Portfolio Review

7/16/2012


Upgrade & downgrade

Southwest Airlines ($10; LUV), the largest carrier in the U.S. by passengers flown, is being added to the Long-Term Buy List. Until recently, high fuel costs have muted some of the operational gains coming from Southwest's acquisition of AirTran in May 2011. But fuel costs are subsiding and ticket prices mostly holding. The consensus projects 107% profit growth in the June quarter and 86% for the year, and estimates are on the rise. Shares trade at just 12 times estimated 2012 earnings. The stock earns a Financial Strength score of just 27, but Southwest has improved its balance sheet and enjoys the strongest finances in its industry. Southwest is being initiated as a Long-Term Buy.


IBM ($186; IBM) has fallen 12% from its all-time high in April. Quarterly sales growth has decelerated in each of the last three quarters, and concerns about weakening demand for technology equipment weigh on the shares. Despite the price declines, IBM is not cheap. The trailing P/E ratio of 14 is roughly in line with the five-year average, while price/sales and price/cash flow ratios are higher than historical norms. IBM has nearly doubled since we began recommending it in late 2006, but its Quadrix® Overall score has fallen to 69. IBM is being dropped from the Long-Term Buy List and should be sold.

Health reform makes Medicaid look good

Medicaid providers are suddenly positioned for growth following the Supreme Court ruling on health reform. WellPoint ($61; WLP) struck first in the Medicaid grab, agreeing to acquire Amerigroup ($89; AGP) and its 2.7 million members for $4.9 billion. That price tag represents a rich 43% premium to Amerigroup's stock price prior to the announcement, yet investors approved of the deal, pushing WellPoint shares slightly higher.

WellPoint's move could presage more consolidation. UnitedHealth Group ($56; UNH) and Aetna ($38; AET) both have the wherewithal to make acquisitions. Medicaid plans could swell by 17 million members under health reform, though that target may prove optimistic, as some states appear intent on rejecting the expansion. Aetna and UnitedHealth are rated Buy and Long-Term Buy. WellPoint is rated B (average).

Stores swat at swipe fees

Visa ($122; V) and MasterCard ($420; MA) are close to settling a longstanding antitrust lawsuit brought by a group of U.S. retailers, according to published reports. The lawsuit accuses the two electronic-network companies of colluding to fix interchange fees merchants must pay to cardholders' banks for noncash transactions.

Estimates of a potential settlement range from $6.5 billion to $12 billion. Visa has agreed to pay two-thirds of any settlement, with MasterCard covering the balance. Retailers are also pushing for a temporary reduction in interchange fees and the elimination of the no-surcharge rule. That last provision would allow retailers to assess a surcharge on items purchased with credit and debit cards in order to recoup part of the swipe fees.

Although American Express ($58; AXP) is not named in the lawsuit, it, too, could be affected. Amex allows surcharges to cardmember purchases only if the retailer applies that fee uniformly across all accepted electronic networks. Until now, retailers that accept all major cards have been unable to implement surcharges, but that would change if Visa and MasterCard lift their ban. Amex is a Focus List Buy and a Long-Term Buy. Visa is rated Buy and Long-Term Buy. MasterCard is rated B (average).

Banks in another ugly mess

J.P. Morgan Chase ($34; JPM) is one of more than 10 banks that could get ensnared by a global probe into the manipulation of interest rates used to price an estimated $350 trillion of products such as credit cards, student loans, and home mortgages. Barclays ($10; BCS) has already agreed to pay a $450 million fine, and civil lawsuits against the banks could spiral into the tens of billions of dollars.

J.P. Morgan could provide more details on the investigation, as well as an update on trading losses linked to the London Whale, when it reports June-quarter profits. The bank was slated to release results July 13, after this issue went to press. The stock is rated Long-Term Buy.

Enterprise tech update

Researcher Gartner projects corporate technology budgets will rise 3% globally in 2012, up from its prior 2.5% estimate because of currency effects but below last year's 8% expansion. Growth is projected to decelerate across all spaces of the market, potentially causing trouble for recommended stocks such as Cisco Systems ($16; CSCO), EMC ($24; EMC), Intel ($26; INTC), and KLA-Tencor ($45; KLAC).

Semiconductor maker Advanced Micro Devices ($5; AMD), a rival to Intel, reported lower-than-expected sales in the June quarter on weakness in Europe and China. The warning could hint at trouble ahead for Intel, and some analysts have trimmed their 2012 estimates. In other news, Intel agreed to invest $3.1 billion for a 15% stake in Dutch semiconductor-equipment maker ASML Holding ($53; ASML) and spend another $1 billion to fund ASML's research.

KLA-Tencor, a maker of test and inspection equipment for semiconductors, alleviated some concerns by reporting robust demand at chip foundries, though it expects orders to decline in the September quarter as makers of memory chips delay production investments. Management said June-quarter revenue reached the upper end of its prior guidance of $840 million to $900 million; the consensus projected sales of $873 million. KLA-Tencor also raised its quarterly dividend 14% to $0.40 per share, a move that will take effect when the company declares its next payout in August. Intel is a Focus List Buy and a Long-Term Buy. Cisco and EMC are rated Buy and Long-Term Buy. KLA-Tencor is a Buy.

Corporate roundup

Citing a "stagnant at best" environment and weak tourist spending in major cities, Macy's ($35; M) said same-store sales rose 1.2% in June, missing the consensus estimate of 1.9% and the retailer's internal expectations. However, Macy's reiterated its full-year target for same-store sales, up 3.7%. Macy's is a Focus List Buy and a Long-Term Buy.


Comcast ($31; CMCSa) sold its 16% stake in A&E Television Networks to other members of the joint venture, a group that includes Disney ($47; DIS), for $3.02 billion in cash; Comcast had valued the stake at roughly $2 billion earlier this year. Comcast is a Long-Term Buy. Disney is rated A (above average).


Apple ($608; AAPL) said its newest iPad will land in Chinese stores on July 20. Rumors continue to surface that Apple is preparing to launch a smaller version of its iPad before the end of 2012. Apple is a Focus List Buy and a Long-Term Buy.


Both Samsung and Hewlett-Packard ($19; HPQ) reportedly plan to release tablets that run on Microsoft's ($30; MSFT) forthcoming Windows mobile operating systems. Microsoft is a Buy and a Long-Term Buy. H-P is rated B.

Rank Changes

Southwest Airlines ($10; LUV) is being added to the Long-Term Buy List, replacing IBM ($186; IBM).


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