Three ways to play the recovery

published 26 June 2009

Each week, a professional investor tells MoneyWeek where he'd put his money now. This week: Alex Illingworth, portfolio manager, global equities, Insight Investment.

The old adage of 'Sell in May and go away' has not resulted in a broad sell-off this year, but more of a sideways move. The good news is that a wider range of sectors is picking up, including utilities and pharmaceuticals. This is healthy; one sector leading a market move makes that move more vulnerable. We have recently met many of the companies whose stocks we own to discuss the direction of their orders. There is not enough evidence either way to be sure of the outlook. But for now, stability has returned. Stable order flows, while at a low level, give companies confidence to plan ahead. Major cost-cutting plans have been largely completed for now, no more big cuts are being put into action.

But it is tough to distinguish between genuine new demand and a reaction to de-stocking. Order stability could perhaps be due to the Chinese stimulus package, or it could just be a rebound from the very depressed levels of 2008's fourth quarter. Will order flow continue? The US stimulus sounds encouraging, but hasn't yet worked its way through the system to raise end demand. For now, stability is good enough for the market, but as we go through the back end of this year, real demand needs to pick up for the market to rise further.

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We're looking for stocks with some downside protection, but also that are leveraged to an improving economy. Norfolk Southern (NYSE: NSC) runs a 21,300-mile US rail network. The group is exposed to the automotive and coal markets, both of which have seen demand fall sharply. However, railway groups have become more efficient in recent years, and a lack of investment in the sector has seen it regain some pricing power. Many long-term deals are expiring and being renewed at more favourable rates, so profits are holding up fairly well in the downturn and any rebound should lead to higher volumes and profits.

Brewing group Anheuser-Busch InBev (Euronext: ABI) sold off last year after its debt-funded takeover of Anheuser-Busch as investors fretted over its ability to refinance its debts. However, such concerns have so far proved too bearish. InBev has been able to sell some assets as well as successfully refinance some of its debts. More work must be done, but InBev has a good track record of taking costs out of businesses. The stability of its beer unit should mean refinancing issues can be addressed. Also, the group's exposure to emerging markets will help grow sales as the world economy picks up.

WW Grainger (NYSE: GWW) distributes more than 870,000 industrial goods across North America. It doesn't make the parts, so takes no raw material cost risk. It consolidates the products, provides the sales channel and distributes to the client. Grainger has 6% of a very fragmented market and is well placed to grow its market share. Smaller rivals are having trouble funding their working capital, while Grainger is investing in improving its customer service to capitalise on this weakness. The group is using its strong balance sheet to offer improved delivery times, lower costs, and to grow its product range and enhance its website. While industrial production continues to disappoint, sales will stay weak. But Grainger has a flexible variable cost model which allows it to adjust. If we see a stronger US industrial picture, Grainger is well placed. Either way, the opportunity now is to use the strong product breadth and financial position to add clients and grab market share.

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