This section of The Farr View describes a few stocks that we find interesting. They are not recommendations to buy or sell. We may be buying or selling in portfolios under our discretionary management. If you have questions about the appropriateness of these issues for your investment strategy, please call us.
Closing share prices are as of June 30, 2008.
Medtronic
(MDT - $51.75)
The company is a leader in a diverse group of high growth industry segments, including cardiac rhythm management, vascular, cardiac surgery, spinal, gastrointestinal, urology, diabetes, neurological, and ear, nose and throat.
Foreign sales currently account for nearly 40% of total company sales. Medtronic’s end markets should continue to grow significantly faster and in a more stable manner than the overall U.S. economy due to attractive demographic trends. Specifically, we believe that MDT has a reasonable chance of increasing EPS at a low-to-mid-teens annualized pace over the next five years. Drivers of this growth should be the recent stabilization in the implantable cardiac defibrillator market, the company’s new drug-coated stent, and the company’s recently expanded spinal division. We find the shares, valued at 18x 2008 EPS, attractive for long-term investors.
United Techs
(UTX - $61.70)
Shares of United Technologies are trading at close to 52-week lows on concerns about the company’s exposure to commercial aerospace, and US housing and commercial construction. Notwithstanding some valid concerns about a global economic slowdown, we find the 20% drop in the stock so far this year excessive, given the company’s stellar execution over the past several years and the positive long-term growth outlook. Over the past five years the company has posted annual EPS growth of 16%, annual revenue growth of 14%, and annual organic revenue growth of 8% (excludes effects of acquisitions and currency fluctuations). At the same time the company has consistently generated free cash flow in excess of net earnings. The stock now trades at just 12.5x the consensus estimate for 2008 and 11.3x the consensus estimate for 2009 - both well below market multiples. We believe a near-term deceleration in earnings growth is now more than priced in, and we believe today’s price represents an excellent entry point.
Paychex
(PAYX - $31.28)
Paychex is the leading provider of comprehensive payroll and integrated human resource and employee benefits outsourcing for small to medium businesses. It serves over 561,000 clients, and 94% of those clients have fewer than 50 employees.
The stock is down 35% from its 52-week high amid concerns of a slowing economy and lower interest rates. Data shows that small businesses (under 50 employees) tend to be much more resilient during economic downturns. In fact so far this year small businesses have continued to add employees despite the job losses reported by larger employers.
Furthermore lower interest rates reduce the amount of money the company earns by investing client funds. The company collects withholding from clients payrolls and invests that money until it must be submitted to the government. So when interest rates begin to rise, the company will benefit from increased investment returns.
Over the past ten years Paychex has shown annual sales growth of 17% and annual EPS growth of 21%. The company has tremendous operating leverage with a ten year average operating margin of 37%.
At 19x estimated calendar 2008 EPS it is trading at a historically low premium to the S&P 500. The stock carries a 3.9% dividend yield, and we believe it is an exciting opportunity for long-term investors.
