2 Stocks Set for a Comeback

08/16/2011 8:30 am EST

Focus: STOCKS

Taesik Yoon

Editor, Forbes Investor and Forbes Special Situation Survey

While the first half of year punished even strong performers, the second half of the year should see quality shine through says Taesik Yoon of Forbes Growth Investor.

The good news for stocks moving forward is that fundamentals tend to win out over the long run. Sometimes it takes a little bit of time.

Remember, last year’s stock-market rally didn’t begin until late September. As such, once the issue of the debt ceiling is fully resolved, I expect stocks to begin better reflecting their fundamental values and business prospects.

The Timken Co. (TKR)
This company is a global producer of highly engineered friction management products, power transmission systems, and various grades of steel.

Its Mobile Industries segment makes bearings, transmission components, and related products for original equipment manufacturers (OEMs) and suppliers of agricultural, construction, and mining equipment, trucks and passenger cars, and trains and rail cars.

TKR’s Process Industries segment supplies similar products to OEMs and suppliers of power transmission, energy, and heavy-industry machinery and equipment. Both segments also serve the aftermarket through a global network of authorized distributors.

TKR’s Steel segment produces over 450 grades of carbon and alloy steel in various shapes, compositions, lengths, and finishes.

Boosted by recovering market conditions and higher steel prices, Q2 net sales jumped 31.5% year-over-year to $1.33 billion. Steel segment sales soared 49.2% to $473.5 million. Even excluding the $50 million in raw-material surcharges, steel sales rose 34.6% on stronger demand from customers in the oil & gas and industrial markets.

Process Industries also had an impressive showing, with sales up 45.7% to $307.5 million on higher demand from the industrial distribution market, growth in Asia, and new product launches. Mobile Industries sales grew 16.2% to $465.2 million, while Aerospace and Defense sales were up 1% to $83.5 million.

The operating margin expanded 182 basis points, to 14.34%. Net income surged 41.9% to $121.5 million, or $1.22 per share. This was 8 cents above the consensus estimate.

TKR raised full-year guidance on the strength of these results, the expectation of persistently robust market conditions in its Steel and Process Industries segments, and expected contributions from the recent acquisition of Philadelphia Gear.

It now sees sales growth of 25% to 30% versus a prior range of 20% to 25%, and expects earnings per share of $4.30 to $4.50 versus the $3.80 to $4.10 previously forecast. This implies second-half earnings growth of as much as 39%.

To support this growth, TKR is increasing its steel production capacity by 120,000 tons, and expanding three of its Process Industries plants located in India and China. Despite these investments, the company’s finances remain in excellent condition, with more cash on hand ($632.8 million) than total debt ($520.9 million).

NEXT: Stock No. 2

|pagebreak|

Towers Watson (TW)
This company is a leading provider of professional employee, risk, and financial management solutions and services designed to help improve organizational performance.

Benefits, its largest segment, offers benefits consulting and administration services. This includes designing, managing, and administering retirement plans; providing advice on the strategy, design, financing, delivery, management, and communication of health and group benefits programs; delivering cost-effective benefit outsourcing solutions; and providing expertise in dealing with international human capital management.

Through its Risk and Financial Services segment, TW offers risk consulting and related software solutions, investment consulting, and reinsurance and brokerage services.

Finally, the company’s Talent and Rewards segment provides advice on executive compensation and incentive programs, consulting services on employee rewards programs, and data, analytics, consulting, and technology solutions, including compensation benchmarking data and employee opinion surveys.

TW expects Q4 revenues to grow 5% to 9% from the prior year, to $787 million to $817 million. This was stronger than expected. However, adjusted earnings guidance of $0.99 to $1.02 per share, which implies growth of 10% to 13%, was actually a bit below the consensus estimate.

Yet we view the guidance as a reflection of management conservatism. Others seem to share our view.

Despite the lower than expected earnings guidance, TW shares surged on the report, and are up approximately 12% since. Nevertheless, the stock remains attractively priced, trading at just 13 times the current year’s (fiscal 2012) consensus earnings estimate of $4.90 per share.

We expect the top line to continue benefiting from additional growth opportunities, stemming from TW’s increased scale and scope. In particular, management sees several key cross-selling opportunities. This includes offering investment consulting products to legacy Towers Perrin retirement clients, while marketing health and group benefits consulting services to legacy Watson Wyatt retirement customers.

We also see synergies from the merger materializing at a rapid pace. As a result, we believe TW’s earnings will continue to surprise to the upside over the near term.

Subscribe to Forbes Growth Investor here…

Related Reading:

Related Articles on STOCKS