Deals aren't dead. Here are 12 stocks that could become buyout targets

  • By Al Root,
  • Barron's
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Deals aren’t dead. Uber Technologies’ (UBER) interest in Grubhub (GRUB) illustrates that, even in the worst of times, management teams will look to the future, trying to buy strategic assets. Picking the companies that might get bought is hard to do, but a few merger-and-acquisition screens are time-tested.

Barron's has identified a dozen stocks to sift through for investors looking at add catalyst-driven ideas to their portfolios.

Year to date, more than 100 deals have been announced or completed. That prorates to about 278 for all of 2020. Not bad considering the damage Covid-19 has wrought on the economy.

When times get tough, businesses often hunker down and build cash. But there are also deals to be had, and that drives some to be bold and start buying.

The average large deal over the past few years has been about $4 billion. Companies worth less than that are a good place to start.

Hot seat

Another place to start is in companies whose stocks have underperformed the broader market and have a long-tenured CEO. It is the proverbial hot seat. Weaker-than-average performance, of course, isn’t always the fault of management, but it is like wounded prey in the jungle that is the stock market.

Steel Dynamics shares (STLD) are down about 10% a year on average over the past three years. The S&P 500 (.SPX) has returned about 8% a year on average over the same span. The Dow Jones Industrial Average (.DJI) has returned about 6%.

Steel Dynamics’ returns are actually better than its peers. Steel has been a tough industry for a while. A merger with, say, Nucor (NUE) would consolidate the industry and allay some fears over growing industry capacity.

L Brands (LB) might look to do something after Sycamore walked away from its plan to purchase Victoria’s Secret. The stock is down 39% year to date and discretionary retailers may have to combine and cut costs to survive in a post-Covid world.

Moog (MOG/A) is an aerospace and defense player. The aerospace industry has been decimated by Covid-19. Demand for new jets isn’t expected to recover for years. When revenue falls, companies will look to increase earnings by cutting costs. Deal synergies can help accomplish that goal.

Yelp (YELP) is in the same industry space as Grubhub and its shares have lost investors about 9% a year on average over the past thee years. In light of the UBER deal, Yelp could now be more-attractive to buyers.

Secular growth

Wolfe Research portfolio strategist Chris Senyek runs a variety of M&A screens, including companies that are growing in growing industries. Growth is an attractive characteristic for any acquirer. M&A doesn’t always have to be predicated on beaten-up stocks.

A lot of the names on his list are in social media, technology and software. That isn’t a surprise. That is where a lot of the growth is. Four that caught our eye are Etsy (ETSY), Splunk (SPLK), Pure Storage (PSTG) and II-VI (IIVI).

All four are loved by Wall Street, relatively speaking, with much higher than average buy-rating ratios. About 55% of analysts rates shares in the Dow Buy.

Unloved in good industries

Another screen Senyek runs is unloved stocks in consolidated industries. Industry consolidation can lead to higher pricing, and better profits, assuming regulators approve deals.

Four names on this list include: Corteva (CTVA), Reliance Steel & Aluminum (RS), Flowserve (FLS) and Woodward (WWD).

Corteva caught Barron’s eye because we have written positively about the agricultural seed and chemical company. Flowseve is similar and one of the beaten-up oily industrials we highlighted as oil prices plunged. Benchmark crude prices are off about 60% year to date.

Reliance is a steel-service center and falls into the Steel Dynamic category.

Finally, Woodward was doing a deal with Hexcel (HXL) that was called off after the commercial-aerospace downturn arrived in 2020. Management might be amenable to other deals in the near future.

Picking winners and losers requires maintaining a delicate balance. It takes two to tango. On a basic level, stocks can’t be so beaten up that management isn’t willing to sell. And they can’t be so expensive that no one wants to touch them.

It is hard to know whether this list will prove prescient over the next 12 months. At least each stock has some other catalyst, such as growth or low valuation, to fall back on.

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