| Possible
New Additions to Our Bellwether Portfolio |
Published: February 2, 2004
Below you'll find a table of companies
that I'm now considering as possible new additions to our Bellwether
Portfolio. My staff and I here at StreetAuthority are constantly
researching and following all of these picks, and we may add a few of
them to this portfolio if and when their risk/reward profiles meet our
stringent investment criteria.
| Company
(Symbol) |
Current
Price |
Market
Cap. |
| Citigroup (C) |
$49.48 |
254B |
| Fannie
Mae (FNM) |
77.10 |
75B |
| Freddie Mac (FRE) |
62.42 |
43B |
| Lowe's
(LOW) |
53.73 |
42B |
| Starbucks (SBUX) |
36.61 |
14B |
| Whole
Foods Market (WFMI) |
67.47 |
3B |
CITIGROUP (C) -- Citigroup is a diversified
financial services behemoth with banking, brokerage, insurance, credit
card, investment banking and asset management operations in over a
hundred countries throughout the globe. Thanks to a series of smart
strategic acquisitions over the years, the company has managed to post
+38% average annual net income growth since 1992. Citigroup's main
competitive weapons are its enormous size and diverse product lineup,
which have allowed the firm to not only outmuscle the competition, but
also to post steady growth amidst virtually any type of market
conditions. When one of the company's business units is struggling,
another one generally fills in and picks up the slack. The stock would
make for a solid addition to our Bellwether Portfolio on a dip back to
$45, so my staff and I will keep a close eye on the shares.
FANNIE MAE (FNM) -- This government-sponsored
mortgage giant has ridden the booming U.S. housing market to big gains
over the past several decades. Fannie makes its money by purchasing
pools of mortgages from lenders and then either repackaging and selling
them as securities or holding them in its own account. Although the
business isn't flashy, the firm has seen its profits soar over the past
decade -- posting average annual earnings growth of +16% since 1992.
Fannie's main competitive advantage lies in its close association with
the federal government. Thanks to its quasi-government-agency status,
the firm can borrow at much lower rates than its competitors. Since
Fannie earns most of its money on the spread between its borrowing and
lending rates, this is a tremendous advantage.
It's hard to find fault with Fannie's superior track
record, but the company's future is not without risk. Given the enormous
size of the firm's current revenue, asset and earnings base (the company
earned $7.9 billion in 2003, or $7.91 per share, on over $1 trillion in
assets), it's going to become harder and harder for Fannie Mae to post
double-digit earnings growth year-in and year-out in 2004 and beyond.
The company also faces a number of regulatory risks, as some members of
Congress are seeking to tighten regulations governing the firm and to
increase competition in the mortgage lending market. Regulators are now
eyeing the firm closer than ever following a widely publicized
accounting scandal at Freddie Mac (FRE) last summer. And finally, if
interest rates head higher in the latter half of the year and the
housing market cools off, then Fannie could see a cyclical slowdown in
its core business lines.
Assuming that the company can continue to effectively
hedge its interest rate risk and that the government does not introduce
new competition into this market, however, Fannie Mae remains a solid
long-term holding and is worth a closer look as a potential Bellwether
Portfolio addition. Moreover, with a respectable dividend yield of +2.7%
and the potential for strong annual dividend increases in the years
ahead, FNM might also be worth considering as a new addition to our
Income Portfolio.
FREDDIE MAC (FRE) -- Freddie Mac is commonly
referred to as Fannie Mae's "sister company"... and for good
reason. Both are essentially involved in the same business line
(mortgage lending) and both are implicitly sponsored by the U.S.
government. The main difference between Freddie and Fannie is size. With
fewer total assets an a market cap of just $43 billion (relative to
Fannie's $75 billion), Freddie is the smaller of the two giants. Thanks
in part to its smaller size (which has allowed it to grow at a faster
clip), the firm has managed to outperform its sister company by posting
+23% annual earnings growth over the course of the last decade.
On the downside, all of the aforementioned risk
factors (see my profile of Fannie Mae above) also hold true for this
stock. In addition, Freddie Mac has come under heavy fire in recent
months following an accounting restatement last summer, and the company
is still under formal investigation by the SEC (Securities and Exchange
Commission). In light of those problems, regulators recently upped some
of Freddie Mac's capital requirements by 30% in an effort to ensure that
the company remains financially stable. On the positive side of things,
however, most of the bad news is probably now behind us when it comes to
this stock. As such, now could be an excellent time to initiate a
position in the shares. As a lower-risk play, however, we'd probably
prefer to add Fannie Mae to our Bellwether Portfolio before taking a
chance with Freddie Mac.
LOWE'S (LOW) -- Thanks to its quality
management team, smaller size and the booming housing market, Lowe's is
quickly catching up to #1 rival Home Depot in the home improvement
market. Here's how the company will continue to fuel growth going
forward:
-- Lowe's currently operates over 900 stores in 45
different states, but has plenty of room left for expansion
(particularly in metropolitan areas). The firm expects to 140 new stores
this fiscal year, helping it to expand its square footage of retail
space by 13-15%.
-- Top executives continue to cut costs and improve the firm's inventory
management. Lowe's is also constantly moving toward a more profitable
sales mix.
-- Home improvement spending should continue to rise in the years ahead.
Current estimates peg the entire U.S. home improvement industry at $400
billion a year.
-- Analysts expect Lowe's to post 18% annual earnings growth over the
next five years.
-- At around $8 billion, Lowe's quarterly revenues are still only about
half those of chief rival Home Depot.
I'm considering adding Lowe's to our Bellwether
Portfolio, but with the stock now trading at more than 20X next year's
(2005) projected earnings of $2.68 per share, I'm a bit hesitant to add
the shares due to valuation concerns.
STARBUCKS (SBUX) -- If you take a look around,
it seems as though this specialty coffee retailer already has a store on
nearly every street corner in America. Yet by expanding into new U.S.
locations as well as hundreds of international markets, Starbucks aims
to grow its store count from nearly 7,500 now to roughly 25,000 by the
time all is said and done. In fact, the firm plans to open a minimum of
1,000 units each year for the foreseeable future (the firm opened 1,003
stores in 2000, 1,208 in 2001, 1,177 in 2002 and 1,127 last year). Yet
this isn't the only source of growth for Starbucks. Thanks in large part
to a +10% surge in same-store sales, company revenues and earnings
soared +28% and +41%, respectively, in its fiscal first quarter (ended
December 28th). The company reiterated its plans to open roughly 1,300
new stores in fiscal 2004 and also raised its full-year revenue growth
guidance to +25%.
Fueled in large part by global expansion, analysts are
calling for Starbucks' earnings to grow at a +20% clip each year over
the next five years. We have no doubt the firm will reach those lofty
targets. Although the shares don't come cheap (trading at 35X next
year's projected EPS of $1.03), we're confident that Starbucks will
continue to dazzle investors over the next several years. Beyond that,
the company's same-store sales growth is likely to slow from around 7%
to 3% as its store base matures. But even then, as long as Starbucks
continues to expand successfully on the international front, the company
should still manage to fuel consistent double-digit annual growth via a
combination of rising sales and new store development. With this
long-term perspective in mind, the stock is likely to deliver returns of
roughly +15% per year for investors over the next decade, so we've
decided to add Starbucks to our Bellwether Portfolio at the opening bell
on Tuesday, February 3rd. We'll initiate coverage of the stock with
a "Buy" rating and a 12-month price target of $43.
WHOLE FOODS MARKET (WFMI) -- With about 150
locations across the country, Whole Foods has come to dominate one of
the fastest-growing niches in the grocery business -- the market for
premium organic and health-oriented foods. By offering quality produce
and a wide selection of healthy food items, Whole Foods has managed to
grow at a fast clip even amidst a general downturn in the grocery
business. While traditional grocers are quickly losing ground to the
likes of Wal-Mart (WMT, $53.85) and Target (TGT, $37.96) -- both of
which have added groceries to many of their stores at rock-bottom prices
-- Whole Foods has carved out a profitable niche for itself. And even
though many traditional grocery chains are now attempting to compete
with Whole Foods by offering a growing selection of health-oriented
items, their selection still pales in comparison to that of WFMI's, so
we don't expect to see significant customer defections here.
On the financial front, WFMI's sales have grown at a
roughly +20% annual clip over the past five years, and all signs are
pointing toward a continuation of that growth in the years ahead. Key to
the company's strategy will be growth in same-store sales (which jumped
roughly +10% last year alone) and an increase in new store openings (the
firm has regularly boosted its total square footage by more than +15%
per year in recent years). Trading at nearly 30X next year's projected
earnings of $2.30 per share, investors have already priced in quite a
bit of Whole Food's future growth potential. Still, I'd gladly add the
shares to our Bellwether Portfolio on a pullback into the $50s.
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