Portfolio Review

12/23/2013


Two rank changes

We are adding United Rentals ($74; URI) to the Focus List. The cyclical company has grown cash from operations in 10 of the past 12 quarters, while operating profit margins have steadily widened, reaching 47.7% in the September quarter from 35.0% in the same quarter three years ago. The U.S. economic recovery should fuel demand for its rental fleet of construction equipment.

Shares have risen 10% since we recommended the stock in November, while the S&P 1500 Index has dipped 1%. Analyst estimates for 2014 have risen in the past 60 days, with the consensus now projecting per-share earnings of $6.00, implying 25% growth. If United Rentals meets that target and its P/E ratio holds at its current level of 16 times trailing earnings, the stock will rally 30% by the end of next year. United Rentals, earning an Overall score of 93, was already a Buy and a Long-Term Buy.


Mylan ($42; MYL) is being removed from the Focus, Buy, and Long-Term Buy lists. The stock has surged 53% since we added it to the Focus List last December, about twice the S&P 500's 27% gain. But share-price action weakened this month, and Mylan's Quadrix® scores are rapidly eroding, with the Overall rank down to 65. Mylan's sales grew less than 1% year-over-year in the nine months ended September, depressed by currency effects and a weaker roster of new-product launches. Shares trade at 15 times earnings, a 17% discount to their five-year average. However, the stock looks less attractive relative to sales and cash flow, resulting in a Value score of just 52. Mylan is now rated B (average) and should be sold.

Television update

DirecTV ($65; DTV) met with investors in December to discuss its long-term prospects. Excluding inflation-plagued Venezuela, management expects profits to reach $8 per share by 2016, up from the consensus earnings target of $4.96 for 2013. The company says growth in Latin America over the next few years could fall short of its earlier expectations, partly due to currency headwinds. However, management expects the region's cash flow to improve substantially in 2014, with growth accelerating through 2016.

The company is also considering an online-video service with programming targeted at specific subscriber groups, hoping to attract both younger and lower-income consumers who have eschewed pay-TV for cheaper options online. In other news, DirecTV is reportedly hammering out details with the National Football League to renew its exclusive contract for the NFL Sunday Ticket. The current four-year contract will expire at the end of next season. A deal could be announced by June and cost more than $1 billion a year.

These initiatives come at a time of industry consolidation, as Charter Communications ($130; CHTR) is said to be preparing a low-ball bid for Time Warner Cable ($133; TWC). Comcast ($49; CMCSa) is also weighing its options to acquire certain markets from Time Warner or buy the entire company. DirecTV remains a Focus List Buy and a Long-Term Buy. Comcast is a Buy and a Long-Term Buy.

J.P. Morgan legal report

J.P. Morgan Chase ($56; JPM) has reportedly entered talks to settle a U.S. investigation into allegations the bank failed to alert officials of red flags concerning Bernie Madoff's Ponzi scheme. The bank could end up paying $1 billion to $2 billion to resolve the probe by the end of 2013. CEO Jamie Dimon has pledged to resolve the slew of legal woes that have shadowed the bank for years. J.P. Morgan has already agreed to pay a total of $22.7 billion in four separate settlements since the end of September, and legal proceedings could end up costing $5.7 billion more than its $23 billion reserve.

Fines and settlements could cause J.P. Morgan to temporarily slow its stock buybacks, which trimmed 2% from the stock count in the six months ended September. But investors seem relieved that J.P. Morgan is taking action to put its legal problems to bed. The shares have risen 8% since the end of September. J.P. Morgan Chase is a Focus List Buy and a Long-Term Buy.

Corporate roundup

Qualcomm ($73; QCOM) named Steve Mollenkopf as its new CEO, replacing Paul Jacobs, who will serve as executive chairman. Mollenkopf, currently Qualcomm's chief operating officer, was reportedly a potential candidate to become Microsoft's ($37; MSFT) new CEO. Separately, a Chinese official claims regulators have gathered "substantial evidence" that Qualcomm fixed its prices in China. Chinese media report Qualcomm could face fines up to $1.2 billion, though China may be posturing in an effort to improve the bargaining power of its telecommunication companies regarding royalty fees for wireless networks. Qualcomm is a Focus List Buy and a Long-Term Buy. Microsoft is rated A (above average).


Shares of Visa ($213; V) and MasterCard ($798; MA) rallied after a judge approved a settlement that will pay U.S. retailers about $5.7 billion, potentially ending a protracted battle over credit-card swipe fees. Several major retailers had opposed the settlement for being too small and suppressing future lawsuits; they plan to appeal the decision. Visa shares are up 41% for the year and hover near an all-time high. That rally has dragged down Visa's Value score to 24 and its Overall score to 61, but the share-price action is encouraging. For now, Visa remains a Buy and a Long-Term Buy. MasterCard is rated A (above average).


CVS Caremark ($67; CVS) issued its 2014 guidance, with per-share profits projected to rise 10% to 14%, compared to the consensus target of 13% growth at the time of the announcement. CVS also raised its quarterly dividend 22% to $0.275 per share, payable Feb. 3, marking the fourth straight year of at least 20% dividend growth. CVS Caremark is a Buy and a Long-Term Buy.


Anadarko Petroleum ($79; APC) shares plunged after a judge ruled the energy company should pay $5 billion to $14 billion to clean up 2,000 U.S. sites. Anadarko is rated B (average).

Cisco still has long-term appeal

The arguments for buying Cisco Systems ($21; CSCO) — attractive valuation, generous dividend yield, transition to a business mix with steadier growth and higher margins, and the ongoing evolution of a networked world — still carry weight. But in the wake of Cisco's disappointing target of an 8% to 10% decline in revenue for the January quarter (the consensus projected 4% growth), the networking giant could stagnate in the near term.

Cisco blamed its gloomy outlook partially on weakness in emerging markets and a cautious spending outlook by corporate executives, both external issues that should clear up somewhat over the next year. But Cisco is also introducing complex new switching and routing platforms and investing in its service and software businesses, transformations that should benefit the company over the long term but consume resources or slow growth in the near term.

The stock's Quadrix Overall score has dipped to 73, hurt by low ranks for Momentum, Earnings Estimates, and Performance. However, the networking giant earns a Value score of 96 and trades at just 11 times the lowest analyst profit estimate for the fiscal year ending July, about 50% below the average communications-equipment stock in the S&P 1500 Index.

The stock yields 3.3%, roughly four times the industry average, yet the dividend equals just 33% of trailing earnings, leaving room for continued growth of the payout. Cisco remains on the Long-Term Buy List for now. We will pay close attention to January-quarter results and guidance, seeking signs of improved demand.


Rank Changes

Mylan ($42; MYL) has been dropped from the Focus List, Buy List, and Long-Term Buy List. United Rentals ($74; URI), already a Buy and Long-Term Buy, is being added to the Focus List. Vanguard Short-Term Investment-Grade ($10.73; VFSTX) now accounts for 4.1% of the Buy List and 6.7% of the Long-Term Buy List.


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