Time to Look for Value in the 'Old Economy'

By JAMES FLANIGAN

March 12, 2000 12 AM PT

Is this a good time to buy “value stocks”--the big, well- known companies that the fevered stock market is thoughtlessly neglecting as “old economy”?

Yes. You may not be rewarded immediately, because the Federal Reserve will probably raise interest rates again. But rewards will come soon because there is intrinsic value in many companies that investors are selling or ignoring.

Johnson & Johnson, Bristol-Myers Squibb and Delphi Automotive Systems are three companies with intrinsic value and stock prices that, if not cheap, are at least reasonable.

But to understand why--to judge value--investors need to think independently, do their own research and understand a little of the prevailing economic environment in the United States and the world.

The current period, with technology surging and traditional companies being sold en masse, is a classic case of the market overshooting and driving prices down to levels that ignore underlying value. That creates opportunity.

Take Johnson & Johnson, the giant company with $27 billion in revenue in all areas of health care, from baby oil and Tylenol to prescription drugs for arthritis and cancer to surgical and medical instruments. J&J;’s stock fell last week to a 52-week low of $66.13 before bouncing back to $70.88. It is down 33% from its high of $106.88, reached last November.

Why? No apparent reason except that “rising interest rates are thought to affect a broad-based consumer products company,” says Douglas Christopher, head of equity research at Crowell Weedon, a Los Angeles brokerage firm that has J&J; firmly on its recommended list.

The market is not looking at the company’s assets, Christopher says. J&J; is building a solid position in biomedicine with subsidiaries such as Centocor, a firm that has developed biotech drugs for treating arthritis, cardiovascular diseases and cancer.

Investors should see J&J; against prospects for the expanding world economy and the Internet, which offer greater markets for Tylenol, Band-Aid and a host of other brand names. J&J;, which has recorded 12% annual earnings growth for the last five years, is currently selling at 21 times earnings, less than the average big company’s price-to-earnings ratio.

The market overshoots its mark. Bristol-Myers, a pharmaceutical company with $20 billion in sales and consumer products ranging from Clairol hair coloring to Enfamil baby formula, fell 9% last week to a new low of $46.44 before bouncing back to $52.38.

The stock dropped because of analysts’ concern that government approval of a drug for colon cancer will be delayed and that another anti-cancer drug will meet competition from generic, non-branded compounds. Such competition generally cuts a drug’s anticipated revenue in half, analysts say.

But the maximum impact of those events on Bristol-Myers’ earnings would be a cut of 10 cents a share in its $2.33-a-share anticipated earnings, notes analyst Sergio Traversa of Mehta Partners, a New York investment firm specializing in the pharmaceutical industry. The market went overboard by sinking the stock $4 a share in one day.

Investors also are ignoring prospects for the company and the pharmaceutical industry. Bristol-Myers this year will have a promising new blood pressure medicine, Traversa says. And advances in biogenetics will multiply drug discovery in this decade.

Bristol-Myers, which has averaged earnings increases of 13% a year for more than a decade, is selling slightly below the market average for big companies.

Still, you say, investors have reasons to worry. Fed Chairman Alan Greenspan suggested in a speech last week that interest rates may rise further to curb the economy. What’s he worried about?

Greenspan is concerned that the U.S. economy is growing at an unsustainable pace, says economist Albert M. Wojnilower, a Fed veteran who now works for Clipper Group, a New York investment firm.

By one measure, U.S. consumer spending grew at an 8% rate last year, a pace made possible only by stock market gains, massive imports and reinvestment by foreigners in the U.S.

Greenspan is worried that excessive U.S. demand will exacerbate massive trade deficits, a decline of global confidence in the dollar and an abrupt reversal in world investment patterns. He wants to head off a disruption to an otherwise healthy U.S. economy. So the Fed, says Greenspan, will be “vigilant.”

But that’s hardly bearish news. In a time of stock market euphoria and in the midst of a presidential election year, the Fed chairman says he and his colleagues will keep a watch on excesses. Investors should be grateful.

And they should not overlook Greenspan’s other comments about just how well the U.S. economy is doing. Productivity in the last five years has advanced 3.5% a year, he said, “nearly double the average pace of the preceding quarter century.”

Investors also might think about just what technological change will mean for basic industries. One of the newest entries to the ranks of global industry is Delphi Automotive Systems, an auto parts colossus with $29 billion in sales that was spun off from General Motors last year.

Delphi stock is selling at $16.19 a share, down 27% from its 52-week high of $22.25 and only eight times the company’s earnings of roughly $2 a share. That’s one-third the market average for big companies.

Did Delphi have a difficult first year? On the contrary, it has picked up business from Fiat, Volkswagen, Jaguar and other non-GM car makers. Its sales and earnings are growing.

The irony for a company consigned to “old economy” status is that Delphi is a prime candidate to benefit from the Internet. It fastest-selling product, at $2.5 billion last year, is a system that offers navigation, e-mail, Internet and phone service for motor vehicles.

More than individual products, the Internet’s transformation of industrial practices favors Delphi. GM, Ford and DaimlerChrysler recently set up a common system for ordering all their parts worldwide on the Internet. Only the most efficient suppliers will survive this cost-saving shift.

But that gives a definite edge to Delphi. Based in Troy, Mich., with 168 manufacturing sites in 36 countries, the company is already one of the most efficient global suppliers of automotive parts.

The lesson for investors is clear: Forget new economy, old economy. Watch for value.

James Flanigan can be reached at jim.flanigan@latimes.com.

VALUE FUNDS

Paul J. Lim has tips for owners of battered funds. C3

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‘Old’ and Sagging

Three “old economy” companies whose stocks have been falling. Weekly closes and latest:

Bristol-Myers Squibb Co.

* 1999 sales: $20.2 billion

* Net income: $4.2 billion

* Employees: 54,700

* Average sales growth last four years: 10.1%