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Stock Screen: Stocks with Low Risk - October 24, 2012
Investors can usually find stocks with low risk or equities with strong expected relative price performance fairly easily. The challenge comes when you want to combine these two features, as the presence of one attribute often means that a stock lags in the other. In this screen, however, we seek to combine the best of both worlds, and search for issues that meet both of these criteria. To generate our list, we first required that all stocks be ranked 2 (Above Average), or higher, for Safety and 3 (Average), or better for Timeliness (i.e. relative price performance in the year ahead), two of Value Line’s many proprietary ranks. Then, to further reduce the relative collective risk that is usually associated with stocks that offer high returns, we limited our cut to equities with a Price Stability Index (another one of Value Line’s proprietary measures) in the upper 10% of our universe. Finally, we required that each stock pay a meaningful dividend, with a floor set at a yield of 2.1%.
Not surprisingly, equities arising from this screen are largely considered defensive in nature, and our list is dominated by established and conservatively run companies, including Aqua America (WTR) and International Flavors and Fragrances (IFF).
Aqua America is the holding company for water and wastewater utilities that serve approximately three million residents in Pennsylvania, Ohio, North Carolina, Illinois, Texas, New Jersey, and several other states. In 2011, residential customers accounted for the bulk of total revenues, at nearly 60%, followed by industrial & other (26%), and commercial (14%).
Management has been restructuring the business portfolio, which, in time, should result in operating efficiencies. To that end, Aqua America has offered to sell its Florida units to the Florida Governmental Utility Authority for $95 million. That move would narrow its list of states served to eight, with the majority of revenue generated from the Ohio, Pennsylvania, and New Jersey markets. We believe that the company’s expansion into the Texas arena, through the purchase of certain plants from American Water, will pay dividends, given favorable demographic trends and a burgeoning oil and gas industry. Acquisitions are a vital component of management’s strategy, since they are a quick way to increase the customer base in this slow-growth industry, while adding a considerable boost to the top and bottom lines.
The Marcellus shale water pipeline venture with Penn Virginia ought to bolster the company’s long-term profitability. That’s partly because we expect natural gas drilling activities in the United States to grow at a nice clip, as LNG export facilities are expected to come on line in the coming years. Construction on phase II of the joint venture is slated for completion by the end of the year, at a total cost of $20 million. Assuming this continues to go well, it appears that the project will be open for business by the end of 2014, and is expected to add $0.10 a share to both 2014 and 2015 bottom-line results. However, further declines in natural gas prices would likely dampen drilling prospects and could throw a wrench into the company’s underlying projections.
International Flavors and Fragrances
International Flavors and Fragrances is a leading manufacturer of flavor and fragrance chemicals sold to consumer products manufacturers worldwide. Particularly, these products are used in such items as perfumes, prepared foods, pharmaceuticals, beverages, and detergents. The Fragrances division accounted for about 52% of the company’s total sales in 2011, and the Flavors unit was 48%. Overseas businesses generated some 76% of sales.
The company continues to exit low-margin operations, in part, via not renewing contracts with less profitable clients. But, in our view, choosing to go after higher-margin business ought to be a more sustainable strategy for long-term success. Specifically, this should help close the gap between pricing and input-cost inflation, and eventually lead to improved gross margin performance. Nevertheless, this year’s sales growth will probably be moderate, as a result.
Meanwhile, the Fragrance Ingredients segment (a key part of the Fragrances division) underwent a strategic review by management. That’s mainly because this unit has been struggling for some time, as low-cost competitors are entering the market. Still, the company concluded that the business is of strategic importance, as it continues to be profitable and to have supply-cost advantages to other units. Consequently, there are plans to decrease operational expenses to make this segment better able to contend with other market participants.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.