Heavy cost cutting brightens outlook for many U.S. stocks

Forget booming markets overseas. According to some industry observers, plenty of money-making opportunities exist right here in the USA, despite the sluggish economy. Some of the more promising areas are technology stocks, health care information firms, selected consumer staples companies and retailers that appeal to cost-conscious consumers. Many of these companies offer stability, innovative new products and the ability to capitalize on weakened competitors, portfolio managers said. Furthermore, corporate America overall has been more aggressive than foreign competitors in cutting costs and finding efficiencies during the recession. “I imagine the rebound will be more pronounced here because our [economic] system is more flexible,” said Abhay Deshpande, co-manager of the First Eagle Global Fund. At many U.S. firms, “the amount of cost cutting is pretty impressive,” he added. The close attention to the bottom line, combined with some top-line growth, is leading to surprising profit numbers from U.S. firms, analysts said.
“People are not expecting much” in terms of a profit rebound, “so it will not be difficult for the ensuing environment to be better than most expect,” said Robert Sharps, the lead portfolio manager for T. Rowe Price Group Inc.'s large-cap-growth strategy. Sure enough, a number of companies have come out with surprisingly good third-quarter results. “Amazon was up 30% in one day, and Microsoft [Corp.] 8%” since coming out with third-quarter earnings that topped estimates, Mr. Deshpande said. And if the economy rebounds more strongly than expected, revenue and profits could be even more surprising. In a report in October, Bill Miller, chairman and chief investment officer of Legg Mason Capital Management Inc., said growth expectations for the U.S. economy of around 2.5% for next year are probably too low, based on historical recoveries and a current trend of upward revisions in profit and economic-growth forecasts.
Last week, the Department of Commerce announced that the U.S. economy grew at an estimated 3.5% annual rate in the third quarter, breaking a string of negative quarters since June 2008 and surpassing consensus estimates of 3.3%. While much of the recent growth was due to government stimulus programs, many companies have found ways to keep revenue growing and profits rolling, some economists said. The Coca-Cola Co., for example, cut costs and boosted the top line by spending more on marketing, said Cliff Remily, co-manager of the Thornburg Investment Income Builder Fund, a global balanced fund offered by Thornburg Investment Management Inc. Others, such as McDonald's Corp. and Sysco Corp., are digging for more operating improvements, he said. “McDonald's is rewarding individual franchisees [who] find more efficiencies and then is incorporating [those changes] throughout other franchises,” Mr. Remily said. Sysco, a food services company, changed its delivery routes to reduce gasoline consumption, he said. “They saved several basis points on margins — and that's something that's a permanent change.” Stronger competitors are benefiting from the misfortunes of others. Christian Andreach, managing director of the consumer research group at Manning & Napier Advisors Inc., looks for strong companies in an industry where there is a “well-identified market share "donor.'” He likes United Parcel Service of America Inc. and FedEx Corp., for example, because he expects that they will gain market share from the U.S. Postal Service and DHL International Ltd. Likewise, ad agency Omnicon Group Inc. grew organically through the last advertising recession in 2002, said Mr. Deshpande, who bought the stock as it sold off last year, and still likes it. “They have a tendency to gain market share when things are weak,” he said. Diamond Offshore Drilling Inc. is picking up partially finished deepwater-drilling rigs on the cheap that more leveraged competitors could not complete, Mr. Remily said. Health care companies that improve efficiencies and lower costs are also favorites with some money managers. Mr. Andreach likes health care information technology companies Eclipsys Corp. and Cerner Corp., and medical tester Quest Diagnostics Inc. “These are companies that not in the cross hairs of what's been going on in Washington” with health care reform, Mr. Andreach said. Analysts also like U.S. technology firms because they are able to create their own growth. In the telephone handset market, for example, half the profits are coming from smart phones, which are “largely a North American phenomenon,” Mr. Sharps said. Much of the intellectual property behind the products, he noted, is from Marvell Technology Group Ltd. and Qualcomm Inc. “And the iPhone is the most rapidly growing [product] because of what Apple [Inc.] has done in melding” software, hardware, music and retailing, Mr. Sharps said, noting the company is expanding in China. Manning & Napier has a big position in Google Inc., Mr. Andreach said, which hasn't been affected by the advertising recession. He said Google has an opportunity to lead the transformation to online advertising, which is still a small part of the overall ad market. On the retail front, Mr. Sharps said he sees winners among those who help consumers make their dollars go further. Among those benefiting from consumer belt-tightening are Amazon.com Inc., Wal-Mart Stores Inc., Kohl's Illinois Inc., Bed Bath and Beyond Inc., and Lowe's, the retail brand of LF LLC, Mr. Sharps said. “What they all have in common is that they're price leaders and will benefit from the fact that lot of capacity has come out of [their] industries,” he said. And “don't count out the ingenuity and innovation” of U.S. businesses in developing new markets and new technologies, Ms. Gay said. “We may see growth well in excess of expectations,” she said. E-mail Dan Jamieson at djamieson@investmentnews.com.