Zacks Bull and Bear of the Day Highlights: HCP, Hercules Kirkland, GM, iShares Basic Materials ETF and iShares Industrial ETF

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Jan 12, 2011, 09:30 ET

CHICAGO, Jan. 12, 2011 /PRNewswire/ -- Zacks Equity Research highlights: HCP, Inc. (NYSE: HCP) as the Bull of the Day and Hercules Kirkland (Nasdaq: KIRK) as the Bear of the Day. In addition, Zacks Equity Research provides analysis on GM (NYSE: GM), iShares Basic Materials ETF (NYSE: IYM) and iShares Industrial ETF (NYSE: IYJ).

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Full analysis of all these stocks is available at http://at.zacks.com/?id=2678.

Here is a synopsis of all five stocks:

Bull of the Day:

We are changing our long-term recommendation for HCP, Inc. (NYSE: HCP) from Neutral to Outperform as we anticipate it to perform well above the broader market.

In the last 30 days, fiscal earnings estimates have been increased by most of the analysts, driven by its diversified portfolio that provides a hard-to-replicate competitive advantage over its peers. The healthcare sector is relatively immune to the downturn in the economy, and provides a steady source of income that insulates the company from short-term market volatility.

Fiscal earnings estimates have moved up for HCP in the last 30 days, indicating that the analysts are bullish about its long-term performance. Our long-term Outperform recommendation on the stock indicates that it would perform well above the broader market.

Together with a promising distribution growth outlook going forward.

Bear of the Day:

The market for home decor and gifts is highly competitive. Kirkland's (Nasdaq: KIRK) primarily competes with specialty stores, department stores, discount stores, and catalog and Internet retailers that carry merchandise in one or more categories that Kirkland's does.

The global economic environment has been challenging for the past fifteen months. Declining real estate value, reduced lending by banks, solvency concerns of major financial institutions, increase in unemployment levels and significant volatility in the global financial markets have negatively impacted the level of consumer spending for discretionary items.

Over this period, Kirkland's also experienced a significant slowdown in customer traffic, which affected its revenues and margins. Our long-term Underperform recommendation on the stock indicates that it would perform well below the broader market. Our target price of $13.00, 10.4X 2011 EPS, reflects this view.

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Cyclical Sector Overview

Autos

Earnings growth in the Auto sector is expected to fall sharply to just 13.64% year over year in the fourth quarter from 90.75% in the third quarter. That is mostly -- but not entirely -- due to higher base earnings in the fourth quarter of last year than in the third quarter of 2009. However, sequentially earnings are expected to be down by 8.20% so it is not only about a higher base.

Keep in mind that for most of the third quarter of 2009, two of the "big three" were in chapter 11 bankruptcy. Those two firms are not part of the S&P 500 -- although I would expect GM (NYSE: GM) to be added at some point in the near future; Chrysler is still not publicly traded) -- but indirectly they did affect the other firms in the sector that are in the S&P 500.

This is a pretty small sector, particularly by number of firms with just six firms in it and accounting for just 1.35% of total expected earnings in 2011 (virtually unchanged from 1.36% in 2010). That number should increase when GM is once again a part of the S&P 500, but it will still be a small sector. Earnings growth was stellar in 2010, rising 2,101.27%, but you should pretty much consider that the same as N/A -- more or less a question of dividing by close to zero.

Growth is expected to slow to a much more normal 14.01% in 2011 and then slow further to 6.79% in 2012. While auto sales have been recovering, they are still far below the levels that were considered normal before the Great Recession. Then it was considered normal for the industry to be selling 16 or 17 million cars and trucks a year in the U.S. Sales fell to an annual rate of below 10 million in the worst of the Great Recession, and have since worked their way back to the 12.5 million level in December.

For 2009 and 2010 as a whole, auto sales have been running below the rate at which we scrap cars, so there is some very real pent-up demand. This is a relatively low margin sector, with net margins expected to rise to 5.57% in 2011 from 5.27% in 2010 (and just 0.24% in 2009). While the sample size of estimate changes is extremely low, almost all of the estimate revisions for both 2011 and 2012 have been upward over the last month.

On a valuation basis, the sector is very attractive with a P/E of 13.6x based on 2010 earnings and 12.0x based on 2011 earnings. I think this sector is very attractive and would overweight it significantly.

Basic Materials

Like Autos, this is a very cyclical industry and has been enjoying very solid growth as the recovery from the Great Recession has progressed. This industry is driven by global demand, not just U.S. demand, and the strong growth in places like China and India play a very big role here.

As with most of the sectors, year-over-year earnings growth is slowing significantly. In the fourth quarter, the sector is expected to report total earnings that are 19.97% higher than a year ago, but in the third quarter growth was 44.11%. As the comparisons get tougher, the rate of growth is slowing on an annual basis as well, with total net income expected to be up 64.62% in 2010, but falling to 30.30% in 2011 and to 18.01% in 2012. Still, that is well above the growth rate for the S&P 500 as a whole for all three years.

Revenue growth is also above the overall S&P 500 for all three years, but is also slowing -- falling from 11.75% expected for 2010 to 8.73% in 2011 and 5.77% in 2012. The direction of commodity prices will play a big role in both the revenue and the earnings growth of companies in this sector. With earnings growing much faster than revenues it means that net margins are rising, going from 4.47% in 2009 to 6.58% expected for 2010 to 7.89% for 2011. That is still below the overall S&P 600 level.

Estimate momentum is better than average, with a revisions ratio of 3.40 (or almost 7 increases for every 2 cuts) for FY1 (mostly 2011) and 2.33 for FY2 (mostly 2012). That could well mean some good short-term trading opportunities in the sector.

Valuations are a bit on the high side, particularly looking at the 2010 P/E of 18.4x. With the better-than-average growth expected for 2011, the P/E based on 2011 earnings falls much close to the overall market average at 14.1x.

I like this sector from a long-term theme point of view (harder to find high quality mineral reserves at a time when the growth of China and India are creating massive demand for things like copper and iron ore). I would have at least a market weight in this sector, and would probably overweight it. It had a nice run over the last few months, so perhaps market weight it now with the intention of padding your position on a pullback. It is a relatively small sector, though, expected to account for just 3.22% of total profits in 2011, up from 2.85% in 2010.

iShares Basic Materials ETF: (NYSE: IYM)

Industrials

This cyclical sector was one of the earnings growth leaders in the third quarter with total net income up 53.07% over the third quarter of 2009. While growth is expected to slow in the fourth quarter, it will still be among the leaders, with 44.51% year-over-year growth expected. For all of 2010, earnings are expected to be 41.32% higher than in 2009.

Looking at 2011, growth is expected to slow to "just" 32.81%. That should be enough to put the sector near the top of the leader board, though, behind only Construction (which is going to grow off an extremely low base). The higher base is likely to slow growth to 12.80% in 2012, but that is still better than the S&P 500 as a whole.

The high growth means that the sector is picking up earnings share, rising from 1.96% of total earnings to 2.26% of total earnings. That still makes it one of the smaller sectors in the index. As far as the top line is concerned, growth is comfortably above the overall market for all three years (but then again fell more than the overall market in 2009). Total revenues are expected to be 12.61% higher in 2010 than the depressed 2009 levels.

The recovery is expected to continue with 11.57% growth in 2011 before falling to a still-solid 8.25% in 2012. Net margins are expected to expand from 7.11% in 2010 to 8.45% in 2011. The sector is close to the very top in terms of estimate revisions, with 3.4 increases per cut for FY1 and 5.5 increases per cut for FY2. Thus, this is an area where there should be some good short-term trades to be made.

Valuations are higher than average for the sector at 19.5x 2010 earnings, but the P/E falls to 14.7x based on 2011 earnings. To make this sector a good long-term investment at these multiples, higher-than-average growth would have to continue into 2013. That is quite possible but far from guaranteed. Still, given the growth profile and the strong revisions, I would be inclined to overweight the sector.

iShares Industrial ETF: (NYSE: IYJ)

Construction

This is a very battered down sector -- one that is just barely making it back into profitability in 2010 after major sector-wide losses in 2008 and 2009. The year-over-year growth in the third quarter was simply massive at 1148.57%, but that really is a case of dividing by near zero.

Surprisingly after such huge growth in the third quarter, year-over-year growth is expected to slow to just 9.59% in the fourth quarter. That is not because last year's fourth quarter was great. Sequentially, earnings in the sector are expected to be down 27.28% from the third quarter. The full-year earnings growth for 2010 cannot be calculated, but looking forward to 2011, the sector is expected to lead the growth standings by a wide margin, with earnings nearly tripling at 192.10% growth. The strong growth is expected to continue into 2012, with total net income rising another 44.29%.

Revenue growth was non-existent in 2010, coming in at just 0.14%. Top-line growth is expected to accelerate to 6.14% in 2011 and to 10.05% in 2012. Still, that makes Construction a big margin expansion story as net margins are expected to climb from 1.13% in 2010 to 3.11% in 2011. That still puts them far below the S&P 500 as a whole.

The estimate revisions picture does not look very good, as it is one of only three sectors with more estimate cuts than increases for FY1. For FY2, the revisions picture is a little bit better with a revisions ratio of 1.33, but that is still well below the overall market.

In short, this sector looks like a turnaround story that is not turning. Along with the high growth comes some very lofty P/Es, with the sector selling for 76.4x 2010 earnings but falling to 26.1x 2012, as there will be something in the denominator. In fairness, the sector probably looks a lot cheaper on a book-value basis than it does on an earnings basis at this point.

With housing prices heading down again, I would avoid this sector entirely. It is a very small sector expected to account for just 0.27% of total earnings in 2011, but that is up from 0.10% in 2010. Unless you are an index fund, avoiding this sector will not put you at major risk of underperforming the overall index.

There will be a time for those with a strong contrarian streak to own this sector, I just don't think the time is now. Wait until the sector starts to be among the leaders in terms of estimate revisions, then pounce on it. You might not get the low tick, but there should be plenty of room to ride it when this sector does finally get its act together.

Get the full analysis of all these stocks by going to http://at.zacks.com/?id=2649.

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