What to Buy in the Selloff

 | Jul 09, 2014 | 6:44 AM EDT  | Comments
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The market has caught a selloff, so what do you buy? I like to go back to what had been working just a week ago, and hopefully pick up a couple of discounts on some very winning names.

Where does this winning list come from? How about the companies that performed best in the quarter that just ended? They are the logical places to go, especially because nothing has happened to change their fortunes and they are all still in favor.

First is Williams Companies (WMB), which is always a competitor in the shipment of oil and gas, and is now a powerhouse after its purchase of Access Midstream Partners. Sure, Williams paid a 50% premium to pick it up. But, when it comes to shipping all of the oil and gas we are finding in the U.S., few companies are in the driver's as much as Williams is. The deal was incredibly accretive, which means that the stock's rally turned out to be justified in despite what had looked like an overpayment. Williams can drop down pipelines into instantly wealth-creating master limited partnerships.

It's hard to imagine this stock getting hammered from the current level, unless oil prices break down hard and natural gas goes back to $3 per MMBtu from above $4 now. I don't think that will happen.

Second is Newfield Exploration (NFX). This long-out-of-favor oil-and-gas play has been shrinking itself and becoming much more liquids-oriented. What many don't realize is that these oil-and-gas companies are actual growth names, with increases that far outstrip all but the highest-growth tech stocks. Newfield has 28% production growth. It also has assets in the just-now-being-rediscovered Woodford and SCOOP Oklahoma shales. I think this one has got further to run, and it has to be added to the list of fast growers along with EOG (EOG), Pioneer Natural Resources (PXD), Noble (NBL) and Anadarko (APC).

Third is Micron (MU). What can I say about a stock that has quintupled in 18 months? How about this? This stock can keep going higher as long as no new capacity is added to dynamic random-access memory (DRAM) -- and it looks like this won't happen. I think Micron can earn $5 per share next year, and while the stock is never going to get a premium multiple, it is difficult to figure out why shares should stay down at current levels, especially because so many wise guys are betting against it.

Why are they doing that? Well, historically, there have been 10 or so producers of DRAM, but many have fallen by the wayside, and not that long ago Micron bought a failed conglomerate of Japanese producers called Elpida -- and it's been nothing but net ever since, as there's now a slap-happy oligopoly with Korean manufacturers Hynix and Samsung. The other part of Micron's business, flash, remains in tight supply as well, as the producers haven't seen fit to add capacity here either.

Now, we know that, for the first time in ages, demand has picked up for personal computers. Typically, then, one of the players in this universe should blink. But when you have so few players you tend to get a lot of forbearance, as there is enough market share for all to go around. The pie is growing anyway, so no one needs to take any more or to truly try capturing more volume by taking it from others.

Fourth, not surprisingly, is Allergan (AGN). This company has been in play ever since Valeant (VRX) decided that Allergan's franchise dovetailed nicely with its ophthalmological unit, and that Allergan's gigantic mid-teens commitment to research and development could be radically scaled back to bring far more money to the bottom line. Now, we don't know what's going to happen here, as Allergan is fighting it tooth and nail. Also, Valeant -- which is being aided by Bill Ackman, the man who would destroy Herbalife (HLF) to save its employees from exploitation -- could raise its bid again.

Valeant needs acquisitions to keep going. Allergan just wants to be left alone to be the largest pharma company with good growth. That's a very reasonable aim, but it's irrelevant at this point. I am not an arbitrageur, but Allergan stock is probably 30 points too high without this deal.

Another takeover name comes in fifth: Pepco (POM), which is getting a bid from Exelon (EXC) and is an acquisitive utility but not all that well-run. We have way too many utilities in this country, and periodically we hear that there is going to be consolidation. But the only real consolidator is Exelon, so I wouldn't count on a wave of these kinds of deals. At the same time, I am a huge believer that we are in a wave of mergers and acquisitions that will be the biggest in history, so nothing can be ruled out.

The sixth stock is one that is also emblematic of this moment: Vertex Pharmaceuticals (VRTX), a company with a meaningful advance in curing cystic fibrosis. We often forget why we take biotech pain like what we experienced on Tuesday. It's because of companies such as Vertex that are working on breakthrough medicines. When they do make breakthroughs, their stocks go from $60 to $90 -- with no speed limit.

For instance, Gilead (GILD) has a terrific hepatitis C pill that it purchased from a company with no revenue, Pharmassett (VRUS), at a gigantic premium to where it had been. Then there's Idenix (IDIX), whose shares tripled when Merck (MRK) bought it for its hep C formulation. Owning a biotech, you recognize, can be an amazing speculation holding.

Seven is another oil-and-gas story, this time Anadarko Petroleum. This stock ran up from $86 to $107 when it paid a settlement in a lawsuit that had previously kept its stock from appreciating with the rest of the group, even despite the company's superior production growth. Many spectators thought Anadarko might owe the government as much as $10 billion for the environmental liabilities of its former Kerr-McGee subsidiary. When it paid a little more than $5 billion, much less than people feared, what buyers found was perhaps the oil company most vulnerable to a takeover by one of the majors. It still is, even after the magnificent run. 

Eighth: Old tech has had quite a run -- and, just like Micron, which makes flash memory as well as DRAM, SanDisk (SNDK) has benefited from the tightness in the flash market. I don't see any new foundries on the horizon that will impact the supply and demand. This stock is no bargain, as it sells at 16x next year's earnings, but it will most likely exceed those expectations and vastly exceed them if the pick-up in device hardware proves to be a reality.

The ninth is a played-out odyssey: Iron Mountain's (IRM) status change to real estate investment trust. Many bears thought the record-keeping company would not be able to change into REIT status and pass on juicy rents to shareholders. They were wrong, and Iron Mountain enjoyed a nice short-squeeze-enabled rally. It's a sale.

Finally, there's one I like very much: Molson Coors (TAP). Here's a stock in a growing industry -- beer sales were up more than 3% this quarter, whereas carbonated sodas were down about the same amount, according to Alcoa's (AA) numbers last night. Consolidation in this group, moreover, is ongoing and positive. Anheuser Busch Inbev (BUD) has made no secret that it covets SABMiller, and if that happens the U.S. Justice Department will most likely order it spin off Miller to -- you guessed it -- Molson Coors.

The next thing you know, you'll have the son of Constellation Brands (STZ), a stock that's up more than fourfold when it got the rights to sell Corona and Modelo in the U.S. for a song because of antitrust concerns involving Inbev's purchase of Budweiser. Molson Coors is a buy on its own, but this divestiture win would move its stock quickly to $100.

So, if the market continues heading down, recall what worked last quarter -- not just the stocks, but the themes as well, such as oil-and-gas pipelines and production, mergers and acquisitions, new drugs and old tech. Those are all very much in play, and the weakness allows you to get in these themes for prices you would have killed for just 10 days ago.

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