2 best rebound stocks of 2013
Apple is among the biggest underperformers this year, but this pair of laggards may have even brighter prospects.
By David Sterman
One of the biggest investment stories of 2013 has surely been the ongoing slump in shares of Apple (AAPL), which have fallen 21% this year after dropping a similar amount in the final months of 2012.
Surprisingly, Apple doesn't have much company in this regard. Only eight stocks in the S&P 500 ($INX) have fallen by 20% or more in the first half of 2013, which is an unusually small percentage. A rising tide has surely lifted (almost all boats) in this extended bull rally.
Still, it's helpful to focus on companies with broken stock charts, because a few of them have so badly underperformed the broader market, and now sell at such severely low valuations, that they've become compelling bargains. Of course they are only compelling bargains if the key drivers are in place to help deliver improving results. I looked at these eight market laggards, and two of them caught my eye as solid rebound candidates.
It's hard to spot a directional trend for Apple's shares right now, based on the fundamentals, though the company at least stopped the bleeding a few months ago by following the advice I gave on StreetAuthority about buybacks and dividends.
1. Joy Global (JOY)
This provider of mining equipment has felt the impact of a slump in the commodities sector. The company's sales hit a recent cyclical peak at $5.6 billion in its 2012 fiscal year, and are likely to be stuck at around $5 billion in both the current fiscal year and fiscal 2014 as well. You have to look to fiscal 2015 to spot an expected upturn, as sales are expected to rise around 5% that year (to around $5.25 billion).
Yet even with the tepid sales outlook, Joy Global is still expected to post operating margins in the 20% range. And shares trade for less than nine times projected fiscal 2013 profits, and less than 5.5 times EBITDA (earnings before interest, taxes, depreciation and amortization), on an enterprise value basis. Free cash flow, which is expected to dip below $300 million in the current fiscal year, should rebound above $500 million in fiscal 2014 and 2015, thanks to reduced capital spending and headcount reductions, according to analysts at Citigroup. Management is expected to use that cash flow to reduce the share count by up to 10% over the next two years.
Though it may seem counterintuitive, the best time to buy cyclical stocks like this is when they are at the bottom of the cycle -- as long as they still generate solid cash flow in that phase of the cycle. Back in early 2011, when investors were paying nearly $100 a share for this stock, they were unwisely expecting a mining boom that would lead to an acceleration in earnings for stocks like this. It's when expectations (and share prices) for cyclical stocks are already robust that investors should be looking to sell. Joy Global may have few near-term fans now -- but it's built to flourish when the first signs appear that the commodity cycle has bottomed out.
2. F5 Networks (FFIV)
A decade ago, Fortune 500 companies sought to establish distinct computer networks for each of their operations. Employees interacted on one network, clients on another, and telecom systems on yet another. These days, that approach has been replaced by the use of one massive network, which enables the company's IT managers to more closely integrate all of the various communications and computing processes on one platform, which can also save a great deal of money in terms of hardware and software purchases.
This company, a leader in the delivery of network software that controls applications, security software and other mission-critical systems across an enterprise, has surely benefited from the trend. Sales have surged from $400 million in fiscal 2006 to nearly $1.4 billion in fiscal 2012.
But a move to upgrade many of its software components this year has led to a slowdown in sales, and some wonder if this company is now too big to grow at a solid pace. After all, sales are expected to rise just 5% in the current fiscal year (to around $1.46 billion).
Yet that growth slowdown may prove short-lived. In the current fiscal fourth quarter, F5 is releasing "Big IQ," which should give IT managers much more functionality as they manage massive networks. That release, along with some key hardware upgrades on F5's "5000" and "7000" systems, is expected to lead to double-digit sales growth in the fiscal year that starts in October.
Despite the recent slowdown, analysts at Merrill Lynch remain bullish: They think "the company maintains one of the better (long-term) growth rates in the industry and one of the better margin structures (80% gross margins and 32-33% operating margins)," which underpins their $95 price target. That's where shares stood back in early March, before a recent pullback below $70.
As a further catalyst, Cisco Systems (CSCO) has recently exited the $200 million application delivery control (ADC) market, and "F5 is in the best position to capture the lion's share of this incremental share of this market," according to analysts at Morningstar, who peg the fair value of this stock at $100.
Risks to consider: These stocks have been weak in an otherwise strong market. If the market retrenches from here, it will be hard for these stocks to regain traction, so they may be best regarded as long-term opportunities.
Action to take: Though a number of companies in the group above face serious challenges, both Joy Global and F5 Networks have proven solid track records and continue to generate very strong cash flows, even as sales growth has hit a current rough patch.
David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.
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