The Economics Journal

A recession or a depression is not uniformly bad to everyone. There a lot of companies that can benefit from the current market condition, if their business model is good and they have enough cash to not rely on the debt markets. There are certain industries that will be created or be greatly benefitted as consumers shift their choices and lifestyles. In great depression, for example, the nascent movie industry greatly benefitted as more unemployed folks paid a nickel to watch a movie and spend 3 hours of their time. Then there are strong companies in weak markets where the recession helps in killing the weaker competitors and giving the strong ones a greater share of the market pie. They can also afford to give their employees lesser salary and bargain hard with their suppliers. Then there are companies that offer an inferior good (in an economic sense) that can be substituted for a superior good. Those who would normally buy at Nordstrom or Macy’s might move to Wal-Mart or Amazon.com, for example.

In looking at the prospective companies, we should not just see the market share, but also look at their profitability and balance sheet, because even increasing revenues cannot help if the companies run operating losses or are way deep in debt. ERTS is an example where  Here we look at companies that might benefit from the depression/deep recession ahead of us.

Games:

Wall Street Journal Reports about the increasing usage of online games and movies among those who are out of work. According to Comscore data, among of leisure minutes jumped up almost 20% lat year. A lot of these people spend time in Online games, where the number of visits went up 27% last year according to the report from edge-online.

Not all companies in gaming are profitable, however. The market leader, Electronic Arts (ERTS) is losing money and cutting jobs.

Companies to look for in this space

1.  GigaMedia (GIGM) making games targeting Chinese audience that has no debt, gross profit margins above 60%, a P/E around 8 and PEG of 0.46.

2. Activision Blizzard (ATVI) makers of Guitar-hero and other popular games, with very good growth, lot of cash and good profit. Its P/E is a bit high, but it is selling at its book value and profit and revenue growth is pretty attractive.

Movies:

If you have a whole day off, don’t have money to go to vacation or parties, you want to forget the sorrow, what would you do? If you are like most people, you will watch Movies and TV. And movie industry will grow up to meet the demand. Also, the times of sorrow produces great ideas and inspiration for the movie producers. Great depression was a great time for the movies and many of my personal favorites including – Gone with the Wind, Wizard of Oz, It’s a wonderful life, City of Lights, A night at the opera came in 1930s. Theatres are already reporting a spurt in growth. However, that might slow down at some point as people might not be able to afford the $10/per person tickets along with $5 some cost for travel and food. A typical family needs to spend over $50/visit to the theatre and that might be unaffordable for some.

Thus, NetFlix (NFLX) will become a even great choice as it costs less than $15 for a month worth of entertainment for a household. The customer growth and profit growth has been terrific for them, and now around 10 million homes in US use them. The stock has been on a terrific run (see its comparison with S&P 500 in the chart below), has no debt and its bigger rival Blockbuster (BBI) is losing its market share (though I’m personally still holding to them as their store service is good). The only concern is it P/E that is in 20s compared to its competitor BBI which is around 4 and has fallen 60% last year. So, there is some probability that it might be a bit overvalued right now and might not attract Value investors. But, if the profit grows like how it did last quarter (90% yoy growth in profits) then P/E should not be too much of an issue.

Discount Retail

Even the unemployed have to eat and bath. So stores selling groceries and other essential should not be too affected. Moreover, when people stop buying clothes at Nordstrom or JC Penny’s they will have to switch to some discount retailer. Here is where Wal-Mart (WMT) comes. It is a well-run company and has both the cash and the capability to survive long. It can also squeeze its suppliers in this deflationary phase. The stock has fallen off 15% since its peak in September 2008, but it is still holding good and has far outperformed both its competitor Target and the overall market.  It has a lot of cash (about 6 billion), posses great cashflow and a fairly attractive P/E of around 13.

Another company that is profiting here is Amazon (AMZN). It has a 2 billion + cash chest and its revenues are growing. Layoffs would produce a lot of workers who would want to upgrade/polish their skills with new books or spend more time with other books they always wished. Reading is an inexpensive hobby and can survive a depression. Given that online shopping is more cheaper and online time spent per person is increasing their sales are growing. In fact, its sales surged 18% and profits by 9% last quarter. Its high P/E will be a cause of concern to value investors.

Pharma and Consumer goods:

Recession doesn’t mean people don’t get sick or can stop brushing. It is very hard to avoid Johnson and Johnson (JNJ) and Procter & Gamble’s (PG) products in a day’s life and there are companies that have been there forever (overcoming depression and other economic crisis over 100 years). These are also very good in dividends and helps the good old fashioned investors. JNJ is much more cash rich than PG (12b vs 4b) and has lower P/E, but PG is still growing good in revenues, while JNJ has a slightly negative revenue growth last quarter. So, if you are growth investor choose PG and if you are value choose JNJ. Merck (MRK) is another choice that readers should research more on.

Sin stocks

Recession/depression might produce more sin than the prosperous times. Tobacco companies like Altria group (MO) (owners of Phillip Morris) and British American Tobacco (BTI). MO has very little debt and an attractive P/E (~5) compared to BTI that has a net debt over 10b and a P/E of 16. However, MO’s growth of around 6% (last quarter) is far out paced by BTI’s 25% growth last quarter. The liquor company Pernod Richard (RI) is another company the readers should research more on.

Disclosure: I have no positions in the stock discussed here – GIGM, ATVI, NFLX, WMT, AMZN, JNJ, PG, MRK.