Volume 18, Number 11 May 2004
IN THIS ISSUE:

LOOKING FOR STABILITY IN
VOLATILE MARKETS? 

With the economy showing consistent growth, interest rates at their lowest levels in a generation and corporate earnings more robust than they've been anytime in at least the last ten years, you’d think this would be a great time to be in the stock market.  But, in fact, stocks have been taking a beating recently.  For example, since late January, the Dow Jones Industrial Average is down 4.0 percent, and the more volatile NASDAQ Composite Index is off 9.1 percent.  This is just more evidence supporting our oft-repeated advice that you should not try to time the market.

 So, if you shouldn’t time the market, what should you do?  As we have said many times before: put as much money into stocks as you are comfortable with and leave it there.  Our first choice would be to put your money in a diversified portfolio of the turnaround stocks we have recommended.  But many turnaround stocks are quite volatile – meaning that their prices move up and down sharply depending on market moves and company news.  If you have a weak stomach where your money is concerned (which is not a bad thing to have), you may want to focus on the stocks of large, well-capitalized companies.  These stocks tend to be less volatile, but will still give you good returns over time.  And as we’ve mentioned before, if a stock pays a decent dividend, that will further dampen its volatility and enhance your return. 

The table on the next page lists ten large-capitalization stocks that have solid balance sheets and good business franchises.  At the time we put the list together, they each had market caps in excess of $20 billion and were trading within 25% of their 52-week lows (though a couple are also not too far from their highs).  They all use minimal long-term debt, and most have the added attraction of decent dividends and relatively low price-to-earnings ratios.

 Abbott Laboratories — pharmaceuticals and medical devices, — has resolved manufacturing issues with the FDA that have plagued the company in recent years.  The company’s hospital-supply division (about 15 percent of sales) was just spun off to shareholders under the name Hospira (HSP).  Abbott will focus on its medical devices and pharmaceuticals, both areas with good long-term potential. 

             Exxon Mobil, with $246 billion of revenue in 2003, is the world’s largest energy company.  The high price of oil and gas and the strengthening world economy are current trends working in Exxon’s favor.  The company could also benefit in the future from development activities in West Africa and an expanding market for liquefied natural gas.  Exxon sports outstanding financials that management uses to pay a decent dividend and regularly repurchase shares.

Fox Entertainment Group, whose operations span feature films, television programs, TV broadcasting and cable programming, is 82% owned by News Corp.  The company has had good success recently with both its broadcast and cable programming, particularly with the much sought-after younger viewers.

 Gannett publishes over 100 daily and 500 non-daily newspapers, including USA Today, the biggest daily circulation paper in the U.S.  The company also operates 22 television stations.  The recovery in ad spending has been a bit uneven, but we expect it to pick up soon.  The company's strong brands, expanding international operations and solid financials should keep it on the cutting edge of the publishing industry.

 Johnson & Johnson is a pre-eminent healthcare company with operations spanning pharmaceuticals, medical devices, and consumer products.  The company has built a solid line of branded drug products, and recent Medicare reform appears to have protected pricing power in the pharmaceutical sector.  The medical-products unit is delivering solid gains.  The firm's balance sheet is strong, and it has raised its dividend 41 consecutive years.

 Kraft Foods, which acquired Nabisco in 2000, is the largest branded food company in the U.S. and second largest in the world.  Kraft's growth rates have disappointed investors since it was spun off from Altria (formerly Philip Morris), but the company has solid financials and is profitable.  Cost cutting will help the bottom line, but to really get the stock going the company will need better marketing and new products. 

 Nokia is the world's largest manufacturer of mobile phones.  When the company recently reported that competitors were making inroads to its turf, the stock sold off sharply.  But the company has a good pipeline of new products to be released soon.  With Nokia’s powerful market presence and strong balance sheet, the stock could get back into Wall Street’s good graces at almost any time.

Royal Bank of Canada is Canada's largest financial institution with operations extending throughout North America and 30 countries around the world.  Though north of the border, the company has not been immune to events in the U.S., including some exposure to Enron, and, more recently, the reach of New York's Attorney General, Eliot Spitzer.  It has settled its Enron matters, and the Spitzer probe does not appear material.  The company will have to deal with interest rate fluctuations in the coming months, but economic growth in the U.S. and Canada bodes well for the bank.

 Royal Dutch Petroleum has a broad range of energy operations spaning the globe.  Last year's revenues equaled $121 billion.  The company has been tarnished by recent news that it overstated its oil and gas reserves.  It may take a while for Wall Street to regain confidence in Royal Dutch, but the company’s business prospects and balance sheet remain very solid.

 Thomson is a leading supplier of specialized industry and market information.  Its primary markets are law, education, finance, science and healthcare, all of which have good growth potential.  Thomson has been adept at making acquisitions without damaging its balance sheet.  With many of its markets still quite fragmented, Thomson is likely to enhance its leadership position with additional acquisitions.

LONG-TERM OPPORTUNITY IN LONG-TERM CARE?

While we always advocate taking a long-term view, there are many instances where the broad outlook for a stock or group may be very favorable, but investors will be hurt by nearer-term pitfalls.  In few areas has this been more true than with the nursing home and assisted living stocks (which are often together called the “long-term care” industry).  Certainly, demographic trends bode well for the industry for years to come.  But investors in the long-term care stocks have had more than their share of woes over the last decade or so.

 In the early 1990s, the industry became dangerously overbuilt.  By the late 1990s, the industry was on sounder footing until the government messed things up again.  Changes in Medicare and Medicaid reimbursement policies, mandated by the Balanced Budget Act of 1997, led to a crisis in the long-term care sector.  Many companies that had taken on debt to grow suddenly saw their revenues decline precipitously.  By the year 2000, five of the nation's largest publicly traded nursing home companies, as well as a number of private operators, were in Chapter 11.  Some relief was obtained via legislative changes in late 1999 and 2000, but further reimbursement cuts were instituted in late 2002 that once again shook the industry. 

 This situation began to improve in 2003 when legislators granted a rate increase of about 6.3%.  Now it appears that legislators may be more sympathetic going forward.  But considerable uncertainty remains, particularly at the state level where Medicaid budgets are tight.  The industry also faces a spate of lawsuits, especially in Florida.

 For those investors willing to ride the governmental roller coaster, the outlook for the industry is very positive.  The demand equation is compelling.  There are more than 77 million aging Baby Boomers who are likely to need some measure of long-term care.  While there was a short-term over capacity in the early 1990s, most industry observers believe there is now a long-term shortage.  Just as the industry learned its lesson on the capacity front, it seems to be learning how to deal with the regulatory and reimbursement issues.

In the table above and reviews below, we visit a number of players in the long-term care industry.  While several have enjoyed solid rallies with the market over the last year, for the most part, they are still well off their six-year highs and continue to represent long-term turnaround opportunities.

             American Retirement focuses on retirement and assisted living communities.  Management is creating geographically concentrated facilities so that residents can move from one facility to the next as the need arises.  But as the company has added more assisted living centers, it has also added a lot of debt to its balance sheet.  While the company is taking steps to reduced its debt burden, the stock is only suitable for aggressive investors.

 Beverly Enterprises, while engaging in a variety of health-care segments, is primarily an operator of nursing homes.  In 2002, new management entered into settlements regarding questionable billing practices that dated back to the 1990s.  More recently the company has been divesting selected facilities, thereby reducing debt and increasing cash and liquidity.  While it is likely to remain volatile, Beverly’s stock looks interesting.

 Capital Senior Living emphasizes independent living facilities relying on private payments, thus lessening any dependency on Federal program reimbursements.  Many of the firm's operations seek to integrate independent living with assisted living and home care.  The balance sheet is a bit leveraged, but the company has been consistently profitable and generating positive operating cash flows. 

 Genesis and Kindred both emerged out of bankruptcy over the last couple of years and appear to be making good progress.  Kindred’s stock had a nice rebound last year after the company largely extricated itself from the liability quagmire in Florida.

 Manor Care has by far the largest market capitalization in the group, and it is viewed as one of the better operators in the industry.  The company's financials are quite sound, allowing for the repurchase of stock, the reduction of debt, and the payment of a growing dividend.

 National HealthCare provides accounting and financial services to a range of long-term care providers.  About 40% of the firm's activities are managing facilities for other owners.  The other 60% represent operations that were at one time owned by the company but have been spun off to shareholders via two publicly traded real-estate investment trusts, National Health Investors and National Health Realty.  Revenues are rebounding, and the company is solidly profitable. 

 ResCare targets the needs of those dealing with developmental and other disabilities, youth with special needs, and adults with barriers to employment.  The company has achieved an enviable record in the long-term care industry by having reported 48 consecutive quarters of rising revenue.  The firm's financials, bolstered by the recent placement of $50 million of convertible preferred stock, are pretty solid.

Sunrise Senior Living offers a full range of personalized senior living services, from independent and assisted living to care for individuals with Alzheimer’s and other debilitating conditions.  Most revenues are from private pay sources.  Management is in the process of transforming Sunrise into a management-services company, by selling off facilities and then agreeing to manage them.  Some analysts have suggested that the profits generated by this strategy are unsustainable, but the stock has done well over the last couple of years.

As the 1990s progressed, Parametric began developing "collaborative" software, which allows engineers to share their work with other departments around the company or other engineers around the globe.  While Parametric's collaborative software helped to rejuvenate the product line, it was expensive to develop.  When the economic downturn that began in 2000 hit the manufacturing sector, the company's principal market, results deteriorated sharply.  The stock fell to $1.64 by late 2002.  Then in early 2003, the company found it necessary to restate three prior years of financial statements.

            Analysis:  Parametric appears to have bottomed out and be on the upswing.  The new collaborative products are taking hold in the marketplace.  As manufacturers move production around the world, they need software that will link their far-flung operations.  

 At the same time, improving economies in many parts of the globe are boosting the manufacturing sector, leading to an increase in demand for Parametric’s products.  In the company’s latest quarter, ended April 3, revenues grew 5 percent over the previous quarter, stemming five straight quarterly declines, and the company posted its first quarterly profit since the beginning of 2002.  With new products and improving conditions in its marketplace, Parametric should be able to take advantage of its large customer base to grow its revenues and profits.

 Even as it has been developing new products, Parametric has been cutting costs, and it plans to continue doing so throughout 2004.  This will bring more of the sales gains straight to the bottom line.  In case the rebound takes a little longer than we expect, Parametric has a strong balance sheet and plenty of cash. 

 After several years of fighting headwinds, we expect Parametric to have smoother sailing ahead.  It has a strong product line with a large customer base, and the economic conditions are improving in its main markets.  If the company can begin to show consistent profits again, the stock should move up dramatically.  We recommend purchasing Parametric Technology up to $10.

SALE RECOMMENDATION: COMSTOCK RESOURCES

All of the oil and gas related stocks have had a good run over the last year or so.  We think it is now time to begin taking some profits from that group.  We expect energy prices to remain high, but recognize that they can be volatile and unpredictable.   Therefore, we suggest trimming a little from your oil and gas holdings at this time.  Among the energy stocks on our recommended list, we think Comstock is the most logical sale candidate because it could be particularly vulnerable if oil and gas prices begin to retreat.

SALE RECOMMENDATION: MILLENNIUM CHEMICALS

Millennium agreed to be acquired by Lyondell Chemical.  Millennium stockholders will receive approximately one share of Lyondell stock for each share of Millennium.  (The actual exchange ratio could vary from 0.95 to 1.05 share of Lyondell, depending on Lyondell’s price at the time the merger is completed.)  Because Millennium’s stock is trading very near the purchase price and because we have concerns about Lyondell, we recommend selling your Millennium stock at this time.

NEWS NOTES & UPDATES

Huffy continues to struggle.  It is selling off several business lines, but it may face liquidity problems as it makes the transition.  We would not buy any more Huffy until the liquidity issues are resolved, and so we are making the stock a “hold.”

            Disney managed to fend off Comcast’s takeover attempt, but we think management will be more focused on increasing shareholder value going forward.  We are making Disney a “buy” again, up to 28.

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