What to Do Before the Debt Bubble Bursts

06/13/2007 12:00 am EST

Focus:

George Putnam

Editor, The Turnaround Letter

George Putnam III, editor of the Turnaround Letter, says the current debt bubble will burst some day, and he mentions stocks and sectors that may outperform when that happens.

There is a huge wave of debt out there, and it is getting bigger every day. High-yield bond issuance set a record last year. And the pace of new high-yield issues this year is running well ahead of last year. Bank loans are at record levels as well, and the covenants (which protect the lenders) are getting weaker and weaker. All the while, default rates are at historically low levels.

If history is any guide (and it usually is), this wave of debt will break and turn into a wave of bankruptcies and defaults, which could wreak havoc on both the debt and equity markets. We looked back to 1990 and 2000-2002 to see if there were any safe havens for equity investors. The following groups fared relatively well for at least part of each debt-induced bear market: household products, medical supplies, containers, and packaging and health care providers.

The [following] stocks represent interesting investment opportunities for those, like us, who are concerned that we may be facing a sharp upturn in defaults and bankruptcies in the not-too-distant future.

Blyth (NYSE: BTH) successfully marketed its candles and other household items by leveraging off of Tupperware’s direct marketing model. But a string of questionable acquisitions drew management attention away from key marketing and packaging issues. Now management has begun turnaround initiatives, including divestitures. Fortunately, the candle business has historically been a cash generator, and the firm’s catalog, Internet, and European segments are doing well. (The stock closed above $26.50 Tuesday—Editor.)

Black & Decker (NYSE: BDK), while perhaps known best for its power tools, has a wide range of branded products that it sells in more than 100 countries. Recent results have suffered because of the weak US housing market and rising materials costs. Management is restructuring operations to improve productivity, and it’s been using the company’s strong cash flow to buy back shares. The stock, though near the top of a three year trading range, trades at modest valuation levels. (It closed at around $88.50 Tuesday—Editor.)

Newell Rubbermaid (NYSE: NWL) has a stable of well-known household brand names such as Paper Mate, Rolodex, Irwin, Lenox, Graco, and, of course, Rubbermaid. Following a spate of acquisitions, management has spent the last few years consolidating and rebuilding its brands. Higher raw materials costs and ongoing restructuring charges will continue to crimp profitability, but management appears to be positioning the company for sustainable growth. (The stock closed at $29.31 Tuesday—Editor.)

US Physical Therapy (NASDAQ: USPH) operates nearly 300 outpatient physical and occupational therapy clinics. Though the long-term fundamentals of its business are favorable, Medicare reimbursement issues, therapist shortages and doctor-owned hospitals that compete for referrals worked against the company in 2006. Nevertheless, the company was able to sustain profitability and maintain a strong balance sheet. Management’s efforts at improving productivity, reducing overhead and closing underperforming centers should help operations in coming quarters. (It closed at $13.70 Tuesday—Editor.)

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