Portfolio Review

12/31/2012


Technology update

Google ($710; GOOG) accepted a $2.35 billion bid from Arris Group ($15; ARRS) for the TV set-top box business inherited via its $12.5 billion acquisition of Motorola Mobility Holdings. Arris' offer includes $2.05 billion in cash and $300 million of newly issued shares, nearly 16% of the company. The set-top unit produced sales of about $2.5 billion in the 12 months ended September but generated much lower profit margins than the rest of Google's businesses. Separately, Google's Motorola unit is designing a new mobile device under the code name "X Phone," reported The Wall Street Journal. The device is expected to launch in 2013. Google is also reportedly designing a new Nexus 7 tablet that could ultimately be priced at $99 — half the price of the current model and well below the iPad mini's price of $329. Google is a Focus List Buy and a Long-Term Buy.


Apple's ($520; AAPL) iPhone took a 53% share of the U.S. smartphone business in the 12 weeks ended Nov. 25, according to researcher Kantar Worldpanel ComTech. That represents the iPhone's largest share since 2007 and a gain of nearly 18 percentage points from a year ago. Google's slice of the U.S. market slipped to 42% from 53%. As for the iPad mini, Apple reportedly hiked orders for the device to 10 million units for the December quarter, but touch-screen shortages could reportedly limit shipments to eight million. iPad mini shipments could reach 13 million in the March quarter as supplier productivity improves.  Apple is a Focus List Buy and a Long-Term Buy.


Seeking to boost its cloud-computing business, Oracle ($34; ORCL) agreed to purchase Eloqua ($24; ELOQ), which makes web tools for companies to monitor sales results from marketing efforts, for roughly $810 million. The price tag of $23.50 per share represents a 31% premium to Eloqua's close prior to the announcement. Oracle is a Long-Term Buy.


The European Union is reportedly close to concluding an antitrust investigation into complaints that Microsoft ($27; MSFT) failed to comply with orders to build a screen for Windows users to select a web browser. Microsoft is a Long-Term Buy.

Top 15 Utilities changes

UGI ($33; UGI) operates natural-gas and electric utilities in Pennsylvania, but they only account for about 12% of company revenue. UGI's AmeriGas unit (45% of revenue) is the largest U.S. propane retailer. UGI also operates a large international propane business (30% of revenue) and an energy-marketing unit (13%). Last year's unusually warm winter dragged on results in the U.S. propane and marketing businesses, and companywide per-share profits fell 8% despite a 7% rise in revenue. The consensus projects gains of 17% in sales and 33% in per-share profits for the fiscal year ending in September 2013. At 12 times the 2013 estimate, UGI trades at a discount of about 22% to the median gas utility and a 20% discount to the median diversified utility. UGI is being added to our Top 15 Utilities portfolio.


American Electric Power's ($43; AEP) sales have fallen in each of the last three quarters. September-quarter profits declined more than expected, and consensus estimates fell in response. But despite weak operating results, AEP's shares have returned 13% over the last six months, helped by regulators' approval of a plan to phase in market-based pricing. The consensus projects a profit gain of less than 4% next year, and even this modest target may prove difficult to reach, given continued economic weakness in key service areas Ohio and Michigan. Customers in Ohio already have the freedom to switch to alternative power suppliers, and AEP could be vulnerable to an expansion of consumer choice in its troubled markets, possibly even a city-driven switch. See Utility Spotlight to learn how the city of Chicago took advantage of a rival's willingness to undercut Exelon ($30; EXC). AEP is being dropped from the Top 15 Utilities portfolio and now earns a B (average) in our Utility Update.

Corporate roundup

After Abbott Laboratories ($65; ABT) splits into two pieces at the start of 2013, the new Abbott and AbbVie will be included in the S&P 100 and S&P 500 indexes. Abbott Laboratories is a Long-Term Buy.


Chevron ($109; CVX) agreed to buy a 50% stake in the Kitimat liquefied-natural-gas project and a proposed pipeline in Western Canada. Separately, Chevron secured a partnership with Argentine energy company YPF for a $1 billion pilot program that will drill 100 nonconventional oil wells in the country. Chevron is rated Buy and Long-Term Buy.


J.P. Morgan Chase ($44; JPM) purchased daily-deals company Bloomspot, ramping up efforts to craft retail discount programs to spark more spending from its credit-card customers. At first blush, Bloomspot doesn't seem to mesh with J.P. Morgan's businesses. However, if the bank can develop effective loyalty programs, its credit-card unit may be able to boost revenue. Terms were not disclosed, though published reports value the deal at about $35 million. J.P. Morgan is a Long-Term Buy.


A U.S. judge approved a $7.8 billion settlement for economic and environmental losses, a deal reached by BP ($42; BP) and lawyers for plaintiffs harmed by the 2010 oil spill in the Gulf of Mexico. BP has already agreed to pay a $4 billion fine to settle criminal charges with the U.S. Department of Justice but still faces a possible fine of $17 billion if the oil giant is found grossly negligent. BP is rated B (average).


IntercontinentalExchange ($125; ICE) agreed to pay $8.2 billion for NYSE Euronext ($32; NYX), the parent of the 220-year-old New York Stock Exchange. European regulators rejected a proposed merger between NYSE and German's Deutsche Boerse earlier this year.

Retailers see gray Christmas

Shares of retailers fell after SpendingPulse, a unit of MasterCard ($495; MA), estimated that retail sales crept up 0.7% for the eight weeks ended Dec. 24, down from 2.0% growth in 2011 and the weakest since 2008. Online sales, up an estimated 8% according to SpendingPulse, also advanced at a slower pace than last year.

There was no shortage of reasons for the disappointing results. Consumers turned skittish as lawmakers failed to address the fiscal cliff of automatic tax hikes and spending cuts in the weeks leading up to Christmas. At press time, no solution had been found. On the East Coast, some budgets were diverted to repairing the damage caused by Hurricane Sandy.

Despite weak trends in store traffic, some retailers appeared to take a more conservative stance on discounts than last year. That could lead to heavy promotional activity after Christmas as they scramble to clear inventory.

Earnings reports

Nike ($53; NKE) shares rallied after the company said it earned $1.14 per share in the November quarter, up 11% and $0.14 above the consensus. Sales rose 7% on 17% growth in its largest geographic region, North America. For the February quarter, Nike projects low-double-digit sales growth, well ahead of the consensus target of 5%. Nike is rated C (below average).


Walgreen's ($36; WAG) November-quarter earnings per share slumped 18% to $0.58 excluding special items, missing the consensus by $0.12. Sales fell 5% to $17.32 billion, while same-store sales slipped 8.0% on weak store traffic. Management says the flu season — possibly the worst in 10 years — should help revenue improve in the current quarter. Walgreen is rated A (above average).


Rank Changes

We are making no changes to our buy lists. On the Top 15 Utilities Portfolio, we are adding UGI ($33; UGI) and dropping American Electric Power ($43; AEP).


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