Three New buys, Three downgrades

9/9/2013


Three new buys, three downgrades

Capital One Financial ($64; COF) is being upgraded to a Buy and a Long-Term Buy. Through its credit cards, commercial-lending programs, and depository business, Capital One's fortunes are tied to the health of the U.S. consumer. Net interest margin rose in the June quarter, and credit quality seems likely to continue improving. In addition, recent acquisitions should lower Capital One's cost of funds while broadening its sources of funds. Although the consensus projects lower per-share profits in 2014, Capital One seems capable of exceeding expectations. The stock earns a Quadrix Overall rank of 97, with Momentum and Value scores both above 90.

Capital One raised its quarterly dividend to $0.30 per share from $0.05 per share in May, its first hike since the financial crisis. The conservative payout ratio (dividends equal 16% of profits) and 12-month free cash flow of $10.49 billion, up 83%, suggests the company is capable of delivering more big hikes in coming years. At less than nine times trailing earnings, shares trade 31% below their five-year average and 18% below the median for S&P 1500 consumer-finance stocks.


Continental Resources ($95; CLR), one of the largest independent oil producers in the U.S., is being initiated as a Long-Term Buy. The stock enjoys rising Quadrix scores, with all six category ranks exceeding 60, driving an Overall score of 97. Its operations are concentrated in Oklahoma, North Dakota, and Montana. Standard & Poor's upgraded its debt rating to investment grade in late August, further separating the company from smaller North American players.

Cash from operations has risen in 10 consecutive quarters, benefiting from strong growth in production and proved reserves. Last month management raised the lower end of its 2013 targeted production, now projected to rise 38% to 40%. The consensus expects Continental Resources to grow per-share profits 52% and revenue 48% in the second half of 2013.


Dover ($86; DOV), which makes industrial machinery and other products, is being initiated as a Long-Term Buy. For a review of Dover, see Income Spotlight.


Chevron ($121; CVX) and Exxon Mobil ($87; XOM) have delivered weak operating results in recent quarters, reflected in their Quadrix Momentum (27 and 16, respectively) and Overall (60 and 51) scores.

Chevron generated $34.74 billion in cash from operations in the 12 months ended June, and management says annual operating cash flow could exceed $50 billion by 2017. The oil giant's downfall is its lack of production growth. Production fell slightly in the first six months of 2013, and the company has yet to deliver on its promises of higher production from massive international projects.

Exxon looks a lot like Chevron, in that it generates more than enough cash to fund exploration projects as well as dividends and stock buybacks. However, the company's lack of production growth (down 1.9% in the June quarter) calls into question its own predictions of future gains.

Chevron and Exxon look like safe, investment-grade picks for the very long haul. But we're no longer convinced either stock will outperform over the next two to four years. Chevron and Exxon are being dropped from the Long-Term Buy List and now earn ratings of B (average).


For years, Wal-Mart Stores ($73; WMT) distinguished itself by managing impressive growth despite even more impressive size. But those days have passed.

Not since the year ended January 2007 has Wal-Mart delivered double-digit sales growth. During the first six months of the current fiscal year, Wal-Mart has grown sales less than 2% and per-share profits less than 5%.

Wal-Mart's Quadrix Overall score has eroded to 59, dragged down by weak operating momentum, ugly earnings-estimate trends, and poor stock-price performance. U.S. same-store sales fell 0.3% in the July quarter, most likely reflecting weakness among the lower-income consumers Wal-Mart attracts. We don't know when Wal-Mart will get back on the growth train, and we're dropping the stock from the Long-Term Buy List. The company is now rated B (average).

Big deals

India gave Mylan ($36; MYL) its blessing to acquire Agila Specialties, the injectable-drugs unit of India-based Strides Arcolab. Mylan announced the $1.6 billion deal in February, but officials postponed approval in July on concerns foreign companies could take control of India's pharmaceutical industry and deprive its citizens access to essential cancer drugs. The deal will double Mylan's presence in injectable drugs, a market the company sees expanding 13% a year through 2017. Mylan expects to complete the acquisition in the December quarter. The stock is a Focus List Buy and a Long-Term Buy.


Verizon Communications ($46; VZ) agreed to pay $130 billion in cash and stock to acquire Vodafone Group's ($32; VOD) 45% stake in Verizon Wireless. Verizon already holds operational control of the U.S. business and expects the deal will immediately boost per-share profits 10%. The deal is projected to close in the March quarter. Verizon is rated B (average).


Microsoft ($32; MSFT) stepped up its commitment to mobile devices by striking a $7.2 billion deal to buy Nokia's ($5; NOK) phone business. The agreement will also allow Microsoft to license patents from Nokia. Microsoft does not expect the business to turn a profit until fiscal 2016 ending June. Since forming a software partnership with Microsoft in February 2011, Nokia has slouched toward irrelevancy, its global share of the smartphone market falling 20 percentage points to less than 5%. Microsoft's share also lingers below 5%. Microsoft is rated B (average).

Technology update

Apple ($489; AAPL) announced a media event in the U.S. for Sept. 10, followed by one in China Sept. 11. Apple is widely expected to show off its new iPhone and also a cheaper model, the latter likely available in a pallete of pastel colors. The meeting in China has also sparked speculation that Apple could unveil a partnership with China Mobile ($54; CHL). Apple is a Buy and a Long-Term Buy.


Google ($860; GOOG) plans to expand Google Shopping Express, its same-day delivery service, after a trial run in the Bay Area. Retailers use these delivery services, offered by Google and eBay ($50; EBAY), to draw online shoppers away from Amazon.com ($289; AMZN). In other news, Google said it bought WIMM Labs, a company working on a smart watch. Google is a Buy and a Long-Term Buy. eBay is rated B (average). Amazon.com is rated C (below average).


Qualcomm ($67; QCOM) showed off Toq, a smart watch designed to connect to Android smartphones. Toq, set to launch in the December quarter for $300 to $350, will have a limited production run to avoid alienating Qualcomm customers with their own smart watches. Qualcomm is a Focus List Buy and a Long-Term Buy.


Storm clouds continue to gather around the personal-computer industry. Researcher IDC now says PC shipments will fall 10% this year; IDC had projected an 8% contraction in May and a 1% decline in March. 

Corporate roundup

Citigroup ($49; C) sold $6.2 billion of assets, including a private-equity fund and a hedge fund for emerging markets. Like other banks, Citigroup is selling funds in advance of the implementation of new regulations that will limit banks' holdings in alternative investments. Citigroup is rated A (above average).


The U.S. expanded its probe into J.P. Morgan Chase's ($51; JPM) hiring practices beyond China and will now review more than 200 workers across Asia. The bank has been accused of hiring family members of influential officials in exchange for new business. Separately, the U.S. Senate appears to be looking into J.P. Morgan's energy-trading operations. J.P. Morgan is a Focus List Buy and a Long-Term Buy.


Rank Changes

Capital One Financial ($64; COF) is being added to the Buy and Long-Term Buy Lists. Continental Resources ($95; CLR) and Dover ($86; DOV) are being initiated as Long-Term Buys. Exxon Mobil ($87; XOM), Chevron ($121; CVX), and Wal-Mart Stores ($73; WMT) are being dropped from the Long-Term Buy List. Vanguard Short-Term Investment-Grade ($10.64; VFSTX) now accounts for 2.5 % of the Buy List.


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