With continued uncertainty in the macro landscape, investors are struggling to identify stocks that generate alpha despite the turbulent investment environment. This article seeks to pinpoint stocks that have an edge. These are companies which we are more optimistic than the Street and reveals opportunities that the market has not yet priced in.
Verizon (VZ): Industry returns have been under pressure with rising smartphone penetration driving up costs and capex at a faster rate than revenue. Subsidies have been the biggest source of pressure, with costs rising 34% from 2010 to 2011. Verizon started to change this around the beginning of 2011 by tightening upgrade policies and implementing upgrade fees. Volume upgrade and device subsidies are expected to decline after years of steady growth, driving a sharp improvement in margins. There are signs across the industry of growing discipline around pricing, subsidies, and upgrades. If this discipline holds, there is upside to margins and earnings growth for all carriers. The changes to upgrade policies will lower the upgrade rate by 310bps y/y, boosting margins by ~100bps, and that the upgrade fee of $30 will boost margins by a further 40bps
Key Catalysts:
· Carriers continuing to push out upgrade eligibility.
· Lower subsidies.
· Increase in pricing.
Intel Corp. (INTC): Longer-term, Intel Corp. can grow revenue at a 7-12% CAGR with PCCG growing at 5-7%, DCG at 13-17% and Tablets/smartphones adding an incremental 2-3% CAGR (assuming 25- 30% share). The stock enjoys core manufacturing advantage which is meaningful, consequential and widening, which the market is not factoring in fully. This lead helps INTC position well in core markets (PC, Servers) and creates opportunities in new markets (Tablets, smartphones, Networking, and Embedded). The stock presents long-term CAGR of at least 10% and earnings power approaching $4.00 - more than supportive of $35 target price.
Key Catalysts:
· Growth numbers in Storage/Networking.
· Upside to Enterprise Server unit estimates driven by an aging installed base and Cloud/HPC.
· Performance of key products : Ultrabook, Windows 8, Romley, Ivy Bridge and Computex.
Paychex (PAYX): Paychex is well positioned for a sustained recovery in private sector jobs, continued outsourcing and, at some point, maybe a back up in rates. The company has no direct exposure to public sector jobs. PAYX stands out for its high quality, defensive characteristics: largely recurring revenue, highly scalable operating model, strong cash flow, no debt, and 4% yield. 100% of earnings are sourced in the United States. Revenue and earnings growth would accelerate going forward, reflecting an uptick in sales, increases in checks per client and improving retention. Over a normal cycle, PAYX can grow earnings low double-digits.
Key Catalysts:
· Successful price increase implementation in F13.
· Improving retention and new sales.
· Hosting of its first ever investor conference in mid-July, where that management will lay out a long-term strategy for driving growth.
Illumina, Inc. (ILMN): Illumina return to sequential growth over the past two quarters, driven by improving consumable pull-through and the MiSeq launch, are key tenets behind our greater comfort on ILMN's short-term health. Longer-term, the accuracy and ease of use of MiSeq should help ILMN penetrate the clinical market, while ILMN's management team should be able to introduce new products that will allow it to remain a leader in the genomics space. Finally, while ILMN is well-positioned to succeed on its own, there is also the possibility of Roche returning into the mix, providing some support to ILMN's stock around $40/share.
The company is much better positioned to handle some of the challenges in government/academic end markets than it was last year. ~80% of the company's revenues come from customers in government/academic end markets. The customers have adjusted their buying patterns significantly this year so there would not be any spending fall off a cliff again in 2H 2012 as in 2H 2011.
Key Catalysts:
· Quarterly earnings results, as investors monitor the uptake of competing sequencing technologies from ILMN, LIFE and others.
· On a more macro level, any debate or decisions on government funding of genomic research will impact ILMN's stock price given how leveraged they are to this market.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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