STOCK WATCH


Stocks to Buy Now for the Recovery Later

Shares of these five companies should perform better than others when the economy starts to rebound.



Investors are looking for glimmers of hope that the recession is nearing its end and that an economic recovery might be afoot. It will probably be a while before that happens, as jobless claims continue to rise and home prices continue to fall. But when the economy finally does turn, some areas of the stock market will perform better than others.

In the past, industrial sectors and small-company stocks roared out of the gate early. However, as Morningstar equity strategist Paul Larson notes, "There has been nothing typical about this recession." He thinks other types of companies might take the lead this time. With that in mind, we looked at five potential winners among early-recovery stocks.

Need evidence that energy and economic activity are linked? Crude-oil prices are down 63% from their July 2008 peaks, and natural gas is off 66% since June, just as it became clear that the recession would be deeper and longer than had been forecast. Prices remain weak as people drive less and try to conserve energy at home.

Shares of Unit Corp. (symbol UNT), a natural-gas producer and contract driller, could climb once investors conclude that a recovery is in the offing. At its April 29 close of $28.09, the stock is down 68% from its high in early July.

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But Unit has a strong balance sheet, and the stock trades below the company's book value (assets minus liabilities) of $34.56 per share. Joshua Strauss, co-manager of the Appleseed fund, says Unit is well positioned to take advantage of an economic upturn. "And if we're in a weak economic scenario with heightened inflation, which I think is a much more likely scenario, that's good, too, because commodities are a great inflation hedge."

Transportation is another good economic barometer. When consumers start spending again, businesses will need to ship more goods, leading to more demand for freight services. "Freight provides an early indicator of the cycle on both the good side and the bad side," says Eric Ende, manager of FPA Perennial and FPA Paramount funds. The past year has been terrible for the sector. In February, the American Trucking Association's trucking index was down 9.2% from the prior year.

Two of the strongest players in the business, Knight Transportation (KNX) and Heartland Express (HTLD), have similar profiles.

Both companies operate in the truckload segment. They move their customers' wares from pickup to delivery in a single trip, rather than deliver products to another destination for other trucks to pick them up. Both companies have operating profit margins in the high teens, compared with 5%, on average, for their competitors, says Ende. And neither has any debt. When the economy improves, both companies have the financial wherewithal to pay for new trucks and quickly increase their capacity.

Heartland's first-quarter revenues, reported on April 15, fell nearly 23% from a year earlier, with half of the decline attributed to smaller diesel surcharges. But earnings were flat from a year ago, at 15 cents a share. "That's extraordinary in this environment," says Ende.

Knight's results, released April 22, were similar. Revenues were off 16% -- also the result of lower demand and the removal of the diesel surcharge -- but profits rose a penny a share, to 14 cents.

On the surface, the stocks aren't cheap. Knight, at its April 29 close of $17.50, trades at 27 times the average analyst earnings estimate for 2009 of 64 cents a share, while Heartland, at $15.02, trades at 23 times 2009 earnings estimates of 64 cents a share. Once the economy picks up steam, however, the companies may generate earnings well ahead of estimates.

Once thought unaffected by the economic climate, the technology sector is increasingly viewed as cyclical. And within the tech sector, hardware is the most economically sensitive because it's easiest for corporations cut hardware purchases in a bad times. Sales at hardware companies have dropped much more than those of software developers, says Tony Ursillo, a technology analyst with Loomis Sayles. "The hardware companies haven't maintained their profit margins at as high a level as software companies have, so they have more earnings leverage when the economy turns."

When corporations start boosting their information-technology budgets, router king Cisco Systems (CSCO) will surely benefit. Cisco is struggling now, as big companies such as AT&T and Verizon Communications trim capital spending. Revenues for Cisco's second fiscal quarter, which ended January 24, fell 7.5% from the year-earlier period, to $9.1 billion. And orders for new products were down, too.

But eventually, network traffic will revive along with the economy, Ursillo says. Despite a 10% rebound since the stock market's March 9 bottom, Cisco, at $19.25, trades at just 15 times estimated earnings of $1.25 per share for the fiscal year that ends this July. That's well below Cisco's average price-earnings ratio over the past five years. The low price, "combined with its balance sheet -- $10 billion in cash -- makes it a very good value proposition," Ursillo says. "When we see a rebound, Cisco will rebound stronger than the average stock in the sector."

Varian Semiconductor Equipment Associates (VSEA), a leading supplier of ion-implant tools used in the production of computer chips, has experienced an even bigger drop in revenues and, consequently, stands to improve dramatically once the economy picks up steam. Despite snagging market share as several of its competitors defect to the more lucrative solar-panel segment, Varian has suffered greatly in the recession. For Varian's first fiscal quarter, which ended January 2, revenues plunged 58% from the same period a year earlier, to $107.4 million. Analysts expect the company to lose 77 cents a share in the fiscal year that ends this September and to eke out a small profit the following year.

But Jack McPherson, co-manager of Eagle Small Cap Core Value fund, says Varian has "good exposure to a rebound" and should also benefit from less competition in its market. Varian's shares have already gained a lot from their November 20 low of $14.05. But the stock, at $23.65, is still 43% below its 52-week high.




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