Upgrades & downgrades
Drug wholesaler McKesson ($95; MCK) is being upgraded to a Buy and Long-Term Buy. The company has delivered solid growth on the strength of its drug-distribution business, reflecting improved sales of higher-margin generic drugs. Strong demand for generic drugs should help sustain growth, spurred partly by the expected boost in insured individuals following the Supreme Court's decision to uphold health-care reform.
McKesson earns a Quadrix Overall score of 92, and both of its sector-specific scores exceed 90. For fiscal 2013 ending March, management targets per-share earnings of $7.05 to $7.35. The consensus stands at $7.23 per share, implying a 13% increase. Considering McKesson's potential for consistent profit growth, the shares seem cheap. At 15 times trailing earnings, the shares trade at an 11% discount to their 10-year average P/E.
We are removing MasterCard ($440; MA) from the Buy and Long-Term Buy lists due to its declining Quadrix scores and high valuation. Projected to increase per-share profits 18% in both 2012 and 2013, MasterCard still enjoys a strong growth outlook. But the shares trade at 22 times trailing earnings, a hefty 35% premium to the peer group. Up 75% since we first recommended the stock in March 2011, MasterCard should be sold. We prefer Visa ($127; V) and American Express ($59; AXP), reviewed this week in Analysts' Choice. Amex is being added to the Focus List.
Aetna ($39; AET), discussed below, is being dropped from the Focus List but remains a Buy and a Long-Term Buy.
A group of plaintiffs in Ecuador filed to take control of Chevron's ($106; CVX) assets in Brazil. Chevron no longer holds any assets in Ecuador, forcing the group, victors in an $18 billion legal battle over environmental issues, to pursue its award in other countries. In May, the plaintiffs made a similar filing in Canada. Chevron has alleged fraud and appealed the decision with Ecuador's Supreme Court. Chevron is a Buy and a Long-Term Buy.
J.P. Morgan Chase ($36; JPM) shares fell on reports that trading losses linked to the so-called London Whale could be larger than previously believed. Reuters reported that losses could range from $4 billion to $6 billion, while The New York Times said the bank's internal estimates peg losses at $9 billion under the worst-case scenario. In May, J.P. Morgan projected a $2 billion loss but conceded that amount could rise by another $1 billion as the bank unwound its position. J.P. Morgan has said it will give an update when it announces June-quarter results on July 13. In other news, U.S. regulators are investigating J.P. Morgan for allegedly manipulating energy markets in California and the Midwest, inflating electricity costs by at least $73 million. J.P. Morgan maintains it did nothing wrong. The stock remains a Long-Term Buy.
Microsoft ($31; MSFT) has announced a couple of big acquisitions in the past 14 months, including $8.5 billion for Skype and $1.2 billion for Yammer. But as a reminder that not all deals go as planned, Microsoft will take a $6.2 billion write-down in the June quarter, stemming from the 2007 acquisition of online-advertising firm aQuantive for $6.3 billion. Microsoft also dialed back expectations for its online unit (4% of sales in the 12 months ended March), which includes the search engine Bing but remains unprofitable.Â The stock is Buy and a Long-Term Buy.
Seeking to expand further into open-source software, Qualcomm ($56; QCOM) formed a subsidiary to house its research-and-development arm and wireless-chip business. The parent company will retain most of the patents that drive Qualcomm's licensing business. Management said it has no intentions of spinning off the subsidiary, and the move will not affect the company's profits. In other news, CEO Paul Jacobs said supplies of semiconductors are improving, though some customers will miss the launch of new phones. Qualcomm is a Focus List Buy and a Long-Term Buy.
Health stocks have moved in different directions following the Supreme Court's decision to uphold most of the Affordable Care Act. The court found the individual mandate, the reform's controversial underpinning, legal under Congress's taxing power. However, the court struck down a provision that would have let the government withhold existing Medicaid funds from states that refuse to expand Medicaid coverage. Some states are reportedly considering opting out.
The health reform could add an estimated 30 million new customers to insurer rolls by 2016, though state opt-outs would shrink that number. Portions of the vast reform have already begun, though many of the most significant provisions begin in 2014. The court ruling offers some clarity to the sector. Republicans have vowed to repeal the entire law, though they may lack the votes.
Hospitals rank among the biggest winners, with the reform reducing the burden of providing charity care to the uninsured. Higher volumes should also benefit testing services and medical suppliers. Shares of pharmacy-benefit manager Express Scripts ($55; ESRX) have climbed 3.5% since the ruling, versus 2.5% for the S&P 500 Index.
Higher rebates will cost Abbott Laboratories ($65; ABT)Â and other drugmakers an estimated $85 billion over 10 years, according to Moody's. Many of these fees and rebates kicked in last year. Meanwhile, device makers such as St. Jude Medical ($40; STJ) will begin paying a 2.3% excise tax on U.S. sales in 2013.
The individual mandate blankets most of the poor with coverage, favoring insurers with the greatest exposure to Medicaid. But higher membership will be partly offset by provisions that cut into profitability, such as minimum levels for medical loss ratios and the requirement to accept patients with pre-existing conditions. Insurance premiums will likely cost more than the fines for eschewing coverage, creating the risk that healthier Americans could choose to pay the penalty to the government rather than pay premiums to insurers. UnitedHealth Group ($56; UNH) draws about 14% of premiums from Medicaid, and Aetna ($39; AET) just 5%. Shares of both insurers are down more than 5% since the announcement.
That discouraging share-price action is one reason we are removing Aetna from the Focus List. The downgrade also reflects disappointing operating momentum and declining profit estimates. But the shares are cheap, earning a Value score of 96 and trading at less than eight times estimated 2012 earnings — 30% below its peer group. We still expect attractive 12-month returns, but Aetna no longer ranks among our very best ideas. The stock remains a Buy and a Long-Term Buy. Both Express Scripts and UnitedHealth Group are rated Buy and Long-Term Buy. Abbott and St. Jude are Long-Term Buys.
Aetna ($39; AET) is being dropped from the Focus List but remains a Buy and a Long-Term Buy. American Express ($59; AXP) is being added to the Focus List. MasterCard ($440; MA) is being dropped from the Buy List and Long-Term Buy List. McKesson ($95; MCK) is being added to the Buy List and Long-Term Buy List.