3 top-notch defensive stocks

In the current climate, a good defense can be your best offense.

By MoneyShow.com Feb 3, 2012 12:37PM

Image: Baker (© Blend Images/SuperStock)By Elliott Gue, Personal Finance


Investors are caught between a rock and a hard place. Yields offered by traditional safe havens, such as U.S. Treasury bonds and high-grade corporate debt, are near multi-year lows.


Meanwhile, ongoing concerns about the E.U. sovereign debt crisis and the U.S. economy have made investors reluctant to roll the dice on equities. That's given legs to the rally in high-quality, large-cap stocks.


In this environment, investors seek out low-volatility names whose underlying businesses can grow earnings even if global economic growth decelerates. Better still, dividend-paying stocks have outperformed pure growth plays for more than two years -- a trend that should continue in 2012 because of the paltry yields available in the bond market.


Here's a look at four large-cap stocks that stand to benefit from below-market volatility, meaningful dividend growth potential and specific upside catalysts.


Sara Lee (SLE
Best known for its eponymous cakes, Sara Lee is also behind iconic brands such as Jimmy Dean sausages, Hillshire Farms meats, and Senseo and Java Coast coffee products.


For years, Sara Lee was a chronic underperformer that lagged its peers in profitability. The culprit was a lack of strategic focus. Many of Sara Lee's largest brands are category leaders, but the firm's portfolio included a number of non-core brands that weighed on profitability.


Like many food and beverage makers, Sara Lee has battled rising commodity costs and shrinking margins in recent years. Furthermore, the company's hodgepodge of product lines made it more difficult to control supply-chain costs.


Management has taken steps to address these problems. Since 2005, Sara Lee has shed less competitive and non-core brands. For example, the company recently sold its North America-focused foodservice coffee and tea business to J.M. Smucker (SJM) in an all-cash deal. Late last year, the firm divested its North American fresh bakery business to Mexico’s Grupo Bimbo (GRBMF).


An exciting catalyst could create value for Sara Lee shareholders: The firm plans to split into two companies in 2012. One firm will retain the name Sara Lee and the North American packaged food and meats business. The other firm, currently dubbed CoffeeCo, will operate the international coffee, tea, and beverages business.


This split will make the firm easier to manage, by reducing the number of brands and product categories in each company’s portfolio. The spin-off should be completed in the first half of 2012.


Sara Lee shareholders will receive a special dividend of $3 per share. Both CoffeeCo and Sara Lee are expected to pay dividends and retain investment-grade credit ratings.


After the spinoff, both firms could become potential takeover candidates in a sector that has seen its fair share of mergers and acquisitions in recent years.


With a beta of just 0.75, Sara Lee is a defensive stock that also boasts top-notch brands. The company will also benefit from management’s value-enhancing plan to split the firm into two companies.


Sara Lee Corp joins the Growth Portfolio as a "buy" under $22.


Johnson & Johnson (JNJ
This company makes consumer staples and health-care products. The consumer business accounts for roughly one-quarter of the firm’s annual revenue, and includes Listerine, Sudafed, Tylenol, Neutrogena, and other well-known brands. In the third quarter, the segment's sales climbed 4.9% year over year, led by a 10.1% uptick in international revenue.


Johnson & Johnson achieved this growth even after temporarily shuttering a major manufacturing facility in Pennsylvania to address quality issues. The company should have these production issues resolved by the second half of the year, and will enjoy a welcome tailwind when these products return to shelves.


The pharmaceutical and medical device segments drive the bulk of Johnson & Johnson’s earnings growth.


In 2011 the firm's patent for Levaquin -- a treatment for bacterial infections -- expired, opening the door for generic competitors that undercut the drug's profitability. Fortunately, Johnson & Johnson has a solid pipeline of new drugs entering the market, including cancer treatment Zytiga and Incivo, which targets the hepatitis C virus.


But Johnson & Johnson's medical devices business boasts the best near-term growth prospects. In mid-2012, the company will close its acquisition of Synthes, a Swiss outfit that specializes in devices used to set bones in trauma patients. These products complement Johnson & Johnson’s existing DePuy line of artificial joints, and will make the combined firm the largest player in the business.


Johnson & Johnson is a classic defensive name with a beta of 0.6 and a consistent record of boosting its quarterly dividends. Over the past five years, the firm has increased its dividends at an annualized rate of more than 9%. Buy Johnson & Johnson under $70.


Pfizer (PFE
This company's pharmaceutical portfolio includes a number of blockbusters, including cholesterol reducer Lipitor, Enbrel for rheumatoid arthritis, and antidepressant Effexor.


When analyzing pharmaceutical giants such as Pfizer, investors must weigh the number of drugs scheduled to lose patent protection against the number of new treatments in late-stage clinical trials.


Pfizer is working through a significant wave of patent expirations: Lipitor lost its protection last year, while antipsychotic treatment Geodon and erectile dysfunction medication Viagra will have their patents expire in 2012.


It’s a tough pill to swallow, but the post-2012 outlook is more favorable. Pfizer has few major patents set to expire through the end of the decade.


Meanwhile, Pfizer boasts a pipeline of more than 90 drugs in development, one-third of which will enter Phase III clinical trials by the end of 2012. Tofacitinib, a treatment for rheumatoid arthritis, is likely to be approved for sale in the US by the second half of 2012.


Eliquis -- a drug Pfizer owns as part of a 50/50 joint venture with Income Portfolio holding Bristol-Myers Squibb (BMY) -- s a promising oral treatment that prevents strokes in patients suffering from an irregular heartbeat.


Eliquis has been accepted for priority review by the US Food and Drug Administration and could receive regulatory approval in the first half of 2012. The drug has already been approved in the EU for patients who have undergone hip or knee replacement surgery.


The company is also likely to spin off its animal health and nutrition business toward the end of the year. Although this business line boasts some market-leading drugs, the move will allow Pfizer to focus on its core business and provides another catalyst for the stock.


Pfizer's stock sports a beta of about 0.8, and the company recently boosted its quarterly dividend by 10% to 22 cents per share, equivalent to a yield of about 4%. Buy Pfizer under $24.


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