Portfolio Review

11/5/2012


Thermo Fisher on Focus, Fifth Third off

We are adding Thermo Fisher Scientific ($61; TMO), a maker of laboratory supplies and diagnostic tests, to the Focus List. The shares have rallied 5% since Thermo Fisher posted strong September-quarter results. With solid operating momentum (profit growth of 17% and operating-cash-flow growth of 35% over the last 12 months) and a cheap valuation, the stock should have more room to run.

Despite challenging conditions, especially for its academic and industrial customers, Thermo Fisher continued to gain market share in the September quarter. Sales grew more than 20% in China, as strength in environmental, food-safety, and health-care markets offset softness in industrial markets. Cash provided by operations jumped 33% to $480 million, marking the fourth straight quarter of double-digit growth.

Thermo Fisher has funneled that cash toward a new dividend, initiated in the March quarter, and stock buybacks, which have reduced the share count nearly 5% in the past year. The stock trades at 13 times trailing earnings (42% below its five-year average) and 11 times trailing cash provided by operations (32% below the five-year average). Thermo Fisher is also a Long-Term Buy.


Fifth Third Bancorp's ($15; FITB) loan growth slowed to 5% in the September quarter, hurt by a decline in commercial mortgage and construction lending. However, the residential-mortgage portfolio averaged $11.58 billion in the quarter, up 16% from a year earlier, while total commercial loans rose 7% to $46.90 billion. As the economy in general and the housing market in particular continue to recover, Fifth Third's loan growth should continue as well. Unfortunately, those loans are a bit less profitable today than they were a year ago.

The bank's net interest margin — the difference between the amount earned on loans and paid out on deposits — was 3.56% in the September quarter, flat with the June quarter and down nine basis points (0.09%) from a year earlier. Low interest rates have put pressure on net interest margins industrywide, and while Fifth Third is managing its margins well, the erosion will probably continue.

Consensus estimates project 21% profit growth in the December quarter, followed by a 2% decline in 2013; the latter target seems unduly conservative. Also, at just 10 times trailing earnings, Fifth Third trades at a 28% discount to its peers and 32% below its three-year average P/E ratio. While Fifth Third's loan growth and valuation remain compelling, uncertainty over margins drops the stock outside our favorite 12 to 17 names. Fifth Third is off the Focus List but retains its Buy and Long-Term Buy ratings.

September-quarter earnings

Apple's ($593; AAPL) per-share earnings jumped 23% to $8.67 in the September quarter, coming up $0.08 short of the consensus estimate. But sales rose 27% to $36.97 billion, slightly ahead of the average analyst estimate. Helped by the release of a new iPhone in late September, Apple said it sold 58% more smartphones than it did in the year-ago quarter, along with 26% more iPads and 1% more Macintosh computers.

Gross profit margins shrank in the quarter, a trend likely to continue as the less-profitable iPads make up a larger portion of the company's sales. For instance, Apple says margins on the iPad mini, slated to launch on Nov. 2, are "significantly below the corporate average." Margin pressures could point to rising production costs as the devices become more complicated to manufacture. Notorious for issuing conservative guidance, Apple's December-quarter outlook trailed analyst projections; its per-share profit target of $11.75 even trailed the $13.87 reported in prior year's quarter. Apple is a Focus List Buy and a Long-Term Buy.


Visa ($139; V) earned $1.54 per share in the September quarter excluding the reversal of previously recorded tax reserves, up 21% and $0.04 above the consensus. Operating revenue advanced 15% to $2.73 billion, as payment volumes increased 6% and processed transactions 2%. For fiscal 2013 ending September, Visa expects sales growth in the low double-digits, in line with the consensus estimate of an 11% increase. Visa also said Charles Scharf, a former executive at J.P. Morgan Chase ($42; JPM), was slated to succeed Joseph Saunders as CEO on Nov. 1. Scharf served on Visa's board from 2007 to January 2011. Saunders, head of Visa since 2007, will remain executive chairman until March. Visa is a Buy and a Long-Term Buy. J.P. Morgan Chase is a Long-Term Buy.


Comcast ($38; CMCSa) grew per-share earnings 39% to $0.46 excluding gains on asset sales in the September quarter, matching the consensus estimate. Comcast posted 15% sales growth to $16.54 billion. Revenue from the cable business rose 7%, mostly on growth in high-speed internet, business services, and advertising.  Comcast added 294,000 net new subscribers in the quarter, 28% higher than additions in the year-earlier period. Coverage of the 2012 London Olympics helped drive a 31% sales surge at NBC Universal. Comcast said it will at least break even on its $1.18 billion investment in the London games. Hoping to build on that momentum, NBC agreed to pay about $250 million to televise English Premier League soccer games over the next three years. Comcast's cash provided by operations advanced 9% to $5.01 billion and has risen in seven of the past eight quarters. Shares rallied on the quarterly results. Comcast is a Long-Term Buy.


McKesson ($93; MCK) posted September-quarter earnings per share of $1.92 excluding special items, up 18% and $0.14 above the consensus. Revenue slipped 1% to $29.85 billion at the distributor of drugs, medical supplies and equipment. For fiscal 2013 ending March, the company raised the bottom end of its profit range by $0.10 per share; the new midpoint calls for 14% growth in per-share earnings. In other news, McKesson agreed to acquire PSS World Medical ($29; PSSI) for $2.1 billion in cash and the assumption of debt. A supplier of disposable medical supplies and diagnostic equipment, PSS World generated annual sales of about $2.10 billion in fiscal 2012 ended March, versus McKesson's $122.7 billion. McKesson is a Long-Term Buy.

News roundup

Microsoft ($29; MSFT) CEO Steve Ballmer said Microsoft has sold 4 million upgrades to Windows 8 since its debut Oct. 26, ahead of the initial pace set by Windows 7, Microsoft's most successful operating system to date. Windows 7 launched in October 2009, in the midst of recessionary headwinds, and has since sold 670 million licenses. Walt Disney, ESPN, Lego, and Twitter are developing applications for Windows 8, though Facebook ($21; FB) has yet to make any announcement. Microsoft is a Buy and a Long-Term Buy.


Google ($680; GOOG) introduced a larger model of its Nexus tablet, priced at $399 — $100 less than Apple's iPad — set to go on sale Nov. 13. It also unveiled new models of a smaller Nexus tablet and smartphone. In related news, Google said it now offers more than 700,000 apps, matching Apple's selection. Google is a Focus List Buy and a Long-Term Buy.


Abbott Laboratories ($66; ABT) will repurchase up to $7.7 billion in bonds ahead of its January split into two companies. AbbVie (branded pharmaceuticals) is expected to sell nearly $16 billion of debt and give Abbott (nutritionals, medical devices, and generic drugs) an $8.5 billion cash infusion that will help pay for the debt buyback and retire other debt. Citing smaller cash flows and less business diversity after the split, Standard & Poor's reduced Abbott's credit rating to A+ from AA. Abbott Laboratories is a Long-Term Buy.


Disney ($49; DIS) agreed to pay $4.05 billion in cash and stock for Lucasfilm, which owns the Star Wars and Indiana Jones franchises. In the past seven years, Disney paid more than $11 billion in separate deals for Pixar and Marvel Entertainment. Disney is rated A (above average).


With a market value of $6.5 billion, BMC Software ($41; BMC) has reportedly shopped itself to several private-equity firms, in addition to Cisco Systems ($17; CSCO), EMC ($24; EMC), Dell ($9; DELL), and CA ($23; CA). Cisco and EMC are rated Buy and Long-Term Buy. Dell is rated B (average).


Rank Changes

Thermo Fisher Scientific ($61; TMO) is being added to the Focus List. Fifth Third Bancorp ($15; FITB) is being dropped from the Focus List but remains a Buy and a Long-Term Buy.


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