Portfolio Review

6/4/2012


Don't give up on J.P. Morgan

J.P. Morgan Chase ($34; JPM) reportedly sold about $25 billion of high-yielding securities in an effort to offset huge trading losses. On May 10, J.P. Morgan disclosed more than $2 billion in losses since the end of March, with the possibility of another $1 billion or so to come in the June quarter. These losses stem from derivatives designed to hedge the U.S. corporate bond market.

The bank also said it had gained $1 billion on the sale of other securities. This is good news and bad news. Good news because the gains offset some of the losses. Bad news because the sales will eliminate a reliable source of income.

J.P. Morgan did not offer specifics about the securities sold. But a Reuters analysis of profits on past sales estimates the bank would have to divest $25 billion in debt securities to garner $1 billion in profits. CEO Jamie Dimon has expressed reluctance to sell profitable securities — which suggests he probably won't sell enough to offset all of the losses.

And those losses could get even uglier. The original projection of roughly $3 billion in losses and $1 billion in gains translates to a per-share-profit decline of about $0.50. The consensus projects per-share profits of $0.90 in the June quarter, down from $1.24 a month ago, while the September-quarter estimate has declined by $0.13 per share. However, some analysts think the losses could top $5 billion. A $5 billion loss equates to $1.30 per share. For perspective, the consensus projects per-share profits of $4.44 this year and $5.41 in 2013.

CEO Jamie Dimon, who already acknowledged "egregious mistakes" were made, is expected to testify before the Senate early this month. With politicians clamoring for increased regulation and Dimon openly critical of Washington's reform efforts, the hearing could get heated.

However, the shares have fallen 17% since news of the trades hit the market, and J.P. Morgan currently trades at less than eight times trailing earnings, at least 50% below the sector median and the company's own three-year average P/E ratio. The sell-off cost J.P. Morgan more than $27 billion in stock-market value, dwarfing even the largest estimate of trading losses. The decline reflects not just lower profits, but also a loss of prestige and the danger that the trading miscue could convince investors and regulators that the financial giants have grown too big to manage. While the bank will likely continue to take a public-relations beating, the shares already reflect plenty of bad news. J.P. Morgan retains its Buy and Long-Term Buy rating.

Mutual fund closes

Vanguard High-Yield Corporate ($6; VWEHX) has closed to new investors, but current shareholders can invest in the fund without limit. Income-hungry investors have flocked to high-yield bonds. As a result, cash inflows to many funds have surged and some have shut their doors, including previously recommended T. Rowe Price High Yield ($7; PRHYX), which closed to new investors in April. We plan to review a new pick among high-yield bond funds in the next issue.

EMC still a strong buy

Shares of EMC ($24; EMC) dipped after rival data-storage maker NetApp ($30; NTAP) reported solid April-quarter results but offered downbeat guidance, citing economic uncertainty and challenging conditions in Europe. Hampered by weak capital spending on information technology, many tech companies have issued cautious forecasts. But EMC stands tall in the group, reflecting a growing product line, market-share gains, and favorable pricing and margin trends. Moreover, robust cash flow and a strong balance sheet should help sustain growth.

Finally, EMC holds an 80% stake in VMware ($95; VMW), a maker of cloud-computing software expected to grow profits 24% this year. The consensus calls for EMC to earn $1.74 per share in 2012, up 15% on 11% higher revenue — conservative estimates, in our view. EMC is a Buy and a Long-Term Buy.

Technology roundup

Apple ($572; AAPL) CEO Tim Cook said television is an area of "intense interest" as the tech giant looks to accelerate its new product offerings. The company is said to be working on a TV set that seamlessly works with Apple's other devices. In other news, the latest iPad may soon hit shelves in China — Apple's second-largest market. The stock is a Focus List Buy and a Long-Term Buy.


According to published reports, Google ($594; GOOG) plans to ship about 600,000 tablet computers in June in preparation for a July launch. Rumors that the Internet-software titan plans to introduce its own tablet have been circulating since December, when an executive revealed that development was underway. In other news, a jury found that Android, Google's smartphone operating system, did not infringe on Java patents held by Oracle ($26; ORCL). The jury had found that Google infringed Oracle copyrights. The fine for copyright violations could be capped at $150,000. Both Google and Oracle are rated Long-Term Buy.


A European court rejected MasterCard's ($416; MA) bid to overturn a 2007 restriction on cross-border fees. MasterCard plans to appeal. MasterCard is a Buy and a Long-Term Buy.


Microsoft ($30; MSFT) is reportedly in talks to sell its 50% stake in MSNBC.com to Comcast's ($29; CMCSa) NBCUniversal. Microsoft is a Buy and a Long-Term Buy. Comcast is a Long-Term Buy.


Research In Motion ($10; RIMM) warned that it expects an operating loss in the May quarter, followed by a few more "challenging" quarters. The stock, already down more than 22% for the year, fell another 8% on the news. The consensus projects per-share profits of $0.42 for the May quarter and $1.86 for the year ending February 2013. In other news, RIM has hired investment bankers for a strategic review, a move widely seen as a plea for a suitor to buy the company. RIM is rated B (average) but looks riskier than most of our monitored stocks. While an acquisition is possible, subscribers should not bet on one.

Corporate report

The U.S. Senate approved the Food and Drug Administration's $6.4 billion fee agreement with drug and medical-device makers that will fund regulatory reviews through 2017. The Senate approval was not a surprise, and health-care recommendations Abbott Laboratories ($62; ABT) and St. Jude Medical ($40; STJ) barely moved on the news. Abbott and St. Jude are Long-Term Buys.


Macy's ($39; M) same-store sales rose 4.2% in May, slightly above the consensus. Online sales contributed to the growth, jumping 42%. Macy's is a Focus List Buy and a Long-Term Buy.

Rank Changes

No changes were made this week in Dow Theory Forecasts.


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