Two Stocks That Bucked the Trend

07/02/2008 12:00 am EST

Focus: STOCKS

Stephen Biggar

Director, Product Strategy, Argus Research Corporation

Stephen Biggar, global director of equity research for Standard & Poor’s, recommends two stocks that have held up well amid the current market turmoil.

The shares of CVS Caremark (NYSE: CVS), one of the nation’s largest drugstore chains, rose 3.2% through June 25th.

CVS reported first-quarter operating earnings of 55 cents a share compared with 43 cents in the comparable period in 2007 and [a penny] above our expectations. Results benefited from an improved product mix, well-controlled promotional spending, and increased generic drug dispensing rates, which drove expansion of retail pharmacy margins.

For 2008, we see sales increasing about 15% to $88 billion, reflecting the acquisition of Caremark Rx in March 2007 and continued improvement within recently acquired drugstores.

We believe pharmacy operations will benefit from increased sales of [more profitable] generic drugs and increased sales leverage, reflecting same-store sales growth of approximately 5.5%. Although sales growth will be [hurt] as consumers convert to lower-priced generic drugs from higher-priced branded alternatives, we believe overall results will benefit since generics carry wider margins than branded alternatives.

The company’s pharmacy benefit management (PBM) business faces difficult comparisons in the first half of 2008 given the loss of a significant client. We look for this segment to benefit from easing comparisons in the second half and anticipate significant new client wins in 2009.

We look for overall margins to expand on improved purchasing power and a more favorable pharmacy mix. As a result, we believe operating earnings per share will rise 28% to $2.48 in 2008 from $1.94 a year ago.

We believe the shares should trade at a P/E-to-growth (PEG) ratio comparable to that of the Standard & Poor’s 500. Assuming that the shares trade at one time our projected long-term growth rate of 19%, and applying that to our forward-12-months earnings estimate of $2.58, we arrive at our 12-month target price of $48. (The stock closed above $39 Tuesday—Editor.)

We expect General Dynamics (NYSE: GD), the world’s sixth-largest arms maker, to continue to perform well even after current chief executive officer Nicholas Chabraja’s planned retirement in June 2009. The shares fell 3.3% through June 25th.

In particular, we see strength in aerospace, combat systems, and marine systems driving growth. GD’s funded backlog grew 16%, year-over-year, in the first quarter, with a two-year backlog in the aerospace segment, which sells Gulfstream business jets. Although we expect a slowdown in orders of business jets, we continue to see this business driven by demand for business travel in Asia, the Middle East, and other emerging economies.

We see combat systems’ results driven by the continued need for land vehicles, and the need for replacement of such vehicles when the US pulls out from Iraq. In marine systems, we expect the Navy to continue to replace its aging fleet.

We project earnings of $5.85 a share in 2008 and $6.40 in 2009. Our 12-month target price of $102 is based on a P/E ratio of about 16x our 2009 estimate, slightly above the stock’s historical average, due to the company’s strong growth prospects. (The stock closed below $84 Tuesday—Editor.)

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