Stocks for Bears

It’s a scary and volatile world at the moment:  floods, cyclones, earthquakes, tsunamis, US housing crashes, Aussie housing bubbles, the GFC, QEII, PIIGS, Japanese debt, revolution in the Middle East and Charlie Sheen.  As the Chinese curse goes, we are living in interesting times.

So what’s a bear to do?  I’ve never been the “head for the hills” type.  Gold, silver and lead (preferably small calibre) may be great when the proverbial really hits the fan, but I am not expert enough to differentiate between it hitting the fan and the planet just having a bad month.  Besides, I prefer my investments to generate returns. My business partner The Prince considers gold a “security asset”, which is a fancy term for insurance, not investment.  Unless gold ingots suddenly become intelligent and start making Ipods or a better drink than Coca Cola, they’ll remain exactly that.  Making money from them assumes some other sucker trader investor will pay more for them than you did.

So for a simple, returns-loving bear like me the only other options are deposits, bonds and equities.  The first one is a given; cash is king when things look pear-shaped and no bear would be caught without it.  In fact I’ve got a hefty chunk of my assets in the paper stuff.  Bonds are great too, but pretty hard to get a hold of in Australia unless you are a wholesale investor or want to pay a huge spread when purchasing government bonds.

The last choice – equities – will cause the bear the most consternation.  What companies do you invest in during dangerous times?

Safety First

The obvious thing to look for is safety – i.e. companies that will continue to generate after-tax profits even during down times.  Even better are those companies whose products may actually have higher demand during a recession.  Straight away we can forget very small caps and most mining stocks.  Discretionary spending stocks like Myer (MYR) are also out the window – one doesn’t need a Gucci handbag to line up at Centrelink.  Add to this list anything that is leveraged to the business cycle (Autos, Real Estate, Software, Technology, Banks) and we suddenly have very few industries to pick from. 

Let’s look at some of those left standing.

Utilities

Unless you really hit the skids, you’ll still be using power during a downturn.  Power providers should be a low-risk, low yield option for share investment. Alas, building power stations requires a lot of capital which is more often than not sourced via debt (or capital raisings). 

Power generation is also at the whim of government regulators as well as the massive vagaries of a future carbon tax scheme, so even the power on-sellers can get shafted.  In any event, listed Australian companies that produce or sell power (e.g. Origin, Alinta) are generally poor investments with low Returns on Equity (ROE) and high debt.  Origin just proved the point by announcing a capital raising to help pay down debt.  You can get better returns on high yielding term deposits at almost zero risk.

Healthcare

Healthcare should be a winner at all times – no one wants to stay sick and our demographics mean healthcare services and products will be a growth industry for several decades.  However, I am yet to come across an Australian healthcare company that doesn’t have terrible ROE, massive debt or is burdened by government regulation (think nursing homes).  Cochlear is the one excellent exception to this rule, but it does have some FX risk given more than half of its income is foreign.  On the whole, health care will be unhealthy for the bears portfolio.

The Vice Squad – Alcohol, Tobacco, Guns, Gambling

The industry bad boys of gambling, defense, tobacco and alcohol are also popular at any stage of the business cycle.  However, Australia has no massive defence industry like the US, so exposure to recession-proof armaments companies is almost impossible.  Ditto for tobacco.  We have a few gambling-oriented companies (Tatts and Tabcorp) but they have very high debt and are at the mercy of government licensing.  So basically, vice doesn’t pay too well in Australia.

Food Staples

Gotta eat, right?  No matter what happens to the market we all buy milk, bread and vegies.  And more often than not it’ll come from one of the two behemoths Coles and Woolworths.  Coles is part of the mining/insurance/food conglomerate Wesfarmers, which is exposed to a multitude of risks (and poor business management), so bears should stay away. 

Woolworths (WOW) has a very high and consistent ROE, manageable debt levels and experienced management.  Despite recent pressure from Coles, it is still the dominant player and is an excellent company to own even at its current price.  WOW is definitely a stock for the bear stocking.

Discount Merchandise

During a recession, what little discretionary spending that survives will be further down the value chain.  Australia’s economy is built upon a profligate, debt-riddled consumer that will be out of pocket in a recession.

“Two dollar” shops may actually do better than during good times – perfection for the bear equities investor.  In Australia, the stand out discount seller is The Reject Shop (TRS) with very high ROE, very low debt and a great business model.  With a recent correction due to the Queensland floods, TRS is looking good even at today’s price.  Even if it doesn’t drop even further, it’s a definite buy for the equity bear.

The Debt Industry

The last and best industry during a recession is that which profits from bad debt.   Whilst there aren’t too many listed loan sharks, Cash Converters (CCV) comes close.  It has good ROE, negligible debt and experience in charging usurious interest rates on pay day loans.  They won’t break thumbs, but they should do well during tough times.

Another debt-based company for the bears is Fox Symes and Associates (FSA).  They specialise in debt restructuring agreements and hold 51% of the Debt Agreement market.  When debt problems go up, their debt services revenue increases.  Nice.

FSA have forayed into low-doc (but very low LVR) loans recently, which will be a cause for concern during a downturn, but the majority of their revenue is still from debt services.  FSA’s ROE is high (although volatile), debt is manageable and their market share is impressive.  Given that they are trading at the same value as their equity per share, FSA is a steal right now.

 

Summary

So, if you are a bear that still can’t shake the equities habit then I’d suggest WOW, TRS, CCV or FSA.  They provide either non-discretionary/ low-cost goods or counter-cyclical services.  All things being equal they’ll do better during a recession, or at least not be killed as much as other equities. Remember, price volatility is not risk, it is opportunity to buy at lower prices and sell at higher prices. There will be plenty of opportunities going ahead.

If anyone has any other favourite bear stocks (I hate the term “defensive”), shout them out – I’d love to hear some differing opinions.

Disclaimer: Empire Investing and this blogger have positions in some of the companies mentioned above, and may consider future positions (both long and short). This post is general information only and is not a recommendation to invest.

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Comments

  1. Have a look at Cellestis (CST). They have developed a blood test for the detection of tuberculosis which is about to become the new ‘gold’ standard for the detection of tb, replacing the 100 year old mantoux skin test. Sales and profits are increasing at a solid pace. There is no debt, about $20 million cash in the bank and they pay a dividend.
    Currently there are over 50 million skin tests performed each year in the western world. When living standards fall, as they have done in the US and now Japan, Tb becomes a real problem. Anyway, check it out.

    • A came across CST myself a few weeks back Michael and was thoroughly impressed. Good figures, a product that improves on the 100 year-old TB test and increasing acceptance around the world.

      They’re still subject to the same FX risk as COH (maybe even more – can’t recall the segment split) so not a bear stock in my books. But I’d still want to own them at the right price.

  2. Thanks for the article.

    Some thoughts:

    a) what about engineering stocks? anything there for the “safe” basket, or too business-cycle dependent? what about companies that have heavy exposure to maintenance contracts (you gotta keep it all going….)

    b) oil (and similar) stocks? (or does that fall under “utilities”?)

    c) what about non-consumer technology, research, engineering type stocks? how do they tend to fare (by this I mean those stocks that are not necessarily about directly serving consumers, but perhaps are more focused on serving industry itself

    d) what about sale platform companies that receive increased sale in distressed times? For example, I would expect that carsales.com.au and realestate.com.au are doing quite well out of these times, with increased distressed listings….

    Just some thoughts.

    Cheers,
    Stewart

    • Hey Burb

      We think Monodelphuous is one of the better engineering stocks, but they’re all tied to the business cycle unless they do defence contracts (and then their revenue is dependant upon politicians – no thanks).

      In theory the maintenance specialist should do well but I don’t know of too many maintenance-only outifts. The likes of United Group all have heavy manufacturing and construction revenue streams in addition to their maintenance crews.

      Oil stocks would be killed as commodities dropped.

      You make a valid point about carsales and the like – there would probably be a surge of distressed buying in the early stages of a recession. However, customers would soon drop away and car dealerships would go bust, impacting their revenue. However the brand-name websites (Wotif, carsale etc)will bounce back quickly once the recovery starts due to their scalability and low capital requirements. I’d definitely buy them when there’s blood on the trading floor.

  3. Good post Q, keep ’em up!

    To the sleuth of bears out there I suggest Pacific Brands Group. Owner of such brands as Bonds, Rio, Holeproof, Jockey, Berlei, Yakka, Sheridan, Dunlop shoes and a few other names. Sure, they do fall under the consumer discretionary umbrella, but exactly how discretionary are undies and socks? As long as fathers/grandfathers have birthdays and Christmases, there will be a market for undies and socks.

    On the face of it, this looks like a bit of a dud stock – low/negative reported earnings, low price to book, bit of debt, stock has gone sideways (or worse) all year – job done. Take a bit of a deeper look and there might just be a few decent puffs left in this cigar butt than the market thinks.

    The market doesn’t like large negative reported earnings, even if they are largely due to non-cash charges. Take a look above the bottom line and you’ll find some decent profit margins and strong cash flows. My pencilings could be wrong, but I see a free cashflow yield in excess of 15% at these prices.

    Aside from reported earnings being low, ROE is hampered by the weight of intangibles sitting on the balance sheet, much of this is goodwill – a legacy of private equity ownership saw a tendancy to expand by debt-fuelled buying. If you strip out the goodwill then ROE is closer to the range of 15-20% (on normalised earnings). In anycase, the market is valuing goodwill as less than zero.

    Gearing has been excessive in the past but is dropping to more tolerable levels. Given the large cash flows and management’s recent tendancies to pay down debt, this should improve with time.

    The one big-ish macro threat to PBG at this point is the rise in cotton prices over the last year. If you believe the global growth story, then this will continue, which could seriously crunch margins and become a big cost for PBG in the future. On the other hand if you suspect good-old speculation is playing a role in the market, the recovery is not sustainable, or that supply will soon recover, then the threat of cotton prices are more likely a short term obstacle.

    Other bear-ish ticks include reinstatement of dividends and big-ish market cap.

    Disclosure – no position, but thinking about it.

    • Nice monster post Lighter – agree with all the points you’ve made. PBGs ROE is the biggest issue. They have some good branded products – I swear by the ol’ bonds undies – they’ve just been lacking good management.

      We’ll be looking for higher ROE and some benefits to flow from the overseas manufacturing move before promoting them to the Index.

      • I tend to agree, the Boss-Lady has brought alot of the change but we don’t really know what she’ll do once the change is all brought.
        I also have some doubts about the clumsy long and short term renumeration incentives. More could be achieved by just making em all own shares.

    • Looks like another exception to my healthcare rule. BKL has great ROE, low debt and a great brand name. It also has expanding revenue coming in from Asian operations. Combined with an ageing population and the popularity of vitamins, we consider BKL a Very Good company. A little pricey now, but I’d definitely snap them up if they dropped a few bucks.

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