Portfolio Review

9/23/2013


Rank changes

Focus List

Dover ($90; DOV), an industrial conglomerate, is being upgraded to a Buy and Focus List Buy. Dover makes products ranging from machinery to foodservice equipment to electronic components, positioning the company to catch the gusts of an improving economy. Rising operating profit margins in the past 12 months have contributed to a 26% surge in free cash flow to $768 million. Modest requirements for capital investment allow Dover to focus on returning cash to shareholders. Dover is also a Long-Term Buy.


Capital One Financial ($69; COF), profiled in Analysts' Choice, is also being added to the Focus List. The stock was already rated Buy and Long-Term Buy.


We are removing CVS Caremark ($61; CVS) from the Focus List, though it remains a Buy and a Long-Term Buy. The stock no longer ranks among our 12 to 18 favorite picks for 12-month returns. CVS shares are up 26% for the year but have traded sideways since the end of July, which coincides with the stock's Overall rank slipping to 77 from 89. Revenue rose just 1% in the first half of 2013; growth should improve in the coming quarters, though it will likely lag the double-digit gains CVS had posted in seven straight quarters entering this year. At 17 times trailing earnings, the stock trades 5% below its 10-year average price/earnings ratio.


Foot Locker ($33; FL) may have lost a step, as it missed the profit consensus in the July quarter and saw same-store-sales growth dip to 1.8%, the weakest gain in more than three years. But we still like the company's chances to finish the race well. Per-share profits rose 21% in the quarter and 24% over the last 12 months. The consensus projects profit growth of just 4% in the six months ending January 2014, rebounding to 11% growth in the fiscal year ending January 2015, targets that seem somewhat conservative. Foot Locker has been removed from the Focus List because it is no longer among our very favorite stocks. But we remain optimistic about its year-ahead potential and still rate it a Buy and a Long-Term Buy.

A new buy

Whiting Petroleum ($55; WLL) is leveraged to the booming, oil-rich Bakken area; the company is the No. 2 oil producer in North Dakota. Whiting also operates one of the largest oil-recovery projects in the Permian Basin of Texas. Last month the company agreed to pay $260 million for roughly 39,000 acres in the Bakken region with estimated reserves of 17.1 million barrels of oil. Robust production gains and favorable oil prices should help drive profit growth. The consensus expects per-share earnings to increase 18% this year and 9% in 2014. Whiting Petroleum, which earns a Quadrix Overall score of 94, is being initiated as a Buy and Long-Term Buy.

Downgrades

U.S. Bancorp ($38; USB) trimmed its long-term guidance, citing softer mortgage activity. Management now projects long-term revenue growth of 6% to 7%, compared to its prior range of 7% to 8% growth. The guidance doesn't surprise us, as it reflects the headwinds facing all banks, and the shares are trading near five-year highs. U.S. Bancorp looks cheap versus its history but trades in line with the peer group; rivals Fifth Third Bancorp ($18; FITB) and Wells Fargo ($43; WFC) sport more attractive values. Still, U.S. Bancorp has decent long-term prospects as net interest margins improve, and the stock remains a Long-Term Buy.


CF Industries ($201; CF) is being removed from the Buy and Long-Term Buy lists. The stock looks cheap from nearly every angle in Quadrix but lacks the growth we prefer for our recommended stocks, with per-share profits projected to fall 13% this year and 12% in 2014. Nitrogen pricing remains weak, and guidance recently issued by rivals hints that demand could be slowing.

In late July, activist investor Daniel Loeb disclosed his stake in the company, citing CF's potential to boost its dividend. At the moment, chances of a big dividend bump appear cloudy at best. CEO Stephen R. Wilson suggested last month CF would maintain a course that emphasizes stock buybacks over dividend growth. The stock rallied after CF announced Wilson will retire on Jan. 1. But Wilson's successor, W. Anthony Will, currently oversees the company's ambitious plan to expand capacity, so he may be just as unwilling to devote the resources required for a significant dividend hike. The stock is now rated B (average).

Financial update

J.P. Morgan Chase ($53; JPM) is expected to pay at least $800 million in fines related to the "London whale" disaster that led to more than $6 billion in trading losses. But the settlement will not preclude the bank from potentially facing criminal charges, and two traders were indicted for allegedly hiding the extent of the losses. CEO Jamie Dimon cautioned that additional legal headaches could be coming down the pipe. The Commodity Futures Trading Commission is reportedly investigating the bank's use of credit derivatives to allegedly influence a bond-market index. J.P. Morgan Chase is a Focus List Buy and a Long-Term Buy.


Separately, J.P. Morgan said internal stress tests showed it has sufficient capital to survive another economic crisis. Wells Fargo ($43; WFC), Citigroup ($51; C), Bank of America ($15; BAC), and Goldman Sachs ($167; GS) came to a similar conclusion. Each year the Federal Reserve conducts stress tests on U.S. banks to check if they have sufficient capital to survive another economic crisis. The results help determine the amount of capital that banks can return to shareholders. Six months after the Fed tests, banks must conduct their own tests. In other news, Wells Fargo reportedly plans to sell mortgage-servicing rights on $41 billion of loans. Wells Fargo is a Focus List Buy and a Long-Term Buy. Citigroup and Goldman Sachs are rated A (above average). Bank of America is rated B (average).

Managed-care review

Aetna ($68; AET) said it will not join the health exchange New Jersey plans open this fall as part of the Affordable Care Act. Aetna had already bowed out of six other state exchanges. Cigna ($84; CI), which has minimal exposure to the individual insurance market, continues to plan to participate in only five of the state exchanges. Cigna will consider expanding into additional states if the early results are encouraging. Cigna is a Long-Term Buy. Aetna is rated A (above average).


Rank Changes

Capital One Financial ($69; COF) and Dover ($90; DOV) have been added to the Focus List. Dover has also been added to the Buy List. CVS Caremark ($61; CVS) and Foot Locker ($33; FL) have been dropped from the Focus List but remain Buys and Long-Term Buys. Whiting Petroleum ($55; WLL) has been initiated as a Buy and a Long-Term Buy. U.S. Bancorp ($38; USB) has been dropped from the Buy List. CF Industries ($201; CF) has been dropped from the Buy and Long-Term Buy lists.


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