2 Sectors Looking Better Than You Think

04/25/2012 6:30 am EST


Equity analyst Brian Sozzi tells MoneyShow.com why he likes potential in financials and industrials, and issues some cautionary notes about the retail sector. He tells Kate Stalter about plenty of stocks in which he sees strength.

Kate Stalter: Today, our Daily Guru guest is Brian Sozzi; he’s the chief equity analyst for NBG.

Now, Brian, I know that you’ve spent a large chunk of your career as a retail analyst, and that’s still an area that you follow. Consumer discretionary in the first quarter was one of the leading sectors. Tell us what you’re seeing in that area right now.

Brian Sozzi: Well, right now, Kate, it’s a price-competitive market, but within the first quarter you’re seeing a lot of upside to the numbers that many companies put out there on the first-quarter earnings conference calls. The consumers have shown a willingness to buy full-priced items, whether it’s at Home Depot (HD) or Lowe’s (LOW) or even at an Abercrombie (ANF) or at an American Eagle (AEO).

And part of that is weather, sure, but I also think part of it was an early Easter shift. So the consumer’s more engaged in the mall, they’re more engaged online, whether it’s a Wal-Mart (WMT) or even a Target (TGT), for example, and that is good. That’s a good sign.

Where I’m coming in and asking questions is: Is this sustainable going into the summer, with gas prices, in that you’re only one hurricane away from going over $5 a gallon?

And I think that the market might be a little bit too complacent in terms of valuing these stocks, valuing these consumer discretionary stocks in terms of, if gas does continue to rise, how does that impact earnings? How does that impact sales? We haven’t seen it. I’m thinking that we could see it in the summer.

Kate Stalter: And you mentioned in passing there, some of the online retailers that have done well. Would the same thing apply to them? I imagine it would, if you did see gas prices going higher. People wouldn’t have as much money to spend on Amazon (AMZN), for example.

Brian Sozzi: Correct. There are parts of Amazon today that are not working as well as you would think, and one part is the video games. Sure, you’re downloading content directly from the consoles, from Electronic Arts (EA) and Activision (ATVI), but it’s a price competitive category, and you don’t necessarily need that video game post-holidays, so the consumers are making tough decisions.

But it’s not to the extent that many thought coming into the first quarter. I wouldn’t say that’s necessarily a good, positive sign as we go up into the back half of the year, but things could have been worse, I think. But again, that’s not a reason to necessarily get encouraged in the retail sector.

Kate Stalter: Let’s talk about some other sectors where you’re seeing either strength or weakness at this time. How about the financials? That’s a sector, obviously, that gets a lot of attention as people look to that as some kind of bellwether for the general market. What are you seeing there?

Brian Sozzi: Currently, I’ve been supportive of how the financials stocks have acted on earnings day. You have JPMorgan (JPM), you have th Wells Fargo (WFC); you have even something like a Capital One (COF). These companies come out reporting some good earnings; they suggested that their dividend payouts are going to increase in coming quarters.

Loan growth is there. Commercial-industrial growth has been there. Earnings beats have been there. It just hasn’t been rewarded, I think, in the valuations.

But the financial story has been vastly improved than we’ve seen over the past couple quarters. So whether that continues is anybody’s guess. But if you look around; let’s say the Stanley Black & Decker (SWK), for example, their industrial sector was quite strong. So there’s lots of tie-ins to the improved results that the financials are reporting.

Kate Stalter: Well, you just mentioned the industrial sector, let’s segue into that. What about that one?

Brian Sozzi: The industrials have been OK. You see a Stanley Black & Decker, you see a Snap-On (SNA) so far, you see something like Eaton (ETN), General Electric (GE). The numbers have been pretty good, and they’ve been pretty good globally, specifically within Asia-Pacific.

Now, where I’m seeing some of the risk so far is in Europe. There seems to be a language change. I guess this might not be any big surprise, but there’s a language change.

There was maybe solid growth or not worsening growth in the fourth quarter last year from any industrial company. Now we’re seeing more, I just think more of a negative tone in terms of the peripheral countries, and more of, let’s say, Germany and the France coming into the second quarter. So I think you’ll start to maybe see that with some of the reiterated guidance ranges with some of the industrial companies as well.

Kate Stalter: Speaking of guidance, we are speaking right now in the middle of earnings season. We’re talking the day ahead of Apple’s (AAPL) report, and this will run after Apple has reported. Of course, that’s the big announcement that’s eagerly awaited this particular week. But just generally speaking, not just limited to Apple, what are you seeing right now in terms of earnings season?

Brian Sozzi: The numbers are not getting the respect in terms of the beat, in terms of the guidance. The guidance is either in line or maybe upwardly revised to account for the first-quarter upside. You’re not seeing that much stock movement.

I think Bespoke put out a great number that if you beat on earnings, your stock was up a little under 2%. That doesn’t excite me.

I think when you’re looking at the numbers that General Electric put up, there should be a little bit more excitement. But the fact there’s not is, for me, a negative tell on the market, and a reason to maybe be a little more cautious as we go into the second quarter.

Kate Stalter: Why do you think investors are kind of holding back on rewarding companies for better-than-expected reports? Is it just worries about Europe? And then what else may be ahead?

Brian Sozzi: I think two things. I think it’s sustainability of the earnings they saw in the first quarter, Kate. I just don’t think they believe that 20%-plus growth is sustainable.

No. 2, there would be even uncertainty how order trends pan out in the second quarter. For example, I’ll go back to Stanley Black & Decker. They said their sales were up 20% to 25% in the home centers, but they’re not experiencing new orders.

So the likes of Home Depot and Lowe’s are afraid to order new goods because they don’t know if the weather put all those sales in the first quarter and their sales might not be great in the second quarter.

No. 3, earnings quality. I know we’re getting some strong beats on the bottom line, but if you look at the quality, companies have come out and have repurchased their shares in the first quarter. So I don’t think the profit margins have been as strong as the numbers would imply going off the table.

Kate Stalter: A lot of our listeners are either in retirement or saving for retirement, trying to manage their investments with that in mind. What would you say to them, Brian, as they’re attempting to navigate earnings season? What should they be keeping in mind?

Brian Sozzi: I think if you’re not trading the market day-to-day, I think you have to trade around core positions, or you just have to have a continued strong outlook on the future regarding the positions that you have.

Earnings season is very volatile, and if you’re not watching, you’re seeing a General Electric come out and beat on earnings and the stock is not up much, and you’re seeing a JPMorgan come out and beat on earnings, and its stock pulls back on earnings there.

So there’s lots of mixed signals. But I think you have to look for companies with strong investment thesis, like in Apple. Even though there’s a lot of negativity out there right now, it’s still one of the best companies to own in my opinion.

You can look for certain growth stories that are underappreciated; something might be along those lines like a VF Corp. (VFC) in retail—they own 100 strong brands—or even a Dick’s Sporting Goods (DKS). Good strong companies that are paying dividends that make sense, I think, is where you want to look at right now.

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