Morgan Stanley North America recently released their list of best ideas – a list of actionable ideas from various sectors and analysts that rank as their leading stock investment insights (see here for Morgan’s investment outlook). The “best ideas” are Morgan’s ideas that vary substantially from consensus, have favorable risk/reward profiles and have clear catalysts that will corroborate the underlying fundamental analysis. Below are their 9 favorite North American plays on the equity markets:
1. Baker Hughes (BHI) -Price target $90.
Baker Hughes announced the BJ Services acquisition and new leadership in the international business, both in the last month. BJS’s assets should facilitate international growth, and management changes should improve international execu-tion; both can help close the valuation gap. We expect 2011 EPS of $4.90, well above the Street, and that places the stock below 9x earnings, compared to a 10.5 multiple for the group. Ultimately, we think an 18.5 multiple on 2011 is appropriate.
2. Bank of America (BAC) – Price target $30.
Card delinquencies are slowing, and capital markets should be better than most expect in 3Q09. Improvement in the rate of change in early-cycle consumer credit means that reserve build likely peaked in 2Q09, which should cause what was a $1.36 reserve related EPS headwind in 2009 to vanish in 2010. This puts the stock at under 6x our 2011e EPS, which are 20%-plus above the Street, making it the cheapest of our Overweight-rated large-cap bank stocks.
3. Celgene (CELG) -PT $63.
Street estimates for peak sales for 95%+ gross margin Revlimid look low at $4 billion, as we see likely upside to $5 billion and beyond. Additionally, Celgene’s pipeline could emerge as a driver of longer-term growth. We believe investors under-estimate the next generation myeloma drug, pomalidomide; impending Phase II data could surprise to the upside and lead to both an accelerated filing (drug on the market as early as 2012), and the addition of sales for this $500 million-plus peak sales drug to Street models. We believe that data coming in December will lead to these upward revisions for both drugs.
4. Danaher (DHR) -PT $80.
A broad-based “quality trade” should drive DHR, which we recommend as a high-quality midcycle play on economic recov-ery. The stock currently trades in line with group, versus its historical 20% premium, a premium that we argue is justified by its above-peer-average growth, margins, and FCF generation. Our higher-than-consensus estimates are driven by an expected acceleration in the M&A cycle that Danaher’s experienced management team should exploit with its strong bal-ance sheet and deal pipeline. The recently announced acquisition of SCIEX/Molecular devices looks to be accretive and the first of many we expect over the cycle.
5. Hewlett-Packard (HPQ) – PT $62.
We see an exceptional risk-reward, with the stock trading near our “Bear Case” valuation of $46; we recently increased our price target. Under CEO Mark Hurd, Hewlett has been a cost-cutting story, with superior and sustainable ROE (20%-plus). We now believe HP is transforming into a growth story driven by higher R&D investment and a multi-year enterprise server cycle. As a result, we are 4% and 5% above consensus on 2010 and 2011 EPS estimates. Revaluation of shares should occur as this plays out. Proprietary inventory checks suggest a rebuilding of high-margin printer supplies providing down-side protection until the cycle kicks in.
6. Suncor (SU) -PT $49.
Our 2010 EPS estimate of $3.71 is 40% above consensus on our more bullish outlook for crude. Beyond 2010, we expect outperformance to be driven by the company’s targeted C$1.3 billion in synergies (conservative, in our view) from the transformative Petro-Canada merger, and our estimate of 6-7% annual production growth through 2016 — 200-300bps above Street numbers. The oil sands project backlog provides greater visibility for internally funded production growth. Our call on SU is further supported by our preference for oil-levered E&Ps over gas-levered names.
7. Textron (TXT) – PT $25.
Our three-pronged thesis: (1) Proprietary analysis suggests Textron Financial is on the mend with continued improvement in financial markets, and the division is no longer the $1-3/share negative value/drag implicit in the share price. (2) The cyclical Cessna business is now expected to trough in 2010, earlier than most expect, driving positive earnings revisions. (3) Bell is a premium asset, currently undervalued by the market by up to $1 billion, or $4/share; we believe DoD support for helicopters in the QDR could provide a boost for TXT (one of the few stocks representing a play on helicopters).
8. Union Pacific (UNP) – PT $80.
Street numbers for 2010 are at least 10% too low on volumes and productivity, in our view. We assume overall 2010 pric-ing will rise 3.5%, below recent growth rates, despite work that suggests no erosion in pricing power. We expect Y/Y vol-umes to finally turn positive again in 1Q10 after three years of declines. Our price target and estimates rise today, yet we see scope for more upside to earnings, particularly on productivity.
9. Walt Disney (DIS) – PT $35.
Our regression analysis suggests that advertising will grow 3–5% in 2010, implying $2.25 in EPS in 2011, 5% above Street estimates. ESPN should benefit from an estimated 16% increase in 2010 auto sales, while live sports and an extensive library make it a rare secular story in TV. Skepticism surrounds the Marvel deal, but we like Disney’s ability to leverage new characters across film, consumer products, and parks. We believe the Marvel deal is not about making more films, but rather replacing existing Disney live-action projects with Marvel films, which tend to have higher returns with lower vola-tility. We think the deal is mainly about the high-margin licensing business, where the profit opportunity is underestimated.
* Important Note: Best Ideas is not and should not be considered a portfolio. Each investment idea is chosen based on its own merit and without any consideration of the other investment ideas chosen. Specifically, there has been no effort to mitigate the risks of investing in any collective group of Best Ideas. Concepts important to a balanced port-folio, such as negative correlation and diversification, have not been considered. Treating Best Ideas as a portfolio will subject you to the risk of losing all or a substantial portion of your investments.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.