Second-best stocks offer top-notch growth

Fund manager says the No. 2 company in an industry sometimes has more return potential than the market leader.

By TheStreet Staff Apr 22, 2010 9:52AM

TheStreetCrystal ball © Thinkstock/JupiterimagesBy Gregg Greenberg, TheStreet


Susan Kempler, manager of the TIAA-CREF Growth & Income Fund (TIIRX), says stock investors should look past industry leaders and consider companies right behind them, such as generic drugmaker Mylan (MYL) and shipping company UPS (UPS).


The $1.8 billion fund, which has earned five stars from Morningstar (MORN), has returned 6.8% annually during the past five years, better than 97% of its large-cap blend peers. The fund has climbed 8.2% this year, lagging half of its peers. Top holdings include Exxon Mobil (XOM), Apple (AAPL) and Microsoft (MSFT).


Kempler recently shared some stock picks and investment views with TheStreet.


Why do you like the health care sector and generic drug stocks in particular?


Kempler: If you look back to last year when regulatory reform was an overhang for the group, the companies were trading at roughly a 50% discount to the market multiple. We thought they were too cheap given the fundamental outlook for the companies, the aging population and their ability to generate cash flow going forward.


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As for generics, we have $150 billion worth of branded drugs going off patent around 2012 which should translate into approximately $30 billion of revenues for the generic drug manufacturers over the next 5 years. In addition, within the United States, which is the biggest generic drug market in the world, we are seeing pricing stability and consolidation.


Why is Mylan your top pick among generic drugmakers?


Kempler: We bought the stock back in April of 2008 when they bought the generic drug division of Merck KGaA. This gave them a global platform that we believe is important going forward. Previously, they had been mostly domestic based.


Secondly, it was trading at a significant discount to Teva Pharmaceutical Industries (TEVA), which is seen as the leader in the generic industry. We thought Mylan's ability to integrate that acquisition and show synergies made that five multiple discount unfounded.


Outside of health care, you like Halliburton (HAL) in the oil services industry. Why that one?


Kempler: When we bought the stock in 2008 it was trading at a five-point multiple discount to Schlumberger (SLB), which is the leading player in the industry. The company's new management, which really came in around the beginning of the decade, has really improved its offerings to Halliburton clients. They grew their technology base and now they are able to offer bundled products, becoming more of a one-stop shop.


In addition, they have been more defensive during the downturn for oil services, holding up a little better in terms of revenue declines and margin declines. And they have been showing improving returns on invested capital. The proof of the pudding was their win with Saudi Aramco, which is giving them a really nice runway to revenue growth going forward.


Another company you like is UPS. Why UPS as opposed to FedEx (FDX)?


Kempler: UPS is leveraged, just like FedEx and the other capital goods companies, to an improving economy and we like that first and foremost. Secondly, what we are seeing is that because of its renegotiated contracts with the unions, its cost structure is much better. Analysts on the sell side are underestimating its ability to leverage that going forward. We also like the pricing stability in the sector because DHL is no longer out there destroying prices for everybody.


Do the fraud allegations at Goldman Sachs (GS) mean investors should avoid financials?


Kempler: I'm not sure about the need to fully avoid the financials. It's hard to speculate on the outcome of the Goldman Sachs situation. I think that if you are a bottoms-up stock picker like we are, looking at stocks in detail, then you can find financials to fit any environment.


I do think there will be more regulatory reform for these companies, and that will be first and foremost in people's minds when they are thinking of the financial sector.


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