GROWTH IS HARDER TO FIND
Seven of the 15 growth stocks from my August recommendation list have made new 52-week highs since then, as the S&P has increased 6.7% since August 1. Three of those seven stocks I removed from the list, two because I thought they had exhausted most of their growth outlook. The four I left on the list I struggled with, but decided they still have enough growth to be compelling buys. (Read individual stock comments for details.) I only added two new buy recommendations.
The point is I think it’s getting harder to find growth at a reasonable price (GARP).

Linda Stewart for www.fizone.com

October 29, 2003

Growth Stock Recommendation List Although the list is shorter, I can still recommend 11 growth stocks, which are reasonably priced, offer growth, and are well-managed companies:

Technology

Flextronics – is the largest contract manufacturer. It provides a wide range of services to hardware companies that outsource their manufacturing. The company should benefit in the long term as existing customers resume capital expenditures and new customers switch to Flextronics because they choose to do business with fewer vendors. The company recently reported 3Q earnings and revenues above expectations and has increased revenues in each of the last five years. Nonetheless, the stock price declined after a downgrade by an analyst wary over lack of near-term growth drivers. This stock’s performance will depend on a technology turn-around.

UTStarcom – Added today to the list – This telecommunication equipment company makes switches and software that facilitate migration between protocols such as wireline to wireless, and thereby provides a unique wireless technology for phone carriers in developing countries. Its Personal Access System (PAS) technology currently has almost 17 million subscribers (60% of the market) in China, and they are expanding into other developing countries, such as Thailand, India, and Viet Nam. Growth potential is extraordinary because developing markets have much lower phone line penetrations than developed markets, and UTStarcom’s network access equipment is based on a flexible network architecture that allows service providers to rapidly build out their networks based on existing infrastructure. The company meets 4 of my 5 growth-at-a-reasonable-price criteria: consistently increasing revenues, low debt, 23% anticipated annual growth, and it is not over-priced.

Technology Services

First Data – is a leader in credit card and money transfer processing. They hope to acquire Concord EFS, a PIN-debit system, the fastest growing of all electronic transactions. The Justice Department has filed a civil suit to block the acquisition, contending it would reduce competition among the PIN-debit networks. The uncertainty of the deal has resulted in a sell-off of FDC stock, providing an excellent buying opportunity, according to some analysts. First Data also owns Western Union, which generates lots of cash for the company. Even without the Concord EFS acquisition, FDC should grow around 15% annually.

Health Care

Cardinal Health – is a diverse health care company, including its largest segment of pharmaceutical supply, and medical and surgical products and services, pharmaceutical technologies and services, and automation and information services The company has projected earnings growth to slow to the “mid-teens or better” in 2004, which is still impressive, even if not its historically typical 20% growth rate. Cardinal Health has a big competitive advantage because of its low-cost structure and its operational diversity, allowing it to increase its market share. It also has $1.7 billion in cash, strong cash flow, and a healthy balance sheet. S&P has a 12-month target price of $72.

Pfizer – The acquisition of Pharmacia is complete, and the integration seems to be working: the combined company reported 3Q revenues of $12.5 billion (Johnson & Johnson reported $10.4B; Merck $5.7B; Bristol Myers $5.3B); cost saving synergies are expected to reach $1B for 2003 and $3B for 2004. Revenues from Pfizer’s human pharmaceutical division increased 57% to $11B (90% of total revenue). More than $1B each came from its big-name drugs Viagra, Lipitor, and Zoloft. Pfizer is developing more than 100 new molecular entities, i.e. new drugs, not follow-on products.

Teva Pharm. – Teva is the largest supplier of generic drugs, makes bulk pharmaceutical chemicals, and they have a successful proprietary drug, Copaxone, an injectable treatment for multiple sclerosis. They also have 60 Abbreviated New Drug Applications (ANDA) currently under review by the FDA. Teva is one of the most profitable firms in the generic sector because of volume sales and operating synergies from recent acquisitions. S&P expects revenues to advance over 20% in 2004.

Financial

Capital One – This credit card issuer is up more than 100% since I added it to my list earlier this year. And yet it still meets 3 of my 5 GARP criteria: increased revenues at least 5 years, 16% annual growth anticipated, and it is not over-priced relative to its growth estimate. Their shift away from the riskier sub prime customer and focus on super-prime segment has improved their profitability and their credit quality. Delinquencies and loan loss have fallen. S&P believes that their marketing expertise, combined with steady economic growth, should result in 18-20% loan growth, and that earnings should rise 18% in 2004. They have a 12-month price target of $75.

Industrial

Lennar – This homebuilder is up more than 70% since I added it to my list earlier this year, and it still meets all five of my criteria. In fact, analysts have raised their 5-year growth estimate from 14% to 15% since August. In September the company announced that 3Q new home orders had increased 22%. Most of us had been thinking that interest rates would go up imminently and homebuilding would decline. However, yesterday the Federal Open Market Committee (FOMC) reiterated the need to maintain a stimulative fiscal policy, i.e. they intend to leave interest rates low for some time. S&P predicts home sales will rise 13% in 2004 and mortgage rates to remain buyer friendly at least through 2004. They view Lennar’s business model as the top one in the sector and have a 12-month price target of $108.

Retail/Consumer

Autozone – This national leader in retail auto parts is up more than 40% since being added to the list and still it meets 3 of my 5 GARP criteria. It has increased revenues in each of the last ten years and has consistently exceeded earnings estimates in recent quarters. Contributing to the company’s growth and profitability is an innovative marketing program, such as Loan-A-Tool and free use of computer diagnostic tools, and combining commercial businesses with repair shops. According to S&P, long-term prospects remain bright, aided by the rising number of aging motor vehicles in their prime repair years, and by increased vehicle usage. They have a 12-month price target of $106.

Outback Steakhs. – Added today to the list – This mid-cap company operates a chain of more than 800 Outback Steakhouse restaurants, more than 100 Carrabba’s Italian Grill restaurants, and several other casual dining restaurant chains. They have expanded significantly over the last eight years and have plans to add another 100 restaurants in 2003. While it franchises some of its restaurants, it maintains a majority control over operations. They develop their restaurants as partnerships, with key personnel sharing in profits. They have been innovative in keeping down costs, while keeping customers happy—they pioneered take-away service and call-ahead seating. Growth is anticipated to be 15% annually over the next five years, and the company has increased revenues for the last 10 years. Not a high flyer, but a consistent grower that is managed so well it flourished when the economy was suffering.

Sharper Image – This micro cap specialty retailer sells merchandise that usually cannot be found elsewhere. The company's growth strategy centers on opening new stores and expanding its proprietary product offerings. The firm has posted impressive same-store sales growth. September sales increased 8% sequentially and 25% year over year. Internet sales were up 44%, and catalog sales were up 24%. The company has raised its guidance for 3Q and for the full fiscal year. In August they opened four new stores, and they expect to add another 25 in 2004.

Stocks No Longer on the List Six companies were removed from the Recommendation List, two because of pending mergers and most of the others because of growth concern. By “growth concern” I simply mean that the growth outlook is not robust enough to rate them as compelling buys. It does not mean their fundamentals are no longer good. In fact, in August I removed six companies because their growth outlooks had come down below that of the S&P 500 (one of my GARP criteria), and five of those six stocks have increased in price, three in double digit percentages, while the S&P is up only 6.38% for that time span. If not compelling buys, removed stocks may often still be stocks to keep. Companies removed from the Buy List in October are:

L3 Communications – This supplier of secure communications systems, primarily to the U.S. government, should continue to grow sales, both organically and by acquisitions. They have about 800 government contracts, so they have a diversified base. If you own it, keep it. My concern is that the government will be pressured to reduce its defense budget. S&P also believes there is risk of a defense spending strategy change and expects the shares of L-3 to “perform in line with the S&P 500 over the next 12 months”, which is not enough growth to be on my buy list, but should still be in double digits.

IDEC Pharmaceut. – This biotechnology company has had phenomenal growth. It develops and makes immunotherapeutic and cancer-fighting products, the biggest two being Rituxan (with partner Genentech) and Zevalin. Rituxan was the first monoclonal antibody approved for treatment of cancer, and 3Q sales surpassed forecasts by more than $16 million. Sales of Zevalin, the first approved radioactive monoclonal antibody, have disappointed, hampered by reimbursement issues, as one dose costs $17,000. The impact of the pending merger with Biogen, which is supposed to close in November, is unclear, but will most likely slow Idec’s growth of recent years. S&P feels that Biogen’s multiple sclerosis drug, Antegren, must have positive Phase III trials in order to justify the merger, as they are bearish on Biogen’s other two drugs, Amevive and Avonex. Morningstar feels the added free cash flow raises the combined firm’s fair value by $3 - $6 per share. Idec’s 5-year growth projection is 22% annually; Biogen’s is 14%. I think this company remains a good hold, but not a compelling buy.

WellPt. Health Net – This managed healthcare company has agreed to be acquired by the smaller Anthem Inc. for stock and cash ($23.80 plus one share of stock). The proposed deal valued Wellpoint at approximately $101. Since the announcement WellPoint has risen to about $90 per share, but Anthem has decreased to about $69 per share (plus $23.80 equals $93 value for Wellpoint, not much upside from where it is now). With this deal pending, I cannot recommend buying WellPoint. In fact I will probably sell my shares, as I don’t see any more upside until at least well after the deal is final, and perhaps not for another year or longer, while the integration is in progress.

AIG – This insurance and financial services company is being removed for two reasons. Its business mix has become increasingly focused on life insurance, an industry which is usually given a P/E multiple lower than that of the broader market. In other words, investors are unwilling to pay a premium for life insurance stocks. The other reason is more troubling: regulators are interviewing NYSE specialists who trade AIG stock because of allegations that they were asked to invest more of their firms’ money in AIG stock when there wasn’t enough public interest to support the stock’s price. These requests to influence trading in the company are said to have come from Dick Grasso (chairman and chief executive of the NYSE at the time), who had been urged to do so by Hank Greenberg, CEO of AIG. Mr. Greenberg is a former NYSE Board member who sat on the compensation committee when Mr. Grasso was receiving exorbitant pay packages.

Fannie Mae – This company has been a consistent performer over the years: increasing income 15% annually over the last five years, managing credit losses and cost of debt, and maintaining a pristine corporate governance record. Unfortunately, pressures are growing for regulatory changes that may threaten the advantages of Fannie Mae’s government sponsored status or at least impinge on its operating model by increasing requirements. Until this concern is resolved, I don’t feel comfortable recommending it to new buyers. If you own it, keep it. But I will recommend selling if changes are implemented that crimp its profitability.

Home Depot – This stock is up 13% since the August list, and yet next year’s sales are now estimated to increase only around 10%, less than the growth estimated for the S&P 500. While this company has been a solid investment year after year, I have removed it because I don’t think now is the time to buy it. If you own it, keep it. The company has been “home improving” itself, and those changes—store remodeling and customer service initiatives—should show up in earnings and sales growth increases and market share recapturing from chief competitor Lowe’s. The positive results of the renovation should become evident over the next year or two.