News Analysis date published New: 
Thursday, November 17, 2011 - 11:00
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Thursday, November 17, 2011 - 11:09
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Thursday, November 17, 2011 - 11:00

3 Cheap Stocks with a Shrinking Share Count

Thursday, November 17, 2011 11:00 AM

If every year brings a fresh theme for investors, then 2011 will surely go down as the year cash-rich companies spent a lot more money buying back their own stock.

In past periods of slow economic growth, companies deployed their cash to make deals in order to boost sales and profits. Yet merger and acquisition (M&A) activity has been surprisingly tepid this year, even in the context of more than $2 trillion in cash parked on S&P 500 balance sheets. Sure, there have been a few big M&A deals -- most notably in the energy sector -- but it's clear that stock buybacks have been the preferred route to earnings-per-share (EPS) growth for many companies.

I've been periodically describing intriguing big buyback plans from large companies to small-cap stocks at the tail end of each earnings season (companies typically pair buyback announcements with earnings releases). So with the third-quarter earnings season winding down, it's time for a fresh look at this theme.

A frenzy of stock buybacks
Since the beginning of October, nearly 12 companies have announced new or updated buyback plans that are set to shrink their share count by at least 10%. As a result, each one of these companies should be able to boost EPS by a commensurate margin even if net income stays flat.

To make the list, I focused on stocks that trade for less than 13 times projected 2012 profits, which is the mid-point multiple of the S&P 500. Here's what I found...



1. WellPoint Inc. (NYSE: WLP)
The health insurance industry is surely in transition. A major reform of the U.S. health care system is set to create new mandates regarding the acceptance of all patients, coverage of more basic preventative services and the limit the amount of insurance premiums that can be earmarked for administrative overhead. This uncertainty may explain why shares of WellPoint, one of the nation's largest managed-care companies, trade below levels seen back in 2007. After all, the changing health care environment has already led free cash flow to fall from $4 billion in 2007 to just $1 billion in 2010.

Yet WellPoint's management contends that the company's profit picture can actually brighten -- despite the regulatory challenges -- through better cost controls. The company is backing up this sentiment with a hefty $5 billion stock buyback that could shrink the share count by 20%.

Analysts at Merrill Lynch agree with the company's move. "Health care reform will not be as onerous as many expect and that confirmation of this will lift the group." In fact, WellPoint is their top pick in the group, as they predict the company's EPS can rise from about $7 this year to roughly $9 by 2013. Roughly $0.60 of this gain is expected to come from the share buyback, but analysts suggest the boost may be even stronger because WellPoint may buy back $2.5 billion to $3.5 billion in stock in 2012, higher than the $1.6 billion Merrill Lynch currently anticipates the company is buying back.

2. Viacom Inc. (NYSE: VIA-B)
Business is booming for this firm, which owns Paramount Pictures, MTV Networks, Nickelodeon, Comedy Central and other well-known cable networks. Fiscal fourth-quarter sales rose 22% year-over-year to $4.05 billion, pushing operating income up 27% to $1.06 billion. This is such a steady business, poised to flourish in almost any economic climate, that management has expressed a willingness to borrow money if needed to fuel its stunningly large $10 billion share buyback program (of which $3 billion has already been completed).

Analysts at Needham have crunched the numbers and figure the buyback will drop Viacom's share count from 610 million at the end of 2010 to 552 million by the end of 2012. They also say Viacom's operating income will expand at a 4.8% annual pace through the next decade. By this math, and using a target price-to-earnings (P/E) ratio of nine on projected 2012 profits and the shrinking share count, they figure shares are worth $63 -- 40% above current levels.

3. Amgen Inc. (Nasdaq: AMGN)
Major drug companies often seek out acquisitions to inspire growth. Yet this firm has always sought to focus its efforts on internal drug development. As I noted back in August, Amgen is one of the few companies that spends more than 20% of its revenue on research and development (R&D) efforts.

Yet even with this level of spending -- which will ostensibly help boost EPS as new drugs under development hit the market -- Amgen is taking another EPS-friendly move by buying back a heady $10 billion in stock that could eventually shrink the share count by double-digits.

To be sure, it's the drug pipeline that will really determine the future direction of this stock. The pipeline is rapidly maturing as key drugs move closer to Food and Drug Administration (FDA) approval. These drugs include:

  • T-Vex, a live-virus cancer vaccine that yielded a 28% response rate in Phase II studies.
  • AMG 386, a Phase III drug that targets ovarian cancer.
  • AMG 785, a Phase II drug targeting Osteoporosis.
  • AMG 827, a Phase III drug treating rheumatoid arthritis.

While Amgen waits to see which of these drugs will get FDA approval, the company can still depend on valuable existing drugs such as Epogen (which treats dialysis-related anemia), Aranesp (renal-based anemia), Neupogen (low white blood cells) and Enbrel (inflammation). Altogether, the portfolio of drugs accounts for roughly $15-16 billion in annual sales and EPS between $5 and $6. The new drug pipeline should help maintain or even boost these figures if the company can successfully meet the FDA's approval process.

"The long-term value of the pipeline is overlooked," note analysts at Citigroup, figuring shares could trade up from a current $57 to $65. Notably, their profit forecasts don't appear to reflect the effects of the big share buyback, so actual EPS -- and their price target -- could be due for an upgrade when the buyback takes place.

Risks to Consider: Employee stock-option grants could offset some of the benefits of a stock buyback, so it pays to monitor the shrinking share count if you look to buy these stocks.

Action to Take --> Stock buybacks can be a better alternative than dividends, because they don't trigger capital gains. That's why some investors keep dividend stocks in their tax-free retirement accounts while maintaining these capital-appreciation plays in their nontax-advantaged portfolios. There's no guarantee buybacks will boost a stock price, but all other things being equal, they should have a certifiably positive impact on EPS, which should provide support.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.