Portfolio Review

1/20/2014


Financial earnings report

J.P. Morgan Chase ($58; JPM) reported per-share earnings of $1.40 excluding special items in the December quarter, up 4% and $0.05 above the consensus. Among excluded items were legal expenses amounting to $0.27 per share. Revenue slipped 1% to $24.11 billion, also ahead of analyst expectations. Net income rose 18% for asset management, partly offsetting a 57% plunge in investment banking. The mortgage-production business posted a pretax loss of $274 million, as originations slumped 54%.

Wells Fargo ($46; WFC) grew per-share profits 10% to $1.00 in the December quarter, easing past the consensus by $0.02. Total revenue fell 6% to $20.67 billion. Residential-mortgage originations fell 38% as the composition tilted toward purchases and away from refinancing. Deposits grew 8%, while total loans rose 3%, driven by automobiles (up 10%), credit cards (up 9%), and commercial and industrial (up 5%).

Sluggish operating results at both banks reflect headwinds hitting their mortgage businesses as they transition toward an environment of higher interest rates. But their long-term outlooks remain intact. Assuming the Federal Reserve approves their capital plans in March, both banks are likely to boost their dividends soon afterward. Moreover, shares of J.P. Morgan and Wells Fargo are also inexpensive, with trailing P/E ratios more than 20% below their respective five-year averages and more than 30% below the median for S&P 1500 financial stocks. With cheap stocks in shorter supply, J.P. Morgan Chase and Wells Fargo retain their Focus List Buy and Long-Term Buy ratings.

Bond fund out, ETF in

The recommended cash position for our buy lists will now be held in Vanguard Short-Term Corporate Bond ($80; VCSH) — a top bond pick among exchange-traded funds (ETFs). While we are confident in the outlook for Vanguard Short-Term Investment-Grade ($10.72; VFSTX), the switch to an ETF will make it easier to follow our advice using any broker. Similar to the mutual fund that it replaces, the ETF invests mostly in high-quality corporate bonds with maturities of less than three years. On Nov. 30, it held 1,615 bonds, with nearly half of assets in industrial bonds. At 0.12%, the ETF's expense ratio is below the category average of 0.85% and the 0.20% charged by the mutual fund.

Enterprise emerging as a market for Apple

Apple's ($546; AAPL) iPhone and iPad continue to gain traction in the enterprise market. The company is projected to take 11% of global spending by governments and businesses on computers and tablets by 2015, says Forrester Research, up from 8% in 2012 and 1% in 2009. These estimates exclude the iPhone, meaning Apple's enterprise presence could actually be even bigger.

In other news, China Mobile ($50; CHL) reported that iPhone preorders, which began on Dec. 25, have topped 1 million units. Analysts predict Apple's partnership with China Mobile will increase annual iPhone shipments by 15 million to 30 million units. CEO Tim Cook says Apple seeks to expand its China Mobile Alliance, though it will eschew the low-end smartphone market. China Mobile launched the iPhone on Jan. 17.

For the December quarter, industry researchers disagree over Apple's performance in the U.S. personal-computer market. Gartner says Mac shipments rose 28% in the final three months of 2013, one of few bright spots in a U.S. market that fell more than 7%. IDC, however, estimates Mac shipments fell 6%, worse than the 2% decline nationwide. Both researchers say global PC shipments fell 10% for the year, marking the worst annual decline ever. However, the U.S. PC market appears to be bottoming out, and Gartner predicts global shipments will hold flat in 2014. Apple is a Focus List Buy and a Long-Term Buy.

B/E Aerospace: altitude sickness?

B/E Aerospace ($84; BEAV) enjoys solid operating momentum, recently securing a spurt of contracts, while key customers Airbus and Boeing ($140; BA) race to ramp production. B/E won a contract worth an estimated $950 million to supply United Technologies ($113; UTX) with fasteners, hardware, consumables, and logistical services through 2022. The company also announced a separate contract with AgustaWestland worth $200 million through 2018.

Since we first recommended B/E Aerospace last February, its stock has soared 57%, outpacing the S&P 1500's 21% gain. However, that rally has caused its valuation to become a bit stretched. At nearly 25 times trailing earnings, shares trade at a 41% premium to their five-year average and 33% above the median for S&P 1500 aerospace and defense stocks. We will pay close attention to B/E Aerospace's December-quarter report, due Jan. 30. The consensus expects B/E Aerospace to report earnings of $0.91 per share, up 25% on 11% sales growth — and the company will need strong results and guidance to justify its current valuation. For now, B/E Aerospace remains a Buy and a Long-Term Buy. Boeing is rated A (above average). United Technologies is rated B (average).

Corporate guidance

Auto-parts makers Lear ($82; LEA) and Magna International ($84; MGA) issued their 2014 outlooks during the North American International Auto Show, held in Detroit. Lear's sales guidance range has a midpoint of $17.15 billion, up 7% and slightly ahead of the consensus of $17.06 billion. Magna's sales target range has a midpoint of $34.65 billion, implying 1% growth and missing the consensus of $36.16 billion. Both Lear and Magna are Focus List Buys and Long-Term Buys.


Chevron ($120; CVX) shares slumped after the energy giant warned December-quarter earnings would likely fall short of analyst expectations. Chevron is rated B (average).

Health-care update

Celgene ($167; CELG) released preliminary results for the December quarter, while shedding more light on 2014 and its long-term outlook. It said per-share profits rose 22% to $1.61 excluding special items, topping the consensus by $0.06. For 2014, management expects earnings per share to climb 17% to 21% on 15% higher revenue.  At the time of the announcement, the consensus anticipated 21% profit growth on a sales advance of 16%. Reflecting strong projected growth for blood-cancer drugs Revlimid and Pomalyst, Celgene also raised its long-term outlook through 2017. Celgene is a Long-Term Buy.


The Affordable Care Act remains a messy affair, with insurers still complaining of technology glitches and struggling to collect premiums from newly enrolled customers.  Moreover, the enrollment mix from the public exchanges apparently skews more heavily toward older Americans than health officials and some insurers had originally predicted. A dearth of young, healthy Americans would hurt insurers' profitability and eventually lead to higher premiums. The complexion of ACA enrollment could still fluctuate, as WellPoint ($91; WLP) and other insurers expect signups to surge ahead of March 31, the deadline to avoid penalties. WellPoint is rated A (above average).


Rank Change

No changes were made this week in Dow Theory Forecasts, although the cash position of our buy lists is now in Vanguard Short-Term Corporate Bond ($80; VCSH).


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