3 Cheap Consumer Stocks with Big Upside

By David Sterman,

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When I was in junior high school in the late 1970s, pessimism about the economy was all around. My friends' parents were uniformly convinced the United States was in the midst of a great decline that would spell trouble for my generation. I started to believe it and grew depressed. Thankfully, an American revival was just around the corner, with an economic recovery in the 1980s and a subsequent boom in the 1990s.

And now it's happening again. Everyone I've been speaking to is expecting a long period of economic pain that will lead to a steady drop in living standards. But just as the sky wasn't really falling back then, it isn't now either. It's a bit premature to presume a profound economic renaissance like the one we saw under Presidents Ronald Reagan and Bill Clinton, but it's also unwise to buy into the "America's in decline" scenario. Simply put, economic slowdowns are necessary to "clear the decks," setting the stage for the next period of economic expansion.

In this context, it's important to revisit currently-held notions about consumer-facing businesses. Many of them are trading at absurdly low valuations, anticipating an extended period of flat profit growth. But if you could peer around the corner -- and if you had a multi-year time frame -- then you'd see a very different picture.

Already depressed -- and profitable
Let's take Ford Motor ( F ) as an example. The automaker has been counting on the U.S. and European markets for roughly three quarters of its profits and sales (though an aggressive emerging-markets push could soon change this picture). You would think a primary reliance on U.S. and European consumers would spell tough times for Ford. After all, total car and truck sales in North America and Europe are off roughly 30% to 40% from a half decade ago. Yet Ford is on track to earn roughly $2 a share this year. If Ford hits this mark, then it would be a company record. Notably, unemployment levels remain high and consumer confidence surveys are posting very low readings. Just imagine what would be possible under different circumstances.

What is Ford's reaction to the gloom?

  • Ford's CEO Bill Clay Ford, along with three company directors, acquired a collective $900,000 in stock on the open market in early-September
  • In mid-September, it noted that a now-stronger balance sheet is setting the stage for a fresh new dividend in 2012
  • The company's internal sales analyst, George Pipas, told reporters on Sep. 23 that industry unit sales are trending at its best levels since April, and
  • The automaker just announced plans to hire up to 10,000 more U.S. workers. 

These actions come as 9% of the U.S. population is officially unemployed and another 6% aren't even being included in the tally. Ford is focusing on the other 85% of the workforce that's buying cars and trucks. The fact that shares trade for five times trailing and projected earnings (about $9.40) shows you just how deep the gloom is over this consumer-facing stock.

Supply below demand
Even as many of these consumer-facing businesses await an upturn in demand, they're still generating very impressive profits simply by keeping supply low. For example, Delta Airlines ( DAL ) is cutting its least profitable flights, ensuring its remaining flights fill up more quickly. So in an era of minimal economic growth, Delta still managed to earn $1.71 in 2010 -- its second-best performance on record (behind 2007).

A spike in oil prices is crimping profits this year, but oil prices have recently eased, so analysts expect Delta's earnings per share ( EPS ) to reach $1.88 in 2012.  You can only imagine what Delta's profitability will look like with just a modest improvement in employment trends. Meanwhile, shares trade for four times projected 2012 profits (about $6.65), which is why I think this stock can double in a year or two.

A business grows and a stock price shrinks
Let's look at retailer Kohl's ( KSS ) as another example. The company has a virtually unbroken streak of exceptional quarterly execution. Management has been laying out plans and meeting them, again and again. Kohl's sales and profits have doubled in the past 10 years, yet its stock is right back to where it was a decade ago.

Of course, the tough economy has a negative effect on Kohl's growth strategy. The retailer has heavily throttled back plans or new store openings, and will likely only boost sales 5% this year and next. Thanks to ongoing procurement and supply chain improvements, along with a move toward more higher-margin private-label goods, Kohl's should still be able to boost EPS more than 20% in 2011 and nearly 15% in 2012. Trading under 10 times projected (fiscal) 2013 earnings (about $47.74) is a rare low-point for this widely-held stock. If this is a solid profit grower in a lousy economy, then imagine what growth would look like when employment trends finally start to improve.

Risks to Consider: These stocks sport single-digit multiples simply because it's unclear when economic conditions will improve. And they may stay cheap for another year or so, until investors feel the worst has passed.

Action to Take --> The U.S. economy is stagnant and possibly headed for contraction. Yet it's important not to conflate near-term economic sentiment with the longer-term macro backdrop. The U.S. economy has struggled many times before and invariably has snapped back to life. If you wait until economic trends improve, then there's a good chance companies like Ford, Delta and Kohl's won't be available for single-digit multiples by the time you're ready to buy. The fact that these companies are solidly profitable even in tough times speaks volumes about what they can earn when the economy finally turns.

If you're looking for what might improve sentiment toward this sector, then keep an eye on this coming Thursday's (Oct. 6) unemployment data. Jobless claims dropped to 391,000 in the week ending Sept. 30, a decrease of 37,000 from the previous week, according to weekly data from the U.S. Department of Labor. Similarly, the four-week moving average was 417,000, a decrease of 5,250 from the previous week. Another week like this and the four-week moving average will likely dip below 400,000 for the first time since the stock market rout began on July 22. If the jobless claims start to make a move toward 350,000 by year's end, then a whole lot of investors will most likely start talking about consumer-facing stocks once again.

-- David Sterman

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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This article appears in: Investing Investing Ideas
Referenced Stocks: DAL , EPS , F , KSS

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