KSS

The Applied Finance Group (AFG) has a disciplined approach for identifying companies that are expected to outperform and underperform the market by using proprietary metrics and measurements that have been tested and proven through time. Because AFG’s research is fundamentally derived, AFG’s quantitative analysis spans across growth and value stocks, all sectors, industries, and market caps with over 20,000 covered securities globally.

When searching for Large-Cap ideas, AFG’s Buy/Sell list is a good starting place as it has proven to create a significant spread in performance between companies that come up on AFG’s buy list and those on the sell list. Further focusing on companies based on AFG’s proprietary screening criteria (Economic Margin, valuation, quality of earnings, and management’s ability to create shareholder wealth) will save investors time in their research process. The result is a target group of stocks that can help you outperform as well as identify potential torpedoes to avoid in your portfolios.

Below is a list of attractive companies in the S&P 500 from each major AFG sector (excluding financials). It serves as a focus list of companies for investors to begin with as they meet AFG’s criteria to be an attractive opportunity. They are more likely to outperform their sector peers and the S&P 500, the benchmark that AFG’s clients most often compare themselves with.

Source: EconomicMargin.com

AFG's Valuation Metric – Measures the percent to target (deviation between a stock’s current trading price and its AFG current default target price). To derive the intrinsic value of a firm, AFG uses its proprietary Valuation Model (modified discounted cash flow model).

Economic Margin - A corporate performance measurement that addresses the gaps in GAAP, eliminating distortions caused by accounting policies to measure what a company is truly earning above or below their cost of capital.

Management Quality – Assesses management’s ability to make wealth creating decisions.

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AFG Recommendation Performance
9/1998 – 5/2009
Annualized Returns

Source: AFGView client databases from 9/1998 – 5/2009
Universe size: 4,000 to 5,500 firms

With the biggest shopping season of the year just around the corner, we thought it would be timely to highlight some consumer sector companies that look attractive according to The Applied Finance Group’s (AFG’s) criteria for investment opportunity attractiveness, as they are in line to benefit from the upcoming seasonal spending patterns. The list of companies we have provided look the most attractive within the AFG consumer sector in terms of valuation attractiveness, economic performance, and overall investment attractiveness relative to their peers.

One of the companies that we feel particularly confident in is the retailer Kohl’s (KSS) which is currently a holding in The AFG 50, (a model portfolio of 50 large cap stocks designed to help Portfolio Managers save time, make more informed investment decisions, and outperform their benchmark). We are confident about Kohl’s competitiveness because they have a strong cash flow, strong execution, and have been outperforming their competition.

Going into this holiday season, consumers will most likely remain thrifty due to the overriding economic conditions, although their confidence levels have improved so far this year. They will search hard for values, being mindful of budget. We continue to believe Kohl’s will remain one of the most successful retailers in this country, as it strives to and succeeds in providing value to consumers with freshness and relevance of its merchandize.

The complete list of consumer stocks we have provided below, which includes the highlighted Kohl’s, are the companies AFG believes are the most likely to outperform. Companies that AFG identifies as having an attractive valuation, improving Economic Margins (AFG’s corporate performance metric) and an attractive investment opportunity signal have proven over time to outperform those companies with unattractive valuations, declining Economic Margins, and unattractive investment opportunity signal.

Source: EconomicMargin.com

AFG's Valuation Metric – Measures the percent to target (deviation between a stock’s current trading price and its AFG current default target price). To derive the intrinsic value of a firm, AFG uses its proprietary Valuation Model (modified discounted cash flow model).

Economic Margin - A corporate performance measurement that addresses the gaps in GAAP, eliminating distortions caused by accounting policies to measure what a company is truly earning above or below their cost of capital.

Management Quality – Assesses management’s ability to make wealth creating decisions.

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Kohl's Corp (KSS)

The Company operates family-oriented department stores that sell moderately priced apparel, footwear and accessories for women, men and children; soft home products such as sheets and pillows; and housewares.

Why We Like It

1. Sound and successfully executed strategy: Continuous expansion by building new stores; Continuous expansion of private or exclusive labels; Conservative inventory management; more efficient marketing.

2. Fared better than competition in 2008: Opened nearly 80 stores in 2008 or about 9% growth, comps down 7.7% ytd, EBITDA down 6%. Comps and earnings erosions are smaller than competition such as JCP and Macy’s. Not to mention Mervyns which is filing for liquidation.

3. Financial Strength: Doesn’t own credit card operation, therefore, no worries of credit loss. Has financial book debt of just $2 billion, EBIT / Int ratio is more than 10 times.

4. Going forward: In 2009, Kohl’s is going to continue to utilize its strong financial position to continue to open new stores and remodel existing stores to grow market share in a very difficult environment. The company has a very attractive valuation and our tgt price is $46, suggesting about 22% upside.

Value Expectations Analysis on KSS

Cvs Caremark Corp (CVS)

The Company is a provider of prescriptions and related healthcare services in the United States. It operates two business segments: Retail Pharmacy and Pharmacy Services.

Why We Like It

1. A juggernaut in providing healthcare services: CVS now has the largest retail pharmacy, and the 2nd largest PBM business in the US. Great potential to bring more convenient pharmaceutical benefits to consumers, at lower cost, by integrating mail delivery, internet, telephone, and walk in options.

2. Less volatile Demand: Drug retail is largely non discretionary, aging population, higher use of drugs for preventive measures, and the proliferation of new pharmaceutical products.

3. Good execution:
* CVS always won the battles related to acquisition targets against other suitors and has always delivered promised synergies from those acquisitions. They are consistent enablers of acquired assets.
* Ytd, front store comps growth has been positive and EBITDA margins have grown consistently from the year ago periods too.

4. Overall: Buying a sophisticated leader of an industry with stable demand at a great price.

Value Expectations Analysis on CVS

Valero Energy Corp (VLO)

An independent refining and marketing company that owns and operates 17 refineries in the United States, Canada, and Aruba. It produces conventional gasolines, distillates, jet fuel, asphalt, petrochemicals, lubricants etc.

Why We Like It

1. Margins for diesel are more favorable than gasoline, since diesel (retail price) is currently selling about 33% higher than gasoline. VLO’s distillate production, which includes diesel, jet fuel and heating oil, rose to 35% of overall production in first nine months of 2008, up from 33% last year.

2. The market has priced in more than 40% sales decline long-term, but we believe that VLO can do better than that.

3. Gasoline demand is down 2.2% from a year ago at 9 million barrels per day. However, it is difficult to believe that a 2% dip in demand would translate into a P/E multiple of only 5.3 (ttm) or EV/EBITDA of 3.2 (ttm).

Value Expectations Analysis on VLO

Freeport-Mcmoran C & G (FCX)

The Company is engaged in the copper, gold and molybdenum mining through its majority-owned subsidiary, PT Freeport Indonesia.

Why We Like It

1. Market is pricing in about 40% long-term sales decline, so there’s been overselling in the stock because we think that FCX can do better than that.

2. One year following the prior recession in 2001, FCX outperformed the S&P 500 Index by 44%.

3. FCX is responding to reduced demand by cutting back production, suspending its $2 per share a year dividend, and delaying spending on expansion projects. The market has rewarded the company’s moves recently, pushing up shares about 20% over the past 5 trading days.

Value Expectations Analysis on FCX

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