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Norman Barnett

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Darling stocks of May

Norm Barnett

TORONTO (GlobeinvestorGOLD)—Spring is the time for renewal. Time to plant a few seeds in the garden, time to clean out the garage of last year's junk. Of course the problem is that as soon as you plant anything, squirrels come along to dig it up. And when you search through the junk you've collected hoping to find that gem to take on the Antiques Roadshow, all you find are old Milli Vanilli records.

Luckily for you it doesn't have to be that way for your investments. Even as the overall market languishes there are companies that may be worth putting into a spring portfolio.
The income trust sector is still inexplicably hot. But the problem with picking up something from this asset class is that if the mood shifts, and you don't have to look hard to find people predicting it will, then there's a good chance that even the decent ones will tumble alongside the detritus.

So what darling bud of May will produce a bountiful harvest come fall? Try Shoppers Drug Mart Corp., the Canadian drug store chain that for years was part of the Imasco conglomerate. Shoppers took advantage of the fact that Canadian drugstores were still just a collection of small, mostly regional chains and independent pharmacies, and instead modeled itself on successful U.S. chains, and even large grocery chains such as Loblaw's.
SC TSX one-year performance chart

The company transformed often small, sometimes grungy pharmacies into gleaming multi-purpose stores. It seems to have worked since it had expanded to 830 stores by the time it went public last year, and after debuting at just over $17 a share, it has never looked back.

The stock is off its high of $25.96, but this is a well-managed company that continues to increase efficiency. Shoppers' operating margins in the first quarter were 9.1 per cent, which is pretty impressive in the retail business. It's even more impressive when you consider that its margins are among the highest in its industry and top Walgreen Co., long considered an industry leader.

Next, please?

What's more, later this summer the company is sweeping out one of last cobwebs of the old chain when it implements a company-wide scheduling system. It should be a big step toward eliminating those days when either the customers outnumber the staff or you have to wait in line 20 minutes to get your prescription filled. Plus, come fall, you'll see a new push on marketing Shoppers' more-profitable house brand of products, which industry analysts expect will boost sales.

Critics of the stock argue that it is expensive relative to its growth outlook, trading at 20 times estimated 2003 earnings. While the concern is valid, Shoppers remains a dependable company in a retail environment that is looking iffy for the next year or two. Patricia Best, an analyst at Merrill Lynch Canada is still enthusiastic about Shoppers, labeling the stock a "buy."

Retail analyst George Hartman at Dundee Securities suggests that the expansion of some of Shoppers big-box stores isn't going as well as it could, but he still thinks the stock is a "buy" because of the strength its franchise, and the drug store business right now will allow the company "to generate higher earnings in spite of the occasional internal and invisible stumble."

Semiconductors? Buy?

In the past few weeks as the tulips have poked through the thawing ground, Zarlink Semiconductor Inc. has also come out of its slumber. The stock has soared more than 90 per cent since the beginning of the year and it's possible the run isn't over yet.

Like Shoppers, Zarlink has slapped on a coat of paint and retooled itself. The company has emerged as a pure semiconductor play that makes the electronic bits for broadband and wireless devices, including a more aggressive foray into chips for set-top boxes.
That transformation required significant capital costs that sucked cash away from the company's bottom line. But the transformation is now complete and Zarlink's latest full-year results bettered expectations at a time when the rest of the semiconductor industry continues to struggle.

Some will argue that people who invest in semiconductors are the same people who like to jump out of airplanes. But Zarlink seems to be making believers out of its shareholders. There was strong reaction when it was revealed that company executives, including Chief Executive Officer Pat Brockett, were buying shares. Plus, for many, the fundamentals continue to improve. For example, gross margins, an important indicator for semiconductor companies, increased in the fourth quarter to 50 per cent from 44 per cent the year before. That's the highest its been since December 2000.

And most industry analysts expect that the company will turn profitable later this year. Desjardins Securities analyst Paul Howbald has Zarlink as his top pick in the technology hardware sector and recently said he thinks investors will continue to drive the stock higher as the company's revenue improves. He just increased his price target on the company to $9.50.

Norm Barnett is a producer at Report on Business Television.

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