This section of The Farr View describes a few stocks that we find interesting. They are not recommendations to buy or sell. We may be buying or selling in portfolios under our discretionary management. If you have questions about the appropriateness of these issues for your investment strategy, please call us.
Closing share prices are as of March 31, 2008.
O’Reilly Automotive
(ORLY - $28.52)
While we remain somewhat cautious on consumer discretionary names given the uncertain economic environment, O’Reilly Automotive is a company that we believe possesses outstanding long-term growth prospects. The company operates in the auto parts retail industry, targeting both do-it-yourself and professional customers. The long-term secular growth outlook for the industry is positive as a large percentage of the US vehicle population approaches prime repair age in the coming years. Additionally, O’Reilly has just announced the acquisition of CSK Automotive. We believe this will be a defining moment in the history of the company. CSK provides O’Reilly with entry into the West Coast market as well as the opportunity to improve the profitability of serial-underperforming stores. With the closing of the acquisition later this year, O’Reilly will become the third largest competitor nationwide with arguably the strongest growth profile. At slightly over 15x the consensus estimate for 2008 and an expected long-term EPS growth rate in the teens, we find strong value in shares of ORLY.
Zimmer Holdings
(ZMH -$77.86)
Zimmer is the global market leader in orthopedic implants (hips and knees). The company competes with Stryker, another stock that can be found in fully-discretionary Farr, Miller & Washington equity portfolios. We like the orthopedic industry. It boasts attractive demographic trends, limited economic sensitivity, an oligopolistic competitive structure (e.g. 70% of the market is controlled by three companies), and the pricing in the U.S. has recently stabilized. Industry negatives include the potential for eventual pricing pressure due to government efforts to control healthcare costs and from less industry pricing power now that payments to doctors for consulting fees are being heavily scrutinized. Zimmer has been run by a new CEO and CFO since mid-2007. The new management upset investors by lowering earnings guidance due to the need for the company to plough more dollars back into growing sales and recapturing some lost market share. We believe that these actions will ultimately enhance shareholder value and find these shares attractive trading at 18x 2008 estimated earnings per share.
Cisco Systems
(CSCO - $24.09)
CSCO is a primary beneficiary of the convergence of voice, video and data on the Internet. Cisco’s business is leveraged to both secular and cyclical growth themes. We believe the current valuation of 17x C2008 GAAP EPS is cheap considering the company’s above average growth prospects in the coming years. In the near term, a cyclical slowdown in corporate information technology spending may constrain the Company’s growth, but over the next three-to-fiver years the secular demand for IP video is likely to result in double digit revenue and earnings growth. IP video refers to any digital video stream delivered over a network using Internet Protocol. The proliferation of IP video will occur because it benefits all participants in the network chain (consumers, content providers and service providers). For consumers, IP video can vastly expand the range of content offered. For content providers, IP video offers low cost distribution, targeted advertising and potentially lower cost content creation. Last, for service providers, IP video is expected to reduce churn and create new revenue streams. Penetration of IP video is only 1% today. We estimate that IP video could account for 80% of video consumption in as soon as 10 to 15 years. To put this growth into perspective, it took color television 18 years to penetrate 80% of US homes. Cordless phones took 19 years to move from 1% to 80% penetration, and it took 16 years for digital telephone service to replace analog. The proliferation of IP video will require significant upgrades to routers used by Internet service providers which in turn will drive demand for CSCO products and services. CSCO currently gets 20% of its revenue from this IP trend. We believe CSCO is a well above average company with exposure to enduring secular growth theme that is selling for an average valuation. The risk/reward appears favorable for this stock.
