5 hot back-to-school stocks

By BusinessWeek

School's out for summer, as Alice Cooper once sang, but the golf-loving metalmeister got the "out forever" part wrong. In fact, the U.S. Education Department projects pre-kindergarten through 12th-grade enrollment to increase to 16.5 million in 2006, up 17% from a decade ago. With the student body expanding, a few stocks stand ready to enjoy seasonal back-to-school trends.

First, though, some of these companies must pass the test of declining consumer spending. Shoppers have tightened their wallets amid soaring gasoline prices and a cooling housing market (see BusinessWeek.com, 07/31/06, "The economy's Pop-Tart problem"). If current trends worsen, it could be difficult for retailers and others to get to the head of this year's back-to-school class.

The quirks of the calendar could further complicate year-to-year sales comparisons this year, some analysts say. Last year the two biggest weeks for back-to-school spending both fell in August, but in 2006 they'll be spread across different months, according to Dan Genter, president and chief executive officer of Los Angeles-based investment firm RNC Genter. "August is probably going to look a little bit weaker compared to last year, all things being equal," Genter says. "But then it's going to make September look a little bit better."

Nonetheless, certain well-positioned outfits stand ready to overcome the negative trends. This week's Five for the Money looks at five smart stocks that might benefit from the annual autumn return of reading, writing, and arithmetic.

1. Apple Computer

Apple (AAPL, news, msgs), which traditionally has had a solid presence in the education market, is looking to tighten its grip. Earlier this year, the computer maker unveiled a new low-end PC that sells for $899 to schools, students, and teachers. In Europe, it's even seeking to build education technology around the iPod (see BusinessWeek, 3/23/06, "Apple loves France, sometimes)".

While Apple isn't the biggest-selling PC maker in the education segment, its presence there has been a boon for its PC business. In 2005, the Cupertino, Calif., computer giant grabbed a 15% share, by units, of the $6.1 billion U.S. education market, far behind Dell (DELL, news, msgs) but ahead of Hewlett-Packard (HPQ, news, msgs). While the overall school market grew by 9.6%, Apple saw its units sold increase by 14.9%, helped by Apple's ongoing focus on the K-12 market, according to IDC analyst David Daoud. Those may not be iPod numbers, but the education space is crucial to Apple's efforts to build brand loyalty "straight from the get-go," Daoud says.

But Apple isn't earning better marks only in education. Following 13 straight quarters of upside earnings surprises, the company stands to turn in more gains thanks to iPod growth, the shift to Intel (INTC, news, msgs) processors, and potential new product launches, observes Bear Stearns analyst Andrew Neff.

"Unlike a year ago when Apple's growth was dependent on one 'hit' product, we see Apple with multiple growth drivers," Neff wrote in a July 19 report. He has an outperform recommendation on the stock. (Bear Stearns has a non-investment-banking relationship with Apple and makes a market in the company's securities.)

Apple shares are still down from their 52-week high of $86.40, touched Jan. 12. Apple shares closed at $67.21 on Aug. 7.

2. Staples

Would a new school year really be complete without new pencils, pens, and notebooks? When it comes to office supplies, Staples (SPLS, news, msgs) is the analysts' current pet, with a better average recommendation than smaller rival Office Depot (ODP, news, msgs). The Framingham, Mass. -based retailer offers a positive long-term story despite rising paper costs, analysts say.

Chalk up some of the appeal to strong revenues. After softening in May, Staples' same-store sales likely accelerated into July, boosted by targeted advertising and better merchandising, says Citigroup analyst Bill Sims, who rates the stock a buy. "Staples continues to see strength in key categories such as office supplies, copy center, digital imaging, and accessories," he wrote in a July 30 report. (Citigroup has a significant financial interest in and an investment banking relationship with Staples, and also makes a market in the company's securities.)

Solid demand seen in Office Depot's recent earnings report also bodes well for Staples, which posts its quarterly results Aug. 15, according to Bear Stearns analyst Christopher Horvers, who has an outperform recommendation on the stock. Shares closed at $23.04 on Aug. 7, down 16.8% from a 52-week high of $27.71. (Bear Stearns has a non-investment-banking relationship with Staples and makes a market in the company's securities.)

A company spokesperson says Staples expects "terrific" back-to-school sales this year, though she declined to go into specific numbers. "Staples has pumped up the color and fun in our back-to-school assortment," the spokesperson says. "We think it's really going to resonate with teens and students of all ages."

3. Gap

The dawn of the new school year brings the chance for a fresh start for students and teachers. Venerable clothing retailer The Gap (GPS, news, msgs) could use one of those this fall, following a dismal 2005 for its Gap, Old Navy, and Banana Republic stores. Shares of the San Francisco-based company have fallen almost 5% since the start of 2006 to close at $16.90 on Aug. 7.

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