Blue Chips are Back

01/26/2007 12:00 am EST

Focus:

Richard Moroney

Editor, Dow Theory Forecasts

Veteran investor Richard Moroney finds new value in old stalwarts. Here he lists his reasons for taking a new look at two companies whose shares have recently suffered pullbacks, paving the way for future gains...

"Although hardware-store sales have been under pressure, home-improvement retailer Home Depot (HD NYSE) capitalized on robust demand for consumer electronics this holiday season by aggressively marketing plasma and flat-screen TVs. A slowdown in the $200 billion home improvement market resulted in a 5.1% decline in same-store sales in the October quarter. But, over the next 12 months, Home Depot should begin to reap the benefits of its fast-growing retail home services and wholesale-supply businesses, accelerating store-reinvestment programs, and international expansion. Retail home services revenues grew 11.3% during the October quarter, and wholesale-supply revenues rose 159%. The $410 billion market for wholesale supplies is twice as large as Home Depot's traditional market. Strength in new businesses helped Home Depot generate 11.3% sales growth in the October quarter.

"Home Depot is the market leader in the US, Canada, and Mexico with about 2,100 locations worldwide, roughly 55% more than rival Lowe's. Home Depot recently accelerated its international expansion by acquiring one of China's leading home-improvement retailers. The worldwide home-improvement market is estimated at $250 billion, and China's market has been growing 20% annually.

"For the year ending January 31, Home Depot forecasts 12% sales growth and 4% to 5% per-share earnings growth. The stock has benefited from the recent departure of controversial CEO Bob Nardelli, as some on Wall Street expect Home Depot's new management to make restructuring moves. Even without a restructuring, Home Depot shares appear cheap at only 14x trailing earnings. Home Depot remains a buy and a long-term buy.

"Merrill Lynch (MER NYSE) enjoys competitive advantages as the world's largest retail brokerage, and efforts to expand beyond the core brokerage business are also paying off. All major divisions have been delivering solid results, particularly investment banking. Merrill Lynch underwriters experienced a record year in 2006, helped by healthy stock-market conditions and merger-and-acquisition activity, trends that should continue in 2007.

"Merrill Lynch is improving its bonus program for its financial advisers, allowing them to receive as much as 30% of the revenue they generate. Many firms, including Merrill, are moving away from transaction-based commissions and rewarding brokers for bringing in revenue regardless of the source in an effort to grow steadier fee-based businesses. Consensus estimates project per-share-profit growth of 24% in 2007, while the sustainable growth rate is 15%. Merrill Lynch is a focus list buy and a long-term buy."

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