After the first down year for U.S. stocks in a decade—and a quick snapback so far in 2019—it’s a good time for investors to re-evaluate which kinds of stocks they want in their portfolios. One good bet: companies with low debt.
Companies that haven’t borrowed too much are perfectly positioned for an environment of slowing economic growth and elevated macro risks. Low or—better yet—zero debt brings financial flexibility and fewer worries about the ability to pay it off if the business hits a rough patch.
Stocks of firms with low debt have outperformed those with higher debt by about one percentage point a year for the past 25 years, according to Barron’s calculations. Low debt companies are also less volatile than the overall market, on average. Over the past few years, though, investors have been rewarding financial aggression more than financial discipline. Companies with more debt have outperformed their more conservative peers by about 10% since the middle of 2015.
In a more uncertain environment, stability might return to favor. And thanks to the Federal Reserve’s interest-rate increases, cash actually earns a return. “Balance sheets will matter more,” says Tony Scherrer, director of research at Smead Capital Management.
We screened for companies that have attractive valuations and strong returns on assets. Here are four that fit the theme, and also have more cash than debt.
Semiconductor stocks had a tough 2018 after a couple of good years—and KLA-Tencor (KLAC) wasn’t immune. Its stock dropped 15% in 2018, nearly twice the 8% decline of the Philadelphia Stock Exchange Semiconductor Index (.SOXX).
This is shaping up as another challenging year for semiconductors. Several end markets, including the automotive industry and data centers, are slowing, says KeyBanc Capital Markets semiconductor analyst Weston Twigg, while the U.S.-China trade dispute is having an impact on demand. China accounts for about 60% of global semiconductor consumption.
On the plus side, KLA-Tencor’s return on assets has improved by five percentage points over the past five years, while its operating margins have increased to 39% from 22% over that span. KLA-Tencor has also been buying back its stock, and shares outstanding have declined by 8%. KLA-Tencor agreed to buy Orbotech (ORBK), which makes optical inspection equipment, in 2018. That deal hasn’t closed, but management believes that it will boost earnings per share in 2019.
KLA-Tencor shares, recently around $98, trade for 11 times estimated earnings for the fiscal year ending in June, near the bottom of its five-year range. Twigg has an Overweight rating on the stock and a $133 price target.
The proposed purchase of Celgene (CELG) by Bristol-Myers Squibb (BMY) has put big biotech firms back in focus. Gilead Sciences (GILD) is a biotech with new management that “needs to do something with their cash,” Smead’s Scherrer says. He sees Gilead as a victim of its own success: “They heal people, but can they do it again?” He’s referring to the company’s lucrative hepatitis C franchise, where the company is facing increased competition.
Gilead purchased Pharmasset, the drugmaker that was developing HIV, hepatitis B and hepatitis C therapeutics, in 2012 for $11 billion. That’s roughly the amount of free cash flow that Gilead is expected to generate in 2019, according to Wall Street estimates. The stock, at about $68, trades for less than 10 times 2019 estimated earnings and yields 3.4%. Shares outstanding have fallen by 10% over the past three years as management has spent over $20 billion on buybacks.
The risk of stagnant sales and competition as products come off patent seems more than adequately reflected in the stock, and the company says it is taking steps to boost its pipeline.
Automotive stocks are in a bear market due to fears about slowing Chinese demand and flattening sales of U.S. light vehicles. Yet those worries won’t stifle demand for products that enable car connectivity and active safety, technologies that allow auto makers to produce vehicles that are truly autonomous.
Gentex (GNTX) recently announced a number of new products, including dimmable glass and biometric authentication, which can identify the driver with a scan of the iris and then start the car and adjust mirrors and seats. Such products have enabled the company to increase sales by 9% a year for the past five years. “We continue to like the Gentex story and believe the company has significant innovation in the pipeline to support future revenue growth,” writes Baird analyst David Leiker.
Gentex, at about $23, trades for 13 times 2019 estimated earnings. It also has about $1.30 in net cash per share. With a market value of under $6 billion, Gentex could be a takeover candidate for a larger automotive supplier looking to expand its high-tech parts franchise.
Like KLA-Tencor, Teradyne (TER) makes semiconductor test equipment and also has faced concerns about the semiconductor cycle. But Teradyne has a fast-growing robotics business, as well, which it purchased in 2015.
Teradyne’s Universal Robots division makes cobots—collaborative robots—that work alongside humans to make manufacturing more efficient. That unit’s sales grew by 28% in the fourth quarter. KeyBanc’s Twigg think that cobots could be a $1 billion product for the company by 2021. Teradyne is expected to generate $2.1 billion in revenue in 2019.
With net cash and the stock trading around $36, or 16 times 2019 estimated earnings, Teradyne is a way to play robotic automation without paying a premium.
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