Portfolio Review

7/21/2014


Time to leave Shire behind

AbbVie ($53; ABBV) raised its takeover offer for Shire ($250; SHPG) to about $53 billion, up from its prior bid of $51.3 billion. That price tag translates to roughly $268 per share at current prices, composed of $126 in cash and 2.7 shares of AbbVie. The bid represents a 57% premium to Shire's stock price before AbbVie made its initial offer in early May. Unlike AbbVie's four previous offers, Shire's board plans to endorse this one, as long as the two parties can agree to terms that include a breakup fee.

Shire trades more than 7% below the latest bid, reflecting uncertainty that a deal will be reached and the risks involved in completing any deal. U.K. law requires AbbVie to make a firm offer by July 18 or abandon takeover talks for up to six months. The acquisition would allow AbbVie to reincorporate itself in the British Island of Jersey, saving an estimated $1.3 billion in taxes by 2020 — unless Congress moves to restrict such deals. As the number of tax inversions has accelerated in 2014, the Obama administration has urged U.S. lawmakers to pass legislation immediately to halt the practice.

Considering these risks, we believe the prudent move is to sell Shire. Unless a rival bidder emerges, upside potential is capped at about 7% — not enough for it to rank among our favorite stocks. Up 71% since we first recommended the stock in April, Shire is being removed from the Buy and Long-Term Buy lists and also dropped from coverage. Shire should be sold. AbbVie is rated B (average).

Merger mania

Whiting Petroleum ($84; WLL) agreed to acquire Kodiak Oil & Gas ($15; KOG) in a $6 billion deal that includes $3.8 billion in stock and the assumption of $2.2 billion in debt. Whiting agreed to issue 0.177 shares for each Kodiak share, a ratio that priced Kodiak's stock at a 2% discount to its price immediately before the announcement. But both stocks rallied after Whiting surged to an all-time high on news of the acquisition.

The deal will push Whiting ahead of Continental Resources ($147; CLR) as the largest driller in the Bakken shale formation, located in parts of Montana, North Dakota, and Canada. Bakken production for Whiting and Kodiak combined for 107,000 barrels of oil equivalent per day in the March quarter, compared to Continental's 83,725 BOE per day. Continental will remain the largest leaseholder in the Bakken, with 1.2 million net acres. Together, Whiting and Kodiak hold 855,000 net acres. Whiting Petroleum is a Focus List Buy and a Long-Term Buy. Continental is a Long-Term Buy.


CVS Caremark ($77; CVS) agreed to acquire Navarro Discount Pharmacy, which generates annual sales of about $340 million. The largest Hispanic-owned drugstore chain in the U.S., Navarro operates 33 drug stores. CVS Caremark, with more than 7,600 stores, is a Buy and a Long-Term Buy.


Time Warner ($84; TWX) rallied more than 15% after it said it rejected in June a takeover bid worth $80 billion in cash and stock from Twenty-First Century Fox ($33; FOXa). Time Warner is rated A (above average). Fox is rated C (below average).

Financial profit reports

Wells Fargo ($51; WFC) earned $1.01 per share in the June quarter, up 3%, to match the consensus estimate. Total revenue dipped 1% to $21.07 billion but exceeded analyst expectations, despite a 39% drop in mortgage revenue. Although mortgage originations plummeted 58%, Wells Fargo reported double-digit growth for commercial and industrial loans, auto loans, and credit-card lending. Total average deposits rose 9%, outpacing average loan growth of 4%, which contributed to a lower net interest margin. Wells Fargo is a Focus List Buy and a Long-Term Buy.


J.P. Morgan Chase ($58; JPM) shares rallied after the bank topped modest expectations for the June quarter. Per-share profits fell 9% to $1.46, exceeding the consensus by $0.17. Reported profits included legal expenses of $0.13 per share. Total revenue slipped 2% to $25.35 billion, well ahead of the consensus of $23.76 billion. Mortgage originations plunged 66%, applications 54%. Revenue from trading equities and fixed income fell 14%, slightly better than J.P. Morgan's May guidance of a 20% decline. Elsewhere, the bank posted solid growth. The commercial bank's average loan balance rose 7%, while the investment bank generated 3% higher fees. The asset-management unit reported a 15% increase in client assets. J.P. Morgan Chase is a Long-Term Buy.


U.S. Bancorp ($43; USB) earned $0.78 per share in the June quarter, up 3% and a penny above the consensus estimate. Net revenue climbed 5% to $5.19 billion, also ahead of the consensus. Average total loans rose 7%, driven by commercial growth. Average total deposits increased 6%. U.S. Bancorp is a Long-Term Buy.

More earnings news

For the June quarter, SanDisk ($106; SNDK) grew per-share profits 16% to $1.41 excluding special items, easing past the consensus by $0.02. Sales advanced 11% to $1.63 billion, also slightly ahead of analyst expectations. SanDisk raised its quarterly dividend 33% to $0.30 per share, payable Aug. 25. Despite the solid results, shares slumped. Softness in SanDisk's gross and operating profit margins may have disappointed investors. Also, the company had previously topped consensus profit estimates by at least $0.13 per share in each of the four prior quarters. SanDisk, which went into the earnings report at an all-time high, remains a Focus List Buy and a Long-Term Buy.


United Rentals' ($108; URI) per-share profits surged 47% to $1.65 excluding special items in the June quarter, $0.19 above the consensus. Revenue jumped 16% to $1.40 billion. United Rentals raised its 2014 guidance for revenue, free cash flow, operating profits, and rental-rate growth. United Rentals is a Focus List Buy and a Long-Term Buy.

Technology partnerships

Apple ($95; AAPL) and IBM ($188; IBM) struck a deal that could boost the presence of iPhones and iPads in business settings. IBM agreed to help Apple design more than 100 enterprise applications for the devices and also sell the devices to its corporate clients. Companies and governments generated about 33% of Apple's tablet sales last year, according to Forrester Research. Apple is a Buy and a Long-Term Buy. IBM is rated A (above average).


Google ($593; GOOGL) and Novartis ($90; NVS) announced plans to build a contact lens that tracks blood-glucose levels. Google is a Focus List Buy and a Long-Term Buy. Novartis is rated C (below average).


Rank Changes

Shire ($250; SHPG) was dropped from the Buy List and Long-Term Buy List. Vanguard Short-Term Corporate Bond Index ($80; VCSH) now accounts for 3.4% of the Buy List and 5.9% of the Long-Term Buy List.


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