From the December 2010 issue of Research Magazine • Subscribe!

December 1, 2010

Consumer Sectors: Strong Positioning

The reviving U.S. economy bodes well for select consumer stocks.

R.J. Hottovy, CFA, Morningstar

Generally speaking, we believe consumer stock valuations appropriately reflect our turbulent spending outlook. However, pockets of value can still be found across our coverage universe.
In contrast to our cautious outlook for consumer spending, we believe that consumer companies are eager to exploit higher-return opportunities for cash balances after two years of anemic returns and limited organic growth prospects.

Acquisitions should remain a consistent theme, as consumer products firms continue to build out their brand portfolios, increase stakes in joint ventures, or bring overseas licensees in-house. Double-digit dividend increases and sizable share-repurchase programs have also become commonplace among consumer firms, often backed by low-interest debt issuances.

Neil Currie, UBS

CVS Caremark [has] initiated a 5-year EPS growth target of 10-15 percent, including 7-9 percent from continuing operations (before share repurchases). 2011 EPS is likely to be lower than this range due to one-time costs associated with productivity projects, including working capital.
With pharmacy-benefit problems seemingly behind the company, management is focused on improving ROI, including a focus on working capital. CVS expects $33 billion of free cash over the next 5 years, of which two-thirds will be returned to shareholders through a combination of faster dividend growth and an average $3 billion-$4 billion annual share repurchase.

Lisa C. Gill, J.P.  Morgan

We maintain our Overweight rating on CVS Caremark. Shares trade at 10.7x our 2011 new adjusted EPS (earnings per share) estimate of $2.91. This represents a 19 percent discount to Walgreens (which we don’t believe is warranted as CVS continues to outperform Walgreens on the retail side of the business) and a 28 percent discount to the average multiple of the standalone PBMs, pharmacy benefit managers. Given the current multiple and the progress the company has made to date (including the new Aetna relationship), we continue to believe the company is not getting sufficient credit for its PBM business.

Zacks Investment Research

Toyota maintains a healthy cash flow. In fiscal 2010, Toyota had a net cash flow of ¥ (Yen) 2.56 trillion ($27.5 billion) from operating activities, an increase from ¥1.48 trillion ($16 billion) in the prior fiscal year,  primarily driven by an improvement in net income and an increase in deferred income taxes.
Meanwhile, capital expenditures reduced to ¥604.5 billion ($6.5 billion) from ¥1.36 trillion ($15 billion) a year ago. The solid financial position gives Toyota the ability to return value to shareholders through dividend payouts and solid growth.

Morgan Stanley & Co. Inc.
Our leading indicator of light vehicle sales remains at elevated levels. Proprietary indicators suggest an improvement in credit quality will lead an eventual recovery in credit availability. As with Nissan, we think Toyota’s U.S. sales will drive earnings, and project OP (operating profit) and EPS to rise 42.4 percent YoY (year-over-year) and 34.9 percent YoY, respectively, in FY3/12.

David Palmer, UBS

The bull case for Kellogg is that innovation improves starting with January shelf sets, and that price increases begin to hit reported revenue by mid-2011. While Kellogg’s company-specific issues continue to linger, we believe that the cereal category will stabilize and grow in 2011 as (1) major players reduce inefficient price promotions, (2) innovation is stepped up, and (3) inflation helps encourage consumers to find lower cost and lower inflation food categories.

Zacks Investment Research

By focusing on brand building and profitability, Kellogg is reporting consistent sales and earnings growth. Earnings momentum is likely to continue in the near future as management provides a healthy future financial outlook.

Kellogg continues to market brands that generate higher margins, part of the Volume to Value strategy. Management is intensifying the brand-building program with increased advertising and promotional expenditures in line with the goal of increasing brand-building spending at twice the rate of sales growth.

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