Two Oversold Gems That Should Rebound in 2016

Nick Lanyi's picture

Friday, December 11, 2015 - 12:30pm

by Nick Lanyi

The U.S. stock market has demonstrated rising volatility of late, as jittery investors are focusing less on economic or stock-specific fundamentals and more on external factors: terrorism, the climate-change talks, Donald Trump's latest remarks.

But look past the short-term noise and you'll see the market in a holding pattern over the past two months. The S&P 500's high and low since October 12 are about 5% apart. The reason for this muted range, I believe, is that investors have been waiting for the Federal Reserve's first increase in short-term interest rates in seven years. If the rate hike occurs next week, the cloud will lift and investors will start to trade a bit more freely, perhaps after taking a holiday break.

The timing of the Fed's hike couldn't be better for undervalued stocks. Coming at the end of the year, when professional and individual investors alike dump some of their losing stocks to harvest capital losses for tax purposes, the cloud-lifting environment I anticipate could raise interest in some down-and-out stocks that don't deserve their recent rough treatment.

Both of the following stocks have suffered this year but they boast top shares in growing markets and are excellent candidates for a rebound in 2016.

DaVita HealthCare Partners (NYSE: DVA) is the country's leading provider of kidney dialysis services, with about a 35% market share. As the #1 player in kidney care, DaVita benefits both from the graying of America and medical advances that have helped kidney-disease sufferers live longer, more active lives. 

DaVita serves more than 175,000 patients at 2,329 outpatient dialysis centers, mostly in the United States. The company's HealthCare Partners (HCP) division is the largest U.S. operator of medical groups and physician networks. Kidney care services accounted for about 64% of revenue last year, while HCP accounted for about 27%, with the rest coming from miscellaneous operations.

In the United States, the population of patients needing dialysis is growing 4% a year, according to DaVita. This provides built-in demand growth for the company, which also has added to its number of centers to capture rising market share. The biggest risk to the company's business model comes from Medicare and Medicaid reimbursement rates, because these federal government agencies pay about two-thirds of DVA's kidney dialysis revenue. In 2014, Medicare announced it would cut dialysis reimbursement rates by 9.4%, but it is phasing those cuts in over the next few years, providing good visibility for DaVita's revenue in the short run.

HCP serves more than 830,000 patients in California, Florida, Nevada, New Mexico and Arizona. This business also benefits from the graying of America, as the healthcare plans and physician practices it works with experience rising demand for medical services. HCP works to lower costs by using data and best practices, but this unit also is vulnerable to cuts in Medicare and Medicaid reimbursement rates. Even so, over the long haul it should continue to outgrow the U.S. economy significantly. 

At recent levels, the stock is trading just above its 52-week low and nearly 17% below its 52-week high, and at only 17.5 times analysts' consensus estimate for 2016 earnings per share, a bargain for a company with solid prospects for 10% to 12% annual earnings growth. The company has paid down debt and generates strong cash flow.

Another plus: Warren Buffet's Berkshire Hathaway (NYSE: BRK-B) owns about 19% of DaVita shares, so you can consider this stock a great opportunity to buy low on one of the Oracle of Omaha's favorite healthcare companies.

FedEx (NYSE: FDX) needs no introduction. The Memphis-based global delivery company made overnight delivery a daily reality for businesses (and shoppers) around the world decades ago; it now operates in 220 countries and ships more than 9 million packages a day using 652 aircraft and more than 100,000 motorized vehicles. The company generated $47.5 billion for fiscal 2015 (ended May 31), with express accounting for 57%, ground delivery for 27%, freight for 13% and services for 3%. 

While FedEx operates in a highly competitive field, it remains #1 in express delivery and has captured the largest market share in freight. Its balance sheet is strong, and revenue has grown consistently at a mid-single-digit clip. But some analysts and investors favor UPS (NYSE: UPS) and nimbler competitors, who have undercut FedEx on price and, in some cases, digital innovation. There's also concern that weaker-than-expected demand in China will torpedo earnings. As a result, FedEx shares have dropped 15% year to date and are trading close to a 52-week low. 

In my view, the pessimism is overdone, especially as the U.S. economy, which continues to drive the company's earnings, is growing at a decent clip. That indicates the potential for better-than-expected performance for FedEx's commercial business. In addition, falling unemployment rates augur well for demand for online shopping services. FedEx continues to make strategic acquisitions, particularly in attractive overseas markets. And in October, the company and its pilots agreed on a new six-year contract, doing away with one of the clouds hanging over the stock price.

FedEx shares currently trade at only 13.8 times analysts' consensus estimate for fiscal 2016 earnings per share, an historically low valuation for this delivery pioneer and market-share leader. 

Risks To Consider: DaVita is vulnerable to changes in Medicare and Medicaid reimbursements. FedEx could be hurt by lower-than-expected economic growth or a higher-than-expected rebound in energy prices.
    
Action To Take: Buy DaVita below $73 and FedEx below $150.

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Nick Lanyi 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.