Some firms now enjoy the benefits of restructuring; others should see earnings shift up later in 2006, analysts say.
Area of Coverage: Consumer Services — Restaurants
Outlook: Generally, we continue to favor the global brand companies with superior brand and capital management, stable cash flow from franchise business models, and international sources of growth.
Effectively, all the fast-food stocks that we are recommending have restructuring programs — with “re-franchising” of restaurants being a common strategy. This is where they are selling company-operated restaurants to franchisees and boosting return and earnings stability in the process. We look at that as a nice value creation kicker for our buys over the next two to three years.Below average industry sales growth in the casual-dining sector has compelled several major casual-dining chains to focus harder on brand and media strategy along with menu innovation. Fast-food companies, and Darden Restaurants in casual dining, have been a little ahead of the game and have addressed brand and menu strategies earlier.
Fast-food restaurant companies such as McDonald’s have improved their capital strategy with re-franchising, and casual dining companies may be next to improve capital decisions. For casual dining chains, slowing down unit growth and re-franchising should be next on the to-do list. In summary, this overall backdrop of corporate self-improvement and international profit contribution are positives for relative EPS in the restaurant sector; so, too, are food costs in the U.S.
Buys: Applebee’s International (APPB), McDonald’s (MCD), Wendy’s International (WEN) and Yum Brands (YUM)
Top Pick: Yum Brands
Why YUM Brands? We see high- quality 13 percent EPS growth in 2006 being driven by accelerating sales momentum in China and high-single-digit-profit growth from the U.S. Other factors supporting profitability include lower food costs. For the medium to long term, we see YUM evolving over the next few years into more of the “China/Taco Bell/franchised-income” company and less of a “company-operated U.S. KFC/ Pizza Hut” company. The China business will be growing, profit-wise, close to 25 percent per year. We believe that investors are well-served in buying YUM now at slightly-above a market multiple.
Oppenheimer & Co.
Area of Coverage: Consumer Products — Household Products
Outlook: Historically, this group outperforms during times of declining interest rates. The group outperformed the S&P by 22 percent in ’01 and by 28 percent in ’02. In the rising rate environment of the last couple of years, however, the group has been a slight underperformer. The group’s earnings strength relative to the S&P 500 has been very poor in the last few years: But, this is actually projected to turn positive in the second half of ’06.
The cost of raw materials also affects group performance. The current cost of plastic resin — assuming no change going forward — would indicate some relief of raw materials cost pressure in the second half of the year. But if the price of oil remains high and plastic resin costs follow, then all bets are off on that.
Currency translation also impacts this group. At this time, for most multinationals with a mixed business portfolio throughout the world, currency translation is relatively neutral to slightly negative.
Buys: Colgate (CL) and Playtex (PYX)
Top Pick: Playtex
Why Playtex? When assessing the group for outperforming stocks, among the things I look for are turn-around situations. Playtex is in a turn-around situation with a new management team. In addition, the company has three strong businesses as well as a strong brand. There is a leveraged balance sheet to be factored into the equation, but Playtex is generating cash to pay that down. We expect the company to double the number of new products in 2006 and have innovations in all three of their major businesses: tampons, infant care and skin care.
Brean Murray, Carret & Co.212-702-6619,
Area of Coverage: General Consumer Products — Apparel & Retailing
Outlook: Short term, this is going to be a very tough year for consumer companies given the effects of higher gas prices and mortgage repayments on spending. One of the reasons we focus generally on fashion-driven trends is that they don’t have as much vulnerability to these economic pressures; but after a certain point, consumer retailers will feel the impact, especially at the malls.
For the long term, we focus on companies that we believe have unique fashion viewpoints, strong management and a strong infrastructure to handle whatever the next trend throws at them. We want companies that understand fashion and understand how to integrate it with their back office infrastructure. Fashion companies don’t ever get it right all the time.
The companies that are run well and use their infrastructure will minimize the damage when they have a fashion miss. On the other hand, when they have a hit, they can maximize the returns they get from that. How they use the back office and the IT infrastructure is almost more important than how well they do line product.
Strong Buys: 1-800-FLOWERS.COM (FLWS), Iconix Brand Group (ICON), and True Religion Apparel (TRLG)
Top Pick: True Religion Apparel
Why True Religion? True Religion is a premium denim manufacturer and a very controversial stock. A lot of people don’t believe that premium denim has staying power. Yet, if anything it has become, in some respects, a way of life for a lot of people to pay $200 for a pair of jeans. It’s become more than just a staple; it’s a fashion item. When that’s the case, you can still get premium margins from it as long as you stay on trend with the right product.
We believe that with the rollout of fleece, further expansion in terms of distribution, and other key catalysts, that True Religion will continue to shine in 2006 and beyond.