Is It Time to Take a Risk With These 2 Recovery Plays?
Around the world, economic green shoots are starting to emerge, and it seems as if a global economic recovery is underway. This got me thinking: Is it now time to take on some risk and search out quality companies at attractive prices that will benefit as the economy recovers?
This is a risky strategy, of course. That's why I'm looking for strong companies that have only struggled during the past few years through no fault of their own. I believe that Abercrombie & Fitch and Joy Global fit the bill perfectly.
Diggers and dumpers
Joy Global specializes in the production of equipment for coal mining, a commodity that has fallen out of favor recently as countries turn to the cheaper, cleaner natural gas to produce power. Is Joy actually a recovery play, though, especially with cheap oil and gas flooding the market and strict regulatory controls limiting the use of coal as a fuel?
We can use history as a guide to try to figure this out. The last time the mining industry was this depressed was in 2008 and 2009. Through this period, however, Joy remained profitable, while peers such as Caterpillar suffered.
Why did Joy remain profitable? Well, it turns out that the company generates a significant portion of its revenue from aftermarket services. This means the company does not have to rely upon new equipment orders to support revenue. In addition, the company remained cash-flow positive throughout the financial crisis and has continued to do so. Management recently authorized a $1 billion stock repurchase program to take place over three years, which should be easily covered by free cash flow. The $1 billion price tag is only about 17% of Joy's current market capitalization.
All in all, Joy is not suffering as much as many would think. Yes, the company is being affected by the slowdown in mining capital spending. However, Joy's aftermarket services division helped the company pull through 2008 and 2009, and I see no reason why it cannot help the company do the same this time around. The $1 billion buyback should drive earnings higher, too.
Abercrombie is something of a contrarian recovery play, as the company did not have a good 2013. Bad press, inventory mismanagement, and economic headwinds are all factors that have affected the company. As a result, management announced in the company's fiscal third-quarter earnings report that full-year adjusted earnings per share are expected to fall in the range of $1.40 to $1.50 -- significantly below the $1.95 per share analysts had expected.
Investors now have to decide whether or not this is a company-specific issue or if the company is being affected by factors outside of its control. There are some factors to suggest that the company's troubles are linked to the global economy, as opposed to internal mistakes.
For example, Abercrombie's target market is the younger generation, where the unemployment rate is currently higher than average. In particular, the global jobless rate for young people aged 15 to 24 -- Abercrombie's key demographic -- has grown to 12.4% from 11.5% during 2007. In some parts of Europe, especially troubled Greece, youth unemployment levels are close to 75%. This has already led Abercrombie to delay its European expansion plans.
Furthermore, the unemployment rate among 16- to 19-year-olds within the United States reached 22.2% during October of this year. This means Abercrombie's key demographic has little money to spend, and what they do have to spend is not going toward expensive clothing.
It would appear that Abercrombie is not alone in reporting lower sales volumes. Peer American Eagle Outfitters is also predicted to report lower sales volumes this year, as teens are no longer prepared to pay premium prices for clothing.
While American Eagle raised its third-quarter outlook at the beginning of the month on better-than-expected margins, the company also revealed that sales continued to be "unsatisfactory."
What's more, these third-quarter figures follow a terrible second quarter, where American Eagle posted mid- to high-single-digit declines in same-store sales, along with weak traffic figures. Wall Street now expects a 4% decline in sales for the fiscal year 2014.
Nevertheless, Abercrombie is not totally dependent upon the global economic environment. Due to cost cutting measures, it has managed to initiate a turnaround, only last week raising its full-year earnings guidance to the range of $1.55 to $1.65 per share.
Overall, both Joy Global and Abercrombie look like potential picks to ride the global economic recovery. Abercrombie in particular is attractive, as it would appear that the company's sales are dependent upon rising incomes and falling youth unemployment -- two key traits of an economic recovery. Meanwhile, Joy's recurring income stream is allowing the company to pay the bills while waiting for earnings to take off when the recovery takes hold.
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The article Is It Time to Take a Risk With These 2 Recovery Plays? originally appeared on Fool.com.
Fool contributor Rupert Hargreaves owns shares of Joy Global. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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