The 100 Best Stocks You Can Buy 2012 Part 32

The revenue mix is balanced: 36 percent residential, 32 percent commercial, 19 percent industrial, and 13 percent other. The service area includes the Atlanta metropolitan area and a large base of modern manufacturing facilities like the many Asian-owned manufacturing facilities, including large auto plants, in the region. The fuel mix is more diverse and less vulnerable to price fluctuations than some, with 55 percent coal, 22 percent oil and gas, 15 percent nuclear, 4 percent hydroelectric, and 4 percent purchased. That said, with its high percentage of coal-fired plants, SO must work to stay up with environmental regulations and pay close attention to transportation costs. Additionally, the company plans to deploy two of fifteen new Westinghouse AP1000 nuclear reactors for its ma.s.sive Vogtle power station in Georgia, purchased with an $8.3 billion loan guarantee from the U.S. Department of Energy.

The company also has engaged in telecommunications services, operating as a regional wireless carrier in Alabama, Georgia, southeastern Mississippi, and northwest Florida and operating some fiber optic networks collocated on company rights of way. The company also provides consulting services to other utilities.

Financial Highlights, Fiscal Year 2010

A return to prosperity in the manufacturing-intensive service area, plus a hot summer and relatively cool winter propelled SO back to top-line prosperity after an 8 percent dip in 2009. Earnings were attenuated a bit by deliberate spending on plant and right-of-way maintenance, and came in at $2.36, a little below initial forecasts but quite sufficient to maintain the $1.82 per share dividend. The company offered FY2011 EPS guidance in the $2.48$2.52 per share range. Additionally, Georgia Power, the largest subsidiary, was granted a 10 percent rate hike in late December 2010.

Reasons to Buy

The recovery hoped for in 2010 appears to be underway and should continue going forward, as first quarter results are very encouraging. The appeal of this stock lies almost entirely in its dividend, which has been raised slowly but steadily for years. The percent plus or minus return won't put you into a yacht, but if you've already got one it will certainly help you keep it. The solid history and relationship with local regulatory bodies makes the dividend and its annual raises look secure for the future. The stock price, too, has been very stable over time with one of our lowest beta coefficients of 0.35.

Southern serves a growing, diverse, and economically stable customer base. This is not Detroit Edison; they aren't dependent on any one dominant industry and rate requests are generally treated favorably due to the low overall tax rate in the area. Finally, the company is in the intermediate stages of being licensed to build new nuclear power facilities; in today's environment, while that does add some risk, we feel this is a good economic move for the future.

Reasons for Caution

Electric utilities are always subject to rate and other forms of regulation, and one never knows what will happen in that arena. Additionally, utilities are always vulnerable to capital costs and the attractiveness of alternative fixed income investments, and are sensitive to rising interest rates, especially if rates rise quickly. SO is more exposed to coal prices and rail freight rates for its transport than most, and these have fluctuated a bit more in recent years. Finally, all electric utilities are exposed to new environmental regulations and the need to replace aging infrastructure.

CONSERVATIVE GROWTH.

Southwest Airlines, Inc.

Ticker symbol: LUV (NYSE) S&P rating: BBB Value Line financial strength rating: B+ Current yield: 0.1%

Company Profile

Southwest Airlines provides pa.s.senger air transport, operating almost exclusively in the United States. At the end of FY2010, the company served sixty-nine cities in thirty-five states with point-to-point, rather than hub-and-spoke, service. The company serves these markets almost exclusively with 548 Boeing 737 aircraft.

The company is one of the largest in the United States and is the world's largest by number of pa.s.sengers flown, which should give an idea of their business modellow cost, shorter flights, and maximum pa.s.senger loads. Indeed, the average trip is 885 miles and the average fare is $130.27, one of the lowest in the industry. The business model is one of simplicityno-frills aircraft, no first-cla.s.s pa.s.senger cabin, limited interchange with other carriers, no on-board meals, simple boarding and seat a.s.signment practices, direct sales over the Internet (84 percent of revenues are booked this way), no baggage feesall designed to provide steady and reliable transportation, with one of the best on-time performances in the industry, and to maximize a.s.set utilization with minimal downtime, crew disruptions, and other upward influences on operating costs. The company has long used secondary airportslike Providence, Rhode Island, and Manchester, New Hampshire, to serve Boston and the New England area; Allentown, Pennsylvania, and East Islip, New York, to serve the New York/New Jersey area; and Chicago Midway to reduce delays and costs. This strategy has worked well, although the company, especially with the recent ATA acquisition, is serving more mainstream airports, too.

The simple, straightforward value proposition has been a customer favorite for years. Recently Southwest has embarked on a few initiatives to squeeze out some extra revenue without alienating the core pa.s.senger group, mostly targeted to business travelers. One is Business Select, which offers priority boarding, priority security, bonus frequent flyer credit, and a free beverage for an upgrade fee. The company also sells "one-off" early boarding for a small fee. Although the company has avoided the cost and complexities of offering international flights, they are expanding partnerships and experimenting with through flights, now to Mexico, and likely soon to other destinations.

Financial Highlights, Fiscal Year 2010

Southwest, like most carriers, has. .h.i.t turbulence in the past three years, first with escalating fuel prices, then with the economic downturn. The company experienced a 6 percent revenue falloff in FY2009, and saw per share earnings nosedive from $.61 in 2007 to $.19 in 2009, even with the benefits of well-known fuel price hedging that separated Southwest from its peers during the worst of the fuel crunch.

The solid business model held steady and allowed Southwest to prosper in the economic recovery; the company pulled through with a record $12.1 billion revenue performance in FY2010 and per share earnings of $.73. The ATA acquisition and a resumed capacity expansion is expected to bring in the range of $13.5 billion in revenues and $.85 per share in earnings for FY2011, and many forecast earnings exceeding $1.00 a share in FY2012.

Reasons to Buy

Those who have read 100 Best Stocks for the past two years have heard us say we'd never put an airline on the list. Why? Because airlines are extremely compet.i.tive with little to no control over prices, and with the major cost components of fuel, airport fees, and union labor, have little to no control over their costs. In other words, the exact opposite of what you'd want to see in a business you own.

However, Southwest has continually proven to be the exception. The value proposition is the envy of the industry, and we're frankly surprised that no one else has been able to emulate it (United and Delta, among others, have tried). The airline realizes that what customers want is no-ha.s.sle transportation at best-possible prices, and has been able to do that better than anyone else for years. It may be true that compet.i.tive pressures make it difficult to control prices, but Southwest nonetheless sets the price in most of its markets, and can set it low because of its operating efficiencies. So not being able to control price is more of a problem for the compet.i.tion than it is for Southwest.

We've continually feared that some other carrier would "get it" and take Southwest's turfor that Southwest would try to get too big for its britches and start flying 747s from Dallas, San Francisco, New York, and Miami to major world destinations like everyone else. None of these things has happenedthe company continues to lead its niche, and at present seems satisfied to stay there. The economic upturn will only make things better as time goes on and other airlines continue to flounder.

Reasons for Caution

The acquisition of ATA and a modest de-simplification of the "Rapid Rewards" frequent flyer program to provide international rewards and sell points to third parties gave us some pause, but the core business model seems intact and should prove successful over time. The company is less hedged against fuel prices than it was in 2008, so a prolonged fuel and commodity spike could hurt, as could a double-dip recession. Investors should watch for any sign that Southwest is straying from its successful, industry-leading business model.

AGGRESSIVE GROWTH.

St. Jude Medical, Inc.

Ticker symbol: STJ (NYSE) S&P rating: A Value Line financial strength rating: A Current yield: Nil

Company Profile

St. Jude Medical, Inc., designs, manufactures, and distributes cardiovascular medical devices for cardiology and cardiovascular surgery including pacemakers, implantable cardioverter defibrillators (ICDs), vascular closure devices, catheters, and heart valves. The company has four main business segments: The Cardiac Rhythm Management portfolio (responsible for about 60 percent of St. Jude's FY2009 revenue) includes products for treating heart rhythm disorders as well as heart failure. Its products include ICDs, pacemaker systems, and a variety of diagnostic and therapeutic electrophysiology catheters. The company also develops catheter technologies for the Cardiology/Vascular Access therapy area. Those products include hemostasis introducers, catheters, and a market-leading vascular closure device. Many products in this portfolio use RF (radio frequency) and other leading technologies for rhythm management, ablation, and other advanced cardiovascular problems.

The Cardiovascular segment (20 percent of sales) has been the leader in mechanical heart valve technology for more than twenty-five years. St. Jude Medical also develops a line of tissue valves, vascular closures, and valve-repair products. The company entered the pericardial stented tissue valve and coronary guide wire markets with new product introductions in the second half of 2010.

The company's Neuromodulation segment (7 percent) produces neurostimulation products, which are implantable devices for use primarily in chronic pain management and in treatment for certain symptoms of Parkinson's disease and epilepsy.

The Atrial Fibrillation business (13 percent) produces a 3D heart mapping system. This tool is used by cardiologists to diagnose and treat irregular heart rhythms, among other uses. The AF unit also produces specialized catheters and other devices used in the treatment of atrial fibrillation.

St. Jude Medical products are sold in more than 100 countries. The company has twenty princ.i.p.al operations and manufacturing facilities around the world. In 2010, the company purchased AGA Medical Holdings, a $200 million producer of devices to treat heart defects and abnormalities with a promising product pipeline.

Financial Highlights, Fiscal Year 2010

By nature, cardiac care is fairly recession proof, and revenue and earnings continued to grow, although at a slightly moderated rate, through the 20092010 period. The company had a strong FY2010 and fourth quarter, with revenues reaching the top of guidance at about $1.35 billion, for an annual total near $5.2 billion, about 15 percent ahead of FY2009 and well on the company's traditional growth track. Earnings for FY2010, net of one-time acquisition costs, came in at a solid $3.01 per share, and the company has projected $3.25 per share in FY2011. That figure may depend on share buybacks, as the company has also announced its intentions to retire $900 million in stock covering the 13 million shares expected to be issued in the AGA acquisition and then some. The company has already retired about 10 percent of its outstanding shares since 2004.

Reasons to Buy

Both the Neuromodulation and Atrial Fibrillation segments have grown rapidly and seem well positioned for growth in at least the 15 percent range. The techniques employed in neuromodulation are growing quickly in the field as a preferred treatment for long-term pain management. St. Jude (and others) see this as a disruptive technology, potentially replacing drug and physical therapy regimens and offering improved lifestyle at a reduced cost. These two businesses serve as solid growth "kickers," complementing an already-solid growth businesses.

Medical equipment shares are out of favor at the moment due to the inclusion in the most recent health care legislation of a 2.3 percent excise tax on gross sales of medical devices, due to take effect in 2013. We're not sure why this should have any effect at all on the bottom line of companies like St. Jude Medical, as nearly all of its devices are paid for by insurers, giving device makers a fair amount of price flexibility. Further, the tax is a write-down against earnings. We'd be surprised at any significant impact to earnings in the year following the initiation of the tax.

Finally, the company has a consistent track record of steady growth and relative earnings and share price stability. The company easily scores a triple play with double-digit ten-year compounded growth in sales, earnings, and cash flows, and we expect this to continue. The company could continue to pick up market share in the wake of Boston Scientific's FY2010 recall, and the new technologies and applications are promising, as is the company's rich investment in R&D at 12 percent in sales.

Reasons for Caution

While much of St. Jude's growth is driven by market fundamentals and organic innovation, some of it is also delivered through acquisition, and some of the recent acquisitions have been expensive. The company could also be slowed by a general belt tightening and further legislative action and uncertainty in the medical field. Finally, as Boston Scientific showed us, errors can be very costly in this business.

AGGRESSIVE GROWTH.

Staples, Inc.