Three Lords are Leaping

Declan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Christmas cheer remains in the air, and whatever fear exists in the market hasn't extended to all sectors.  So which sectors are enjoying the festive period?

One of the strongest performing sectors has been Consumer Discretionary.  It has consistently outperformed the S&P since August, and could be a leader into 2013.  Discretionaries were followed by Health Care in September, while Industrials kicked into life over October.  All three sectors have led when compared to the S&P. 

From the Consumer Discretionary sector, Mattel (NASDAQ: MAT) is pressuring multi-year highs and is nicely positioned for a run in 2013.  All of this is part of a rally that kicked off from the March 2009 low. Q3 earnings were released back in October, with next earnings not due until Jan. 15.

The company has a history of coming in around estimates, with the bulk of earnings loaded in the Christmas Q4 (the next reporting quarter).  Expectations are for $1.14 a share, $0.07 over the comparable quarter reported last year, which itself beat estimates by $0.06. Last quarter's earnings were up, despite currency factors -- which seemed to be the only cloud on the results, with operating income running 23% higher.  There was also reported growth in market share for both Europe and U.S.  As a side note, the increase in accounts receivable days outstanding was attributed to the "timing of sales volumes," and was not perceived as a worry for the company.  

Barbie remains the earnings monster, with her influence seeping into the (now) extensive DVD movie collection.  The push into the DVD market is of course supported by the obligatory wardrobe merchandise, offering further leverage on sales.  Barbie's results were a little disappointing for Q3, in part hurt from cannibalization from Mattel's own product line!  It's Monster High product line is the no. 2 fashion doll, behind you-know-who, which gives Mattel "6 of the top 10 properties in the U.S. toy industry".  Honorable mention, but not too surprisingly given their cost, American Girl merchandise was up 16% for Q3 and will probably be another winner for Christmas.  Mattel were very pleased with the performance of this brand.

Boys were not be outdone, with Hot Wheels offering double digit growth for Q3 in North America, another good sign for the important Q4.  Fisher Price's underperformance in Europe is viewed as a growth opportunity for 2013 (although worldwide sales were up 6% for the brand); Nickelodeon and Disney brands are part of the Fisher Price product range, along with its own property, Thomas & Friends. 

Reading through the conference call notes was like a who's-who of the toy world, and reinforces the strength of the Mattel brand, and its attraction as an investment.

Hi-Tech Pharmacal (NASDAQ: HITK) qualifies as a Health Care stock. Unlike the other two stocks mentioned here, it has enjoyed heavy volume buying in recent days.  However, the opening statement from CFO William Peters, following recent earnings reads more like a script for Debbie Downer than that of a stock that has risen over 30% since the start of December.  Even the bright spot has a dark lining as increased competition threatens revenues from Hi-Tech Pharmacal's leading generic drug.  Hurricane Sandy added its 2 cents and delayed some shipments, contributing to a sales hit of $1-2 million.  Production was also hit by the hurricane, however the company was 'magnanimous' to its employees who "aren't that highly compensated," and the company "didn't think that was fair, not to pay them for that time" -- not exactly a ringing endorsement to go work for Hi Tech Pharmacal!

So the positive reaction to earnings was more likely a relief it hadn't disappointed,  as it did for the prior three quarters, rather than a big beat that the headlines claim.

However, not all things look bleak for the company.  When elements such as Free Cash Flow are examined, the relationship between Net Income and Free Cash Flow narrowed, as total income rose.  This is a big step up from the woes Hi-Tech Pharmacal experienced in 2008, when the components contributing to Free Cash Flow had little to do with Net Income and prospects for the company were far more uncertain.  The result of the improved cash flow is that Hi-Tech Pharmacal has $100 million in cash, enough to offer a one-time special dividend of $1.50 a share on December 28 (ex Dec. 13), at a debit of $20 million in cash.

Heading into 2013, the company is looking for new product launches of generic drugs.  This will have to offset losses in its lead drug, but with a pipeline of 20 projects, it's hoped one or two more may be able to take up the slack.  Four are generic products requiring clinical trials, with Q1 and Q3 the kickoff for two of those projects. When this happens the company expects increased costs (translation, a hit on earnings) as the trials get under way.  Twelve projects are in the hands of the FDA.

Sales from its ECR subsidiary should also grow -- it saw $5.6 million in sales (up 59%) for what amounted to a partial year of sales and marketing promotion.  The company hopes to see double digit growth for ECR in 2013.

Hi-Tech Pharmacal will probably experience another year of rocky earnings in 2013.  Much of its success will likely be down to what products they are able to release to market, and for a general pick-up in demand for its existing products. But investors appear to be forgiving, and it may be further in-line performances will be enough to get the price train rolling.

From the Industrials sector is Emerson Electric (NYSE: EMR).  This stock is unusual in that it has spent over a year knocking just below $52, but never quite managing to break above.  Despite this, it has still managed to attract buyers because of its healthy yield, which is regularly mentioned, such as here, here and here.  In the past two quarters it has come in ahead of analyst expectations (when an impairment charge is excluded for the current quarter), although its seasonal weak quarter is up next.  

While overall net sales growth was a relatively tepid 2%, it did report double digit growth in sales for Latin America and Middle East, and 8% growth in Asia.  The Asia growth was particularly positive given the Thailand floods had a severe impact on its supply chain in the region.  The company expects these impacts to extend into Q1 and Q2 of 2013, with further charges.  Currency factors fudged these figures a little lower, but there are aspects of the business that exceed what the low 2% net sales growth might otherwise suggest. 

From a division standpoint, there was good growth in its Process Management and commercial storage and food waste disposal.  Weakness was in Industrial Automation and Network Power division, the latter attributed to a general malaise in the global telecom sector.  Emerson isn't accepting such underperformance, and may be willing to sell off divisions that drag on earnings.  

The company is expecting earnings-per-share for the first half of 2013 will be "70 to 80%" of projections.  So anything that comes close to analyst expectations, or the 100% figure should be viewed as a big win.  Restructuring costs are also expected to carry into 2013. But there is also the bugbear of Executive Compensation to hit the books too in 2013!  The first six months of 2013 will probably see continued earnings 'underperformance', but this may be the best opportunity to invest.

All three stocks featured here are certainly worth a review for 2013. 

fallond has no positions in the stocks mentioned above. The Motley Fool owns shares of Mattel. Motley Fool newsletter services recommend Emerson Electric Co. and Mattel. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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