Value stocks that can survive the downturn

By Conor McCreery
Globe Investor magazine online, March 14, 2008

To borrow a phrase from baseball, the U.S. economy is putting a lot of crooked numbers on the board right now: The lowest construction spending in 15 years, the biggest slide in manufacturing in five years.

The markets are “going to be going down for 18 months,” says Clem Chambers, chief executive officer of British-based investment site ADVFN, which receives 1.3-million unique visitors a month. “Anybody who isn’t a little panicked doesn’t understand the situation.”

So where to put your money? Mr. Chambers feels you need to be broadly diversified more than ever now. Even holding cash could be painful because of the threat of stagflation. And he cautions against trying to short the market, or trying to pick the bottom on a name that has been crushed. “Do not hold speculative stocks.”

“It’s really important to focus on long-term,” agrees Larry Coats of Durham, North Carolina’s Oak Value Capital Management. “We don’t try to pick the bottom.”

Through the end of February, Oak Value has returned an average of 10.4 per cent by focusing on quality names it feels are undervalued by 30 to 35 per cent.

With all this in mind, here are a few stocks that should hold up in a recession from long-term focused investors:

Coach (COH-NYSE)
Coach has shed over 40 per cent since hitting a high in April, 2007. Best known for its high-end handbags, the company has been hurt badly as investors flee consumer discretionary items. But Mr. Coats likes Coach because of its brand appeal and its balance sheet (almost $900-million U.S. in net cash and short-term equivalents).

He also likes the brand’s versatility.

“Is Coach a luxury brand or a premium brand? They have products that range from a few bucks to $1,200.” Coats looks at the company’s forward earnings as one of the best gauges of value. Coach is trading at 13X forward earnings. – he thinks it should up in the 18 to 19 times range.

Tiffany & Co (TIF – NYSE)
Trading at a similar P/E to Coach (16.5 vs. 16.0), Tiffany is another company Mr. Coats feels is being overlooked because of its high-rent name.

“[It’s] a premium brand disguised as a retailer.”

He also likes Tiffany’s recent partnership with watchmaker Swatch.

“They can use this to better leverage that premium brand.”

The deal will see some of some of the Swiss watchmaker’s high-end products carry the Tiffany name. Oak Value has been in and out of Tiffany since 1998. With the stock down 31 per cent since last October, Oak Value has started to build up its position again. Like Coach, Mr. Coats feels Tiffany has a great brand, and he loves the similarly clean balance sheet. He pegs Tiffany as trading at 14 times forward earnings.

“The stock is easily worth 18 at least,” he says.

American Express (AXP – NYSE)
Sure, Amex is exposed to possible weakness in consumer spending, but Mr. Coats feels the stock is priced more than enough to compensate the investor for any short-term issues.

With Amex’s “closed loop” business model – it avoids partnering with merchant banks, tends to issue a minimum of credit, and is more of a transaction-processing business - Mr. Coats likes Amex’s ability to duck some of the financial meltdown. But even more, he likes how that structure lets American Express target its clients more precisely than its competitors.

Where a MasterCard or Visa customer receives a statement from a merchant banking partner, Amex holds all the information on its customers and the retailers they frequent. This gives it the edge in both contacting cardholders, and providing information to retailers.

“The best way to add value is to have more information than anyone else,” Coats says.

Cash and Gold
Mr. Chambers isn’t in love with any equity names right now. He expects the markets to undergo at least one more major decline, so he’s telling his clients to stay liquid.

“In the short-term you’ll need cash to pounce on things,” he says, and he’s betting “quite a few” quality names are going to look “very attractive” before long.

But he’s hedging his bets – if world markets continue to dribble down instead of crashing he’ll turn to gold. He still sees some upside with it.

“Could it go to $1,200 to $1,500? Easy.”

And while he isn’t terrified of stagflation, a slow decline in equity markets could create an environment where stagflation does raise its ugly head. That means cash and long-term bonds aren’t as attractive.

Advice: Go with what you know
Mr. Chambers says this is not the market to try to become an expert in something unfamiliar. Investors shouldn’t be afraid to put their money into something that is a passion, something the investor follows closely.

“If you think its gold, it isn’t,” he says. “If you know its gold, it is.”

Special to The Globe and Mail