(By Philip Guzier) Implied volatility is near long-term lows, and there is no systematic pattern making one industry cheaper than another, so this week's selections are based on old-fashioned stock-picking to find opportunities to buy bullish exposure to undervalued securities.
Scanning across all of Morningstar analysts' best ideas, I believe that the following companies provide the best opportunities to buy bullish exposure.
WellPoint (WLP)is one of the largest U.S. health insurers by medical membership, serving 34 million people. It holds the exclusive license to the Blue Cross and/or Blue Shield names in 14 states, including California, Georgia, New York, and Ohio. WellPoint's business mix is weighted toward the commercial market, with a particular focus on small-group coverage. Approximately 40% of members are in traditional risk-based products, with the remaining 60% in fee-based products. WellPoint's 14 Blue Cross and Blue Shield plans provide the company with a unique combination of regional and national scale. The former is the key to negotiating favorable provider rates, while the latter is essential for leveraging administrative costs. Investors remain fearful about the regulatory headwinds facing WellPoint, causing the stock to trade for 8 times earnings and with a 40% discount to our fair value estimate. However, we think these concerns are overblown, as the recent health reform law should have only a modest impact on WellPoint's future profits. While we expect ongoing medical cost pressure, this should be partly offset by revenue growth opportunities and potential SG&A leverage. In the meantime, WellPoint generates copious free cash flow, which it is using to repurchase shares at a breakneck pace.
Exelon (EXC)is a holding company with regulated and unregulated divisions. With the recently added Constellation operations, its regulated utilities deliver power to 6.6 million customers at Commonwealth Edison (Illinois), PECO (Pennsylvania), and Baltimore Gas & Electric. Its generation fleet has 34 gigawatts of capacity in 7 states and produces 240 terawatt-hours of power annually. Exelon's 11 nuclear plants generate 80% of the fleet's total output. Even with Constellation's countercyclical distribution and retail businesses in the fold and cost synergies flowing through, Exelon still can't escape its overwhelming leverage to Eastern U.S. power prices. These power prices, highly correlated with sluggish natural gas prices, continue to drag down Exelon's earnings prospects for the next three years. If current markets persist, even Exelon's $2.10 per share dividend could be at risk by 2014. But leverage works both ways, and Exelon is the utilities sector's biggest winner if our outlook for higher power and natural gas prices materializes. Coal plant environmental regulations are tightening and utilities are shutting down plants, all supporting our bullish outlook. With this view, we think Exelon's midcycle earnings power is near $5.50 per share, nearly double our 2014 mark-to-market earnings estimate.
France Telecom (FTE.F)is the incumbent telephone operator in France, which accounts for about half of the firm's sales. French revenue is split among wireless (46%), fixed-line (33%), and other carrier services. FT's other largest revenue sources include Spain (8.8%), Poland (8%), and the rest of the world (19.4%). Orange Business Services also supplies 15.7% of sales, along with an international carrier business and eliminations. Iliad's entrance into the French wireless telecom market was more successful than we anticipated. While the initial surge has passed, France Telecom and the other operators' are responding by lowering prices at their core brands as well as their Internet-only SIM brands. We now expect these lower prices to hurt the firm's ARPU for the next two years as its contract base renews at lower prices. However, despite FT losing some customers and seeing its ARPU decline, we continue to think the stock is significantly undervalued. Mobile termination rate cuts in France, which have been pressuring revenue for seven years, will be virtually over by the end of 2013. Additionally, the firm's cost-cutting and natural attrition should start to benefit margins by 2014. In our opinion, the market is totally focused on the decline occurring now and missing the long-term upside.
Suncor Energy (SU)is an integrated energy company, producing 550 thousand barrels of oil equivalent per day, 90% oil, from its assets in Canada, the North Sea, and other international locations. Key to Suncor's success is its oil sands assets, which produce over 330 mbpd from mining and in situ operations. Most of this is upgraded and sold either to the market or refined at one of Suncor's four refineries in the U.S. and Canada, with total throughput capacity of 455,000 bpd. We have updated our price deck with the most recent forward curves for oil and natural gas. While this will cause a reduction in our near-term outlook for Suncor, the future remains bright for the company, and we are maintaining our CAD 52 per share fair value estimate. Suncor is currently trading below our fair value estimate, and we find it very attractive at these prices. While cash flow will be lower over the near term, we expect Suncor to breach the 10 billion mark in annual cash flow in 2016. Key to Suncor's success is its integrated approach (downstream and upgrading) to expanding its oil sands production, such that its potential exceeds 500 thousand barrels per day of mineable bitumen and over 400 mbpd of in situ bitumen. While Suncor is synonymous with oil sands, its portfolio includes refineries, and offshore and onshore assets in Canada, in addition to its assets in Libya.