Quality at a Discount| Leeb's Market Forecast Analysis and Tips

ICAP scoops up a lagging oil company and a drug maker

On the preceding page, in recognition of the rising level of insecurity in the world, we urged fund investors to make sure they own at least one large-cap growth fund. By the same token, we were eager to add a high-quality large-cap stock or two to our Fund Finds portfolio. As we searched, we stumbled upon a relatively young, small five star-rated Large Cap Value fund: ICAP Select Equity fund (ICSLX). With just a little more than $140 million under management, the fund has been an outstanding performer. It is in the top 10 percent for the category year to date and in the top 11 percent for the past five-year period. The fund selects its holdings from a group of 450 large-cap U.S. and European names, focusing on stocks with attractive valuations, consistent to improving earnings, and clear catalysts for growth, such as new product launches. Recently the fund was featured in an article “Great Funds at Bargain Prices” in SmartMoney.com as one of 58 actively managed funds that have delivered impressive returns at a low cost over the past five years.

We’re not recommending that our subscribers buy ICAP Select Equity fund itself, though, for two reasons. First, with only 27 holdings as of February 2004, it is too concentrated to be a core fund. Second, its turnover is too high—more than 300 percent—and thus it has low tax efficiency. But we looked at its recent purchases with keen interest and are adding the two below to Fund Finds. Both have been lagging their groups in the market but should come on strong in the fairly near future, and both, as a plus, offer healthy dividend yields.

The first is Texas-based Marathon Oil, one of the smallest integrated oil companies. After an impressive 2003, its shares have underperformed both the overall market and other oil and gas companies so far this year. One likely reason is the company’s decision to buy out the remaining portion of its refining and marketing joint venture with Ashland, which Marathon will finance in part by selling additional shares. But given our firm belief that oil and gas prices will be rising, we think this is a savvy acquisition. Kerr-McGee’s recently announced acquisition of Westport Resources, which shook up the energy sector, further bolsters the case for higher energy prices ahead (see p.10). Marathon trades at under 4 times cash flow and at approximately 10 times earnings. This is a significant discount to larger integrated oils like ChevronTexaco and ExxonMobil. With Marathon’s 3 percent dividend yield, a low 30 percent payout ratio, and long-term growth of nearly 10 percent, our target for the stock is 50.

The second addition is British pharmaceutical giant GlaxoSmithKline, which beefs up our underweighted health care holdings. The company’s strength lies in its commitment to research and development, and it now has some 80 products in its drug pipeline. Three drugs are expected to move into their final Phase III trials this year and each could be generating $1 billion a year in revenues by 2005. While earnings growth will likely be flat in 2004, we think this is already largely priced into the stock, which is down more than 10 percent so far this year. Glaxo, which has an attractive dividend yield of almost 4 percent, currently trades at around 13 times next year’s earnings. Its stable cash flow from operations allows the company both to maintain a solid 50 percent dividend payout ratio and to stay committed to share repurchases. With the dividend providing downside protection and the stock trading at nearly a 20 percent discount to other major pharmaceuticals, GlaxoKlineSmith, whose ADRs trade under the symbol GSK, is targeted to reach 60.