Swimming against the tide

6/23/2008


“There’s always a bull market somewhere” is the kind of soothing Wall Street phrase that becomes more popular when stocks are slumping. While most such maxims should be taken with a big grain of salt, our research suggests that there nearly always is a place to make money, regardless of how poorly the broad market performs.

Reviewing the returns of individual stocks and industry groups since December 1994, we learned the following:

>> At any given time, a fair number of stocks will zig when the market zags. In the 11 three-month periods since December 1994 when the S&P 1500 Index declined more than 10%, about 23% of stocks delivered positive returns. These iconoclasts tend to be concentrated in a few groups.

>> In brief and severe sell-offs, stocks tend to move with the market. Based on equal-weighted total returns for the nearly 70 industry groups in the S&P 1500, only 5% of groups gained during months when the broad index was down at least 10%. But, given time, more industries can go their own way. About 13% of groups managed positive returns during three-month periods when the S&P 1500 suffered a negative return worse than 10%, while 29% bucked the trend during such six-month periods.

>>Many of the same industries come up again and again as solid defensive options, as shown in the nearby chart. Unfortunately, some of the defensive groups are likely to underperform during periods when the market is up. Notable exceptions are oil, energy equipment and services, and defense. These industries are home to several of our favorite stocks.

Timing entry into these “bull markets” is not easy, as predicting short-term market movements is very difficult. But investors can tap into such markets by holding quality stocks from groups with a tendency to hold up well during down markets.

The Dow Theory indicates we are in a bull market, but corrections within bull markets are common, and most portfolios could benefit from playing a little defense. While the Forecasts sees plenty of opportunity in traditional growth industries, we also like a number of stocks in industries that have historically done well in down markets. Three such stocks are detailed in the following paragraphs.

The countdown is on as Chevron ($100; NYSE: CVX) nears the completion of two new projects in the second half of this year. Chevron has maintained its production-growth guidance of 3% per year from 2005 through 2010 despite recent production declines. To maintain the market’s confidence, the company must deliver over the next two years. Fortunately, Chevron looks ready to do so.

Though the Blind Faith project in the Gulf of Mexico did not begin production in the June quarter as expected, Chevron still expects oil to start flowing this year. The Agbami field in Nigeria is on schedule to begin pumping in the September quarter. At peak production, Chevron’s share of Blind Faith and Agbami should boost production by 233,000 barrels per day, or about 9% of March-quarter production. A combination of production-sharing contracts and declines in mature fields should prevent Chevron’s production from rising much this year. The company projects 1% production growth in 2008. But production should grow significantly in 2009 as other, larger projects start up. Chevron has planned more than 40 projects that it anticipates will yield at least $1 billion in revenue.

In coming years, natural gas will play a more significant role for Chevron. The company expects large fields off the shores of Australia and Africa to help gas volumes grow from 32% of today’s production to 40% by 2020. High demand and high prices for natural-gas liquids in Asia should make the shift toward natural gas profitable for Chevron, a Buy and Long-Term Buy.


Oil companies are shifting more and more of their exploration budgets to deepwater drilling. This trend seems likely to continue, as most of the world’s known untapped oil reserves are under the ocean floor. Oceaneering International ($80; NYSE: OII), a provider of underwater services to energy producers, is well positioned to capitalize. Nearly two-thirds of deepwater discoveries have yet to be developed, leaving more than 400 undersea projects still in development or under evaluation.

Oceaneering’s remotely operated vehicles (ROVs), which provide one-third of company revenue and nearly half of profits, are capturing most of the new support projects on deepwater rigs. The company is adding about two new vehicles every month to its fleet of more than 210. In the March quarter, ROV rental rates reached $9,400 per day, up 7% from the December quarter.

The company also expects significant growth at its subsea-products division, which manufactures drilling and oil-production equipment. Oceaneering projects 27% to 38% growth in the unit’s operating income this year, reflecting strong demand for the company’s umbilicals, deepwater hoses, and cables for underwater systems. Oceaneering is a Focus List Buy.


In a tough retail environment, Walgreen ($36; NYSE: WAG) is delivering decent results. May sales rose 10%, with sales in stores open at least a year up 3.9%. Aggressive construction of new stores should continue to support sales growth over the next several years. For the fiscal year ending August, Walgreen plans to build 475 stores. By the end of fiscal 2010, Walgreen expects to operate 7,000 stores, up from the current count of 6,252. As measured by revenue, Walgreen is already the largest drugstore chain.

Store growth will likely slow as the company saturates the market and seeks to avoid cannibalizing its own stores. About 139 million people, representing nearly 46% of the U.S. population, already live within two miles of a Walgreen’s. In an effort to create growth streams that will persist even when expansion slows, Walgreen is moving into new markets.

An overnight home-delivery pharmaceutical business gives Walgreen access to a market growing at a 20% clip. On June 10, Walgreen announced a deal to buy the home-infusion pharmacy business of Express Scripts ($66: NASDAQ: ESRX). The company is also grabbing share in the market to provide prescriptions to assisted-living facilities.

By December, Walgreen should operate roughly 400 health clinics, most located within drugstores. While the clinics’ initial costs have pinched profits, over the long term they should boost sales. In March, Walgreen purchased two operators of workplace health clinics. Walgreen, reasonably valued at 14 times expected fiscal 2009 earnings, is a Long-Term Buy.


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