Portfolio Review

9/1/2014


Gilead becomes Long-Term Buy

Gilead Sciences ($106; GILD) is being upgraded to a Long-Term Buy. New hepatitis C drug Sovaldi generated sales of $3.48 billion in the June quarter, roughly 53% of Gilead's total revenue. Fueled by Sovaldi, Gilead topped consensus profit estimates by more than 30% in each of the past two quarters. In the June quarter alone, Gilead produced more cash from operations ($4.19 billion) and free cash flow ($4.09 billion) than it had in any 12-month period in the company's history. Profit estimates for the second half of 2014 and full-year 2015 have surged in the past month. But even those raised estimates could prove too low, considering Sovaldi could launch in Japan next year and Gilead's HIV drugs are also posting solid growth.

A Quadrix standout, Gilead ranks above 85 for both sector-specific scores, while five of six category ranks exceed 80. The lone mark against the stock is a subpar Value score of 41. Yet Gilead shares trade at just 11 times estimated 2015 earnings, a 47% discount to the median for S&P 1500 biotechnology stocks and 37% below the broader health-care sector. The stock has delivered a 42% total return in 2014, and it would be nice to add shares on a 10% pullback. But, even at current prices, Gilead offers attractive 24- to 36-month potential.

Foot Locker's growth outruns projections

Foot Locker's ($55; FL) July-quarter earnings per share soared 39% to $0.64 excluding special items, topping the consensus by $0.10. Revenue rose 13% to $1.64 billion, also ahead of the consensus, as same-store sales increased 7.0%. Growth was driven by healthy product trends, particularly in basketball footwear, and a rebound at Lady Foot Locker, which had struggled in recent quarters.

Operating profit margins rose for the 19th consecutive quarter, and the retailer seems confident this trend will continue, helped by improvement in Europe and a new allocation system that will launch this fall. Foot Locker described a strong back-to-school season, with same-store sales up by high-single-digits in the first few weeks of August.

Management declined to give more specific annual profit guidance than double-digit growth. Still, analyst estimates for the year ending January have risen since the report, while shares have rallied to an all-time high. Foot Locker is a Focus List Buy and a Long-Term Buy.

Cable update

The Federal Communications Commission has asked Comcast ($55; CMCSa) for more details regarding the cable giant's plans to buy Time Warner Cable ($147; TWC) for $45 billion. Comcast must respond to the request, which focuses on the internet business, by Sept. 11, while regulators solicit comments from outside parties. DISH Network ($64; DISH) has petitioned the FCC to block Comcast, claiming the deal would cause the industry "irreparable harm." Regulators expect the review to stretch into January. Comcast had originally anticipated completing the deal by the end of 2014.

AT&T ($35; T) has reportedly agreed to conditions set by the U.S. Justice Department for the proposed $48.5 billion acquisition of DirecTV ($85; DTV). AT&T still needs to secure permission from the FCC to complete the deal.

Investors continue to handicap the likelihood of the deals going through. DirecTV has risen 2% and Time Warner Cable 3% since Aug. 7, the lows for both stocks since the end of June. AT&T's bid for DirecTV equates to about $95 per share (11% above the current price), while Comcast's bid for Time Warner Cable is currently worth $157 per share (6%). Comcast is a Buy and a Long-Term Buy. AT&T and DirecTV are rated A (above average).

Technology roundup

Apple ($101; AAPL), hoping to revive iPad sales that slipped 8% in the June quarter, will begin production on a larger tablet in the March quarter, according to published reports. The new iPad is expected to measure 12.9 inches diagonally; Apple's current tablet features displays of 9.7 inches or 7.9 inches.

In related news, the Los Angeles school district tabled plans announced last year to outfit every student with an iPad. Some tablets have already been distributed under the original $1 billion contract with Apple and textbook publisher Pearson ($18; PSO). However, the district's superintendent says the contract no longer fits school needs; he plans to reopen the bidding process. Apple has an 85% share of tablets used by U.S. educational institutions, according to technology researcher IDC.

Separately, the forthcoming iPhone 6 could suffer supply shortages after Apple made a late design change to a key component in the smartphone's screen. Multiple reports say Apple will show off the new iPhone on Sept. 9, with some speculating a wearable device could also be introduced. Apple, yielding 1.9%, is a Focus List Buy and a Long-Term Buy.


Regulators in China say Qualcomm ($77; QCOM) offered to take steps to resolve a probe involving the company's pricing practices. China has reportedly consulted antitrust officials in South Korea to consider the best course of action. South Korea fined Qualcomm more than $200 million in 2009 for allegedly abusing its market position.

Troubles could be brewing elsewhere for Qualcomm, with the European Union reportedly considering its own antitrust investigation into a complaint filed by a British semiconductor maker since acquired by Nvidia ($19; NVDA). Qualcomm is a Long-Term Buy.

Financial review

Bank of America ($16; BAC) and the U.S. government reached a $16.65 billion settlement over the sale of faulty mortgage-backed securities. The bank will pay $9.65 billion in cash and offer $7 billion in assistance to homeowners and communities. Over the last year, J.P. Morgan Chase ($60; JPM) settled for $13 billion and Citigroup ($52; C) for $7 billion to resolve similar claims. Bank of America's mortgage-related settlements now exceed $65 billion since the financial crisis. In related news, Goldman Sachs ($178; GS) agreed to a settlement worth $1.2 billion involving mortgage bonds sold to Fannie Mae and Freddie Mac.

Big bank stocks got off to a slow start in 2014 but have started to gain momentum. Since the end of June, J.P. Morgan is up 4%, Bank of America 6%, Goldman 6%, and Citigroup 11% — all ahead of the S&P 500 Index's 2% gain. The rally seems to be a mixture of relief that the banks may no longer be haunted by ghosts of the financial meltdown and anticipation that the Federal Reserve will begin to raise interest rates in 2015. J.P. Morgan is a Long-Term Buy. Bank of America, Citigroup, and Goldman Sachs are rated B (average).

Corporate roundup

Lear ($98; LEA) has agreed to purchase of Eagle Ottawa, a leather supplier to the automobile industry, for net cash of $850 million. The move is consistent with prior comments made by Lear that it wants to expand into automotive leather to complement its seating and electrical-systems businesses. Lear is a Focus List Buy and a Long-Term Buy.


Dow Chemical ($53; DOW) has reportedly put up for sale two specialty-chemicals operations that generate annual operating income of $165 million to $175 million. The two businesses could be worth close to $2 billion, putting Dow closer to its goal of raising $6 billion from asset sales. Dow Chemical is a Focus List Buy and a Long-Term Buy.


Rank Changes

Gilead Sciences ($106; GILD) is being added to the Long-Term Buy List.


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