Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall, and joining me today to give his '3 Stock Picks' is Dan Harlow, Manager of the AXA Framlington American Growth fund.
Hi Dan.
Dan Harlow: Morning.
Wall: So what's the first stock today?
Harlow: First stock today is a company called O'Reilly Auto Parts (ORLY), and they are as the name would suggest a retailer of auto parts in the U.S. They have over 4,000 stores.
Wall: And auto is quite often an indicator of how the U.S. economy is doing, and when the U.S. economy is doing well, auto does well. Has that been reflected in this stock?
Harlow: Well, it's benefiting at the moment from a marked increase in miles driven in the U.S. So a function of very strong employment numbers, more people commuting, driving to work and also the much lower gasoline prices we're seeing in the U.S., a clear function of the lower oil price, meaning that Americans are spending more time in their cars.
This August, miles driven was up 3.5% year-on-year which is a pretty significant increase, so we're now at pre-recession highs, and the more you use your car, the more you are going to need to replace the parts. So, there is a nice tailwind to the industry at the moment that O'Reilly are benefiting from.
Wall: Does that mean, then they are overly sensitive to the U.S. economy, because there are some rumors this year that as the rates rise in the U.S. that the economy may have – fear a negative effective. Will you see that in this stock?
Harlow: We don't think we will. What this company is sensitive to are the number of cars on the roads, the age of that fleet, and while the retail sales, the auto SAAR number has been at record level in 2015. There is still a very aged fleet of cars on the streets of the U.S. So, it's a fragmented industry, it's a $140 billion industry and O'Reilly have sales of about $8 billion. So, they have big, big share opportunities.
Wall: And what's the second stock today?
Harlow: The second stock is a biotech company called Celgene (CELG), which is relatively mature biotech company. In that it has very substantial free cash flow. It has a very balanced mix between products on the market today and pipeline. Its largest drug is called REVLIMID, which is for the treatment of blood cancers and that's growing mid-teens year-on-year and the company is looking to expand the label into new indications and into new geographies.
Wall: And how has that done, because biotech became a bit of a buzz word. There was almost rumours of another tech bubble a couple of years ago, is it was the sector on everyone's lips. It did incredibly well in 2013, 2014, and then of course this year, it's actually, or recently rather, it's come off a bit, hasn't it? Has that been reflected in this share price?
Harlow: It has and so the price has sold off from a high last summer of about $130 to about $100 today. Fundamentally nothing has changed for Celgene. They have very clear vision on their numbers, they're looking to grow earnings 20% a year through to 2020, that doesn't factor in pipeline, that's a function of product releases and…
Wall: So guaranteed cash.
Harlow: Well, they're very confident on and we think they can be beaten, but there are broader concerns in the industry around pricing. It's a very emotive subject, very controversial subject, and in an election year it's something that could well be given closer scrutiny. However, we feel the innovative companies like Celgene that are investing heavily in their pipeline in research and development, can justify the prices for the drugs that they achieve. Feel that the sell-off is presenting some opportunity.
Wall: And what's the third and final stock?
Harlow: The third name is Electronic Arts (EA), which is a computer games producer.
Wall: EA Games, I think a lot of people would have seen it across the bottom of their screens.
Harlow: EA Sports, exactly. They're most famed and most known for their FIFA franchise, released and updated every year. Similarly they've got a very strong NFL franchise, American Football franchise. And most recently they've launched the Star Wars Battlefront game.
Wall: Then leaping on the back of very topical things, but this is a very competitive market, isn't it, and one that constantly innovates. I mean, if we think back to what maybe my generation, the first video games that they played. You stuck a cassette in the top of a machine and now a lot of it is online. Are they at the forefront of that innovation?
Harlow: I think you've hit the nail on the head in terms of identifying one of the key issues for company at the moment. There is a game cycle going on, it's been big investment in the new Xbox, new PlayStation, which is helping the business. But what is most exciting is a secular margin opportunity for this company, as people digitally download their games rather than buy from the bricks-and-mortar store, as they're able to cut out the retailer, they're able to retain greater level of margin.
Also the used game business, the second hand game business will gradually shrink, which is an advantage to EA, who will hopefully in time be able to sell more new games and digital downloads are at the low 20% at the moment for consoles compared to PC, which is near a 75%. So, we think there is really interesting margin opportunity there.
Wall: Dan, thank you very much.
Harlow: Pleasure.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
