the metals are platinum and palladium, two obscure metals whose total production each year is less than one-quarter of gold’s production and nearly 1/30th of silver’s production. As with many metals, inventories of platinum and palladium are low, thanks to strong demand in automobile emission controls (catalytic converters), combined with electricity-related work stoppages in South Africa. Stillwater is basically the only way to play the boom in these metals here in the U.S., and that led to a rapid advance in the stock and in earnings estimates. (Now $0.95 a share for ’08, more than double the figure three months ago!) Of course, we’re not pretending to be experts in the platinum market, but the fact is, the uptrend is strong and the inflation theme has shown little sign of abating. We like it, just be prepared for volatility if you buy.
SWC first appeared on an OptiMo screen a few weeks ago, but we thought it best to wait for some type of pullback before featuring it. Now we’ve seen that, as platinum prices have corrected, and this stock has retreated along with it. The downside volume was big, but given the huge run-up prior, it’s not too alarming. If you decide to buy, we advise keeping it light; we suspect some further backing-and-filling is in order, and volatility is likely to be wild. But if you can get a few shares at the right price, the stock could turn into a good winner for you.
SWC Weekly Chart
SWC Daily Chart
Why the Strength
Southwestern Energy is strong today not just because of the general bull move in oil and natural gas stocks, but also because the company has one of the best growth profiles in its group. Southwestern sports accelerating sales and earnings growth (see table below), and the firm continues to predict huge production growth (greater than 30% this year), thanks mainly to its operations in the Fayetteville Shale region, which accounts for nearly half of its production and could see output increase more than 70% this year. Reserves are also surging; 2007 saw reserves grow 41% (almost all natural gas), and at current production rates, that would last about 13 years! But what’s most exciting about Southwestern is the potential upside–management believes earnings will total $2 per share this year (versus the analyst estimate of $1.77) if oil averages $90 per barrel, and natural gas averages $9 per thousand cubic feet; the going prices are now $110 and $9.87. The stock isn’t cheap–52 times trailing earnings–but the growth potential is enticing.
SWN has been holding above 60, which is a key level for the stock; it marked an important breakout back in February, and should offer support if further weakness is seen from here. Also boosting that view is the fact that the stock’s 50-day moving average is near 60, and thus, buying around here and placing a stop just under 60 seems like a solid risk-reward.
SWN Weekly Chart
SWN Daily Chart
Why the Strength
Western Digital is one of the few non-commodity stocks that’s holding its own in this market. The stock is resilient for two reasons. First, the company has made big strides in recent years toward creating some of the most technologically advanced hard drives available. But that alone wouldn’t cause business to improve. The second and more important factor is an explosion in demand for the firm’s drives thanks to newer, innovative electronic devices. Digital video recorders (DVRs such as TiVo and the ones all cable companies offer), music players, laptops and personal storage devices are driving sales of Western Digital’s hard drives. That demand led management to up its current-quarter earnings guidance just three weeks ago. Of course, this industry has experienced many peaks and valleys, so today’s surging demand can lead to tomorrow’s slump. But right now, there’s no question the wind is at Western Digital’s back.
WDC actually hit a temporary peak three weeks ago, just as the firm upped its earnings guidance, as the market was beginning a new downleg. But despite some big-volume selling, the stock has held well, etching a new, relatively tight launching pad. We feel some more consolidation is likely in order, but WDC’s resilience in recent days has been encouraging. If you’re feeling aggressive, you could nibble on some shares here, keep a tight stop around 27-28 (where the 50-day moving average stands) and see how it goes.