How you Should Play With These Forward Picks?

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

I am an avid reader of Jim Welsh’s Micro Tides Newsletter.  The reason why I like him is because of his macroeconomic visions and macro investing capabilities. This month Jim joined Forward Management, LLC, and I think this move will help the firm with investing decisions based on macro events. 

Speaking of Forward Management, this investment advisory firm managed 985 accounts totaling an estimated $5.14 billion of assets under management as of Dec. 31, 2012. It added 33 new stocks to its portfolio in the last quarter. Looking at the new positions this firm took up in the last quarter, I screened out my three favorite picks for further analysis. These stocks are Target Corporation (NYSE: TGT), Precision Castparts (NYSE: PCP) and CF Industries Holdings (NYSE: CF). Let’s discuss these stocks in detail. 

Target

All eyes on the online channel

Target has started a series of modifications in its business model that suggest that the company is taking a more competitive approach towards Amazon. Currently, E-commerce represents only 2% of the company’s total sales. But the fact that its online channel witnessed robust growth in 2012 with a significant increase in shopper satisfaction scores indicates that we can expect 2013 to be a successful year. This is further driven by improvements in the website functionality, along with SKU (store keeping unit) expansion, which includes launching six new brands that will be sold online only. 

Target is finally embracing a multi-channel retail model, including designer labels, and more effectively integrating its online and store assortment. This strategy includes an online preview before actual sale and special discounts. To support this strategy Target is forcing its vendors to be consistent in their pricing across channels. The potential of this strategy can be derived from Target’s history of building solid private labels, which represent over a third of their sales. 

The multi-channel retail model also includes special leverage to its Red Card members with free shipping. Red Card sales have shown no signs of deceleration (membership has grown from 5.6% in Q4’10 to 14% in Q3’12) since its implementation in October 2010. There are multiple benefits of the card for Target, including loyalty (driving 50%+ sales increase in Red Card member sales) and the ability to track consumer shopping patterns. I estimate the Red Card to contribute $13.7 billion in sales for 2013. My confidence in this stock is further confirmed with the announcement of Red Card availability in Canada, where Target plans to open 124 stores in 2013. 

I thin, in the long run investors will realize solid gains from: 1) Target's improved focus on the online channel, which will drive the overall sales, and 2) Red Card discount program benefiting from the Canadian expansion. 

Precision Castparts

The acquisition of Timet should provide overall operational ease with scrap reduction, streamlined internal supply of materials, and drawing down an abundance of inventory. Externally, Timet provides Precision with opportunities to capture all the titanium chips that were previously sold in the open market. Furthermore, the company believes there is significant hidden capacity in Timet that is yet to be utilized. In fact, this hidden capacity has been a hallmark feature of all of Precision’s most successful acquisitions. The company expects synergies of $30-$40 million over 12-16 months and $80-$100 million in synergies over the next 24-36 months. 

Long-term Targets

Precision is not yet finished with its M&A plans, and its robust cash generation should provide the financial support required to continue with this strategy. Management suggested that growth through acquisitions remains a primary focus for the company. As the company expands into significant opportunities, its management set a F2016 EPS goal of $15.50 to $16.50. The figure can approach $20 if additional M&A activity and the $750 million share repurchase are successful. Further tailwinds include the approval of the $750 million share buyback program, as well as $5 billion in free cash flow available to be deployed for additional acquisitions.

Considering the strong free cash flow generation, I opine that Precision will continue to grow with a large deal or collection of smaller deals. Management still has high efficiency to further increase the strategic value of the company and its shareholders.

CF Industries Holdings

Nitrogen - Not so favorable

The stock of CF Industries has outperformed (+135%) against its fertilizer peers (+34%) since the beginning of 2010. While elevated crop prices remain supportive to the strong Nitrogen demand, I think this scenario is going to change and Nitrogen will be replaced by Phosphorus & Potassium (P&K). I see more upside to P&K applications as farmers have the capacity to rebuild the P&K levels in the soil. Farmer incentives to apply nitrogen this spring will not be changed in the near term with corn prices already near $7.50/bu (bushel). As nitrogen prices appear to be bottomed out, NOLA (New Orleans Louisiana) urea prices continued at their low ($393-$410/st fob range last week) too. The company does not expect a repeat of the 1H12 price spike that drove NOLA urea prices to $700+/st fob (freight on board). Moreover, I also see some limitations in urea imports and we can anticipate a 5% y/y decline in nitrogen prices for 2013. I see more risk for nitrogen in the event of any weather-driven delays in planting and rotation of soybeans. This could affect the revenue margin of CF Industries. The aggregation of lower nitrogen prices, higher natural gas costs in 2013, low water levels in the Mississippi River, and the persistent drought in the corn-belt will drive a series of downward estimates. 

Capital deployment likely to be a catalyst

Strong free cash flow generated over the past two years will bring significant returns to its shareholders. I believe management has effectively committed the integrity of its 2013-2016 cash from operations with the announcement of $3.8 billion for nitrogen capacity expansions, $3 billion in share repurchase, and $0.9 billion for pending M&A until 2016. This serves a limited scope for additional capital allocation announcements in 2013. In addition, management’s stated intention not to pursue a more comprehensive MLP strategy suggests limited scope for re-rating in the near-term. Therefore, currently I remain neutral for this stock. 

Conclusion

To sum up, I feel Target Corporation and Precision Castparts provide a perfect opportunity to make long-term investment. Target will gain from its Red Card program and its entry into Canada, while Precision Castparts shall benefit from robust cash generation and heavy M&A activity. On the other hand, I remain skeptical about CF Industries performance considering their lack of infrastructure and operating experience. I will recommend a neutral rating for this stock. 


ShwetaDubey has no position in any stocks mentioned. The Motley Fool recommends Precision Castparts. The Motley Fool owns shares of CF Industries Holdings. 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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