Follow-up on monitored stocks

9/29/2008


DirecTV added, BMC and Wells Fargo downgraded
DirecTV ($25; NASDAQ: DTV) has delivered consistent growth in recent quarters despite the economic slowdown. Operating income rose at least 20% in each of the last eight quarters, supported by solid subscription trends. DirecTV’s focus on high-definition content is offsetting the competitive threats from cable and telecommunications companies. Consensus estimates project per-share-profit growth of 22% this year and 34% next year.

In a field strewn with debt-heavy, cash-poor companies, DirecTV stands out. Cash flow topped net income in each of the last 16 quarters and is trending higher. Long-term debt represents just one-third of total capital, and interest payments are well covered by earnings. Liberty Media ($13; NASDAQ: LINTA) owns nearly 50% of DirecTV, and that substantial minority stake represents a potential wild card. But DirecTV, with a Quadrix Overall score of 90, represents an attractive investment on its own merits. Despite its strong growth, DirecTV is attractively valued at 15 times projected year-ahead earnings of $1.66. The stock is being added to the Buy List.


BMC Software’s ($31; NYSE: BMC) Quadrix scores have deteriorated over the last three months. The Overall score is 79 — not bad, but low enough to make us re-evaluate the stock. BMC’s exposure to the financial-services sector represents a substantial risk. Consensus estimates project per-share-profit growth of 7% in fiscal 2009 ending March and 13% in fiscal 2010, but we have become less confident in BMC’s ability to meet those targets. At 14 times the fiscal 2009 estimate, BMC seems reasonably valued, but not overly cheap. Considering the values available in the technology sector at this time, BMC no longer stands out from the crowd. BMC is being downgraded to Neutral and should be sold. Upgrade candidates include software makers Adobe Systems ($39; NASDAQ: ADBE) and Microsoft ($25; NASDAQ: MSFT).


The Forecasts stuck with Wells Fargo ($34; NYSE: WFC) for months despite declining Quadrix scores, in large part because the conservatively managed bank seemed likely to outperform its peers. Wells Fargo repaid that faith with market-beating returns (up 13% this year and 67% from July lows). But now it’s time to get out. In the wake of the recent surge, Wells Fargo shares trade at 15 times estimated 2009 earnings. That’s not cheap for a bank — and profit estimates are trending lower. While Wells Fargo seems positioned to succeed operationally over the long term, the current valuation appears to discount its strong competitive position. Wells Fargo is being downgraded to Neutral and should be sold. At this time, we do not recommend any bank stocks.

Financial roundup
The $700 billion bailout plan proposed by the U.S. Treasury and the Federal Reserve has met bipartisan resistance. Many in Congress question whether Paulson’s plan to purchase troubled mortgage-backed securities represents the best path to long-term stability, and one skeptic calls it “financial socialism.” Sticking points center on accountability, as Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke want flexibility, while Congress wants oversight. Debate was ongoing at press time, and substantial revisions to the plan are likely.

A temporary solution could authorize a portion of the plan to keep the market afloat in the near term, holding off on the rest of the bailout. While the bailout will certainly have a huge effect on the financial markets, uncertainty regarding the plan makes it difficult to predict that effect.

Until Congress and Paulson hash out their differences, Washington Mutual ($3; NYSE: WM) will likely remain independent. WaMu’s huge deposit base and broad network of branches make the company appealing to many potential buyers. But a deal for the entire company is unlikely unless the government is willing to guarantee the mortgage-loan portfolio, and no such guarantee is on the table. Companies reported to be considering a purchase of part or all of WaMu include J.P. Morgan Chase ($41; NYSE: JPM), Wells Fargo ($34; NYSE: WFC), and Citigroup ($19; NYSE: C).

Meanwhile, other financial companies scramble to remain solvent. The two largest surviving U.S. investment banks, Goldman Sachs ($130; NYSE: GS) and Morgan Stanley ($24; NYSE: MS), sought federal shelter by converting to bank holding companies. The new arrangement exposes the companies to greater government scrutiny and limits their ability to use leverage. But the newly minted banks will benefit from access to both loans from the Federal Reserve and federal insurance for client deposits. Goldman also announced plans to raise about $10 billion by selling $5 billion in preferred shares to billionaire investor Warren Buffett’s Berkshire Hathaway ($4,461; NYSE: BRKb) and issuing $5 billion in common shares. Morgan Stanley sold a 20% stake to Mitsubishi UFJ Financial Group, a Japanese bank, for $8 billion.

Insurer American International Group ($4; NYSE: AIG) agreed to accept an $85 billion loan from the Federal Reserve, effectively staving off bankruptcy. The terms of the loan will give the federal government a 79.9% equity stake in the company. AIG is expected to pay off the loans through a combination of asset sales and new debt and equity offerings. By Oct. 3, AIG plans to release a list of businesses for sale, possibly representing half of the company. Allstate ($45; NYSE: ALL), Canadian insurer Manulife Financial ($36; NYSE: MFC), and Berkshire are all reportedly interested in AIG’s assets. While AIG’s credit-market exposure sparked federal intervention, most of the company’s insurance and finance businesses remain healthy.

J.P. Morgan, Citigroup, Goldman Sachs, Morgan Stanley, AIG, Allstate, and Manulife are rated Neutral, and Wells Fargo is being downgraded to Neutral. Washington Mutual is rated Underperform. We would be sellers of all the stocks.

News roundup
Oracle ($20; NASDAQ: ORCL) reported August-quarter earnings of $0.29 per share excluding stock options and acquisitions, up 32% and $0.02 above the consensus. Sales rose 18%. New software license sales increased 14%, with total software revenue up 20%.  Oracle is a Buy and a Long-Term Buy . . . FedEx ($82; NYSE: FDX) earned $1.23 per share in the August quarter, down 22%. Sales rose 8%. But higher operating expenses, particularly fuel costs that surged by 66%, crimped the bottom line.  FedEx is rated Neutral . . . In a study of 900 psoriasis patients, Johnson & Johnson’s ($68; NYSE: JNJ) Ustekinumab drug outperformed rival Enbrel. J&J expects the Food and Drug Administration to rule on the drug by the end of the year. About 7.5 million Americans and 10 million Europeans suffer from psoriasis. J&J is a Buy and a Long-Term Buy.

Share buybacks
Microsoft ($25; NASDAQ: MSFT) authorized the repurchase of up to $40 billion in stock over the next five years. The proposed buyback represents 17% of market value at current prices. Microsoft also announced plans to boost its quarterly dividend 18% to $0.13 per share. Microsoft is a Buy and Long-Term Buy . . . Hewlett-Packard ($47; NYSE: HPQ) plans to buy back up to $8 billion in shares, on top of the $8 billion it was authorized to repurchase in November. As of July 31, about $3 billion remained from the 2007 program. Hewlett-Packard is a Buy and a Long-Term Buy . . . Nike ($61; NYSE: NKE) plans to repurchase $5 billion in shares, representing about 17% of current stock-market value, over the next four years. Nike is rated Neutral.


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