Portfolio Review

10/6/2014


Dow downgraded

Dow Chemical ($50; DOW) is being dropped from the Focus List, Buy List, and Long-Term Buy List. Added to the Buy List at $48.51 in February, the stock has held up well amid weakness in the materials sector, partly because of expectations about restructuring moves. But the stock now seems a bit expensive relative to industry peers and to its own historical norms based on price/earnings and price/cash flow ratios. The Quadrix Value score has dropped to 54 from 72 at the end of June, and the Overall score has dropped below 80, partly because of a slowdown in operating momentum. While Dow has above-average potential, it no longer merits inclusion on our buy lists. The stock is now ranked A (above average) on our Monitored List.

New bond-fund pick

PIMCO Total Return ($109; BOND) is being dropped from coverage. The fund has been in the news recently, most notably for the sudden departure of longtime manager and legendary bond investor Bill Gross. Separately, the Securities and Exchange Commission is reportedly investigating how the fund purchased and valued certain securities. Baird Core Plus Bond ($11; BCOSX) is taking its place in our Conservative Portfolio. The fund invests in a variety of mostly high-quality bonds, including government, corporate, and mortgage-backed. The fund, yielding 2.4%, has an expense ratio of 0.55%.

Auto stocks tap the brakes

Shares of auto-parts suppliers, including Lear ($87; LEA) and Magna International ($96; MGA), fell after Ford Motor ($15; F) lowered its full-year profit guidance. Ford described weakness in Russia and South America, while a rash of vehicle recalls is taking a toll on North American profit margins. Many of these problems are specific to Ford, though the company also tempered its long-term view for Europe, cautioning that auto demand in 2020 might still lag prerecession levels. It also issued a disappointing 2015 profit outlook, though production should rise, partly due to the newly designed F-150.

U.S. car sales in September fell to an annualized rate of 16.7 million from the eight-year high of 17.5 million vehicles in August; the consensus projected September sales roughly in line with August. General Motors ($32; GM) posted 19% growth in September. Ford's 3% decline was widely expected as the automaker slowed production of its older F-150 pickup.

Ford and GM each contribute 22% of Lear's revenue. General Motors is Magna's biggest customer at 18% of sales, while Ford ranks fourth at 13%. The U.S. represents about 19% of sales for Lear and 23% for Magna. Both companies rely on Europe for 42% of revenue.

While shares of both Lear and Magna have lost ground in recent days, auto-production trends remain encouraging. The auto-parts makers could ease investors' fears by posting strong September quarters; the consensus projects at least 28% profit growth for both companies. Both Lear and Magna are rated Focus List Buy and Long-Term Buy. Ford is rated A (above average). General Motors is rated B (average).

Retail review

A pair of August-quarter reports could boost analysts' profit estimates for Foot Locker ($55; FL). Rival Finish Line ($25; FINL) posted disappointing results, partly due to flat basketball sales. Finish Line admitted to merchandising problems, and its weakness suggests Foot Locker has taken market share, especially in light of Nike's ($88; NKE) strong quarter.

Nike, which accounts for 65% of Foot Locker's revenue, said per-share profits surged 27% on 15% higher sales; both metrics well ahead of the consensus. Sales growth was strongest, up 32%, in Western Europe, where Foot Locker expanded through its $81 million acquisition of Runners Point in July 2013. Nike said sales of basketball footwear jumped at double-digit rates in North America, where Foot Locker has the leading share. Orders placed by retailers for delivery in the next five months are up 11% from a year earlier, partly driven by strong demand for basketball and running footwear. Foot Locker is a Focus List Buy and a Long-Term Buy. Nike is rated B (average). Finish Line is rated Buy at Upside, our sister publication focusing on small stocks.


Macy's ($58; M) plans to hire roughly 86,000 temporary workers for the holidays, up nearly 4% from last year. This move comes at a time when consumer sentiment stands at its highest point since July 2013, according to a poll conducted by Thomson Reuters and the University of Michigan. Consumer expectations for personal income are rising, and consumer spending accelerated in August, according to the U.S. Commerce Department. Macy's is a Buy and a Long-Term Buy.

Technology update

The European Union says Ireland gave Apple ($99; AAPL) illegal tax deals "motivated by employment considerations." The company operates a manufacturing plant there. Apple also licenses its intellectual property in Europe, Africa, and Asia through Irish subsidiaries that protect the revenue from taxes. The computer and electronics giant's non-U.S. tax bill amounted to just 2.5% of its $109 billion of non-U.S. profits over the past five years, according to Reuters, below even Ireland's tax rate of 12.5%. The investigation, though still in the early stages, could result in Apple paying $200 million or more in back taxes.

In other news, Apple won regulatory approval to launch its new iPhone 6 and 6 Plus in China on Oct. 17. Apple ranked sixth with a 6.5% share of China's smartphone market in the June quarter. The iPhone could face some challenges as China Mobile ($58; CHL) curtails smartphone subsidies, causing wireless plans for some high-end devices to nearly double in price. Still, global demand for the iPhone appears strong. Apple is a Focus List Buy and a Long-Term Buy.


Officials from the European Union gave Google ($580; GOOGL) guidelines to follow in order to comply with new privacy rules that let users seek the removal of personal data from online searches. Google is a Focus List Buy and a Long-Term Buy.

Corporate roundup

An experimental combination pill made by Gilead Sciences ($106; GILD) to treat HIV met its goals in a pair of late-stage trials. Gilead, the largest maker of HIV drugs, hopes this new treatment will fend off generic competition. It plans to seek regulatory approval for the drug in the U.S. and Europe in the December quarter. Gilead is a Long-Term Buy.


J.P. Morgan Chase's ($60; JPM) investment-banking revenue slipped 12% to $11.5 billion in the first half of 2014 but still led all peers, according to researcher Coalition. The bank has finished first every year since Coalition started releasing rankings in 2010. J.P. Morgan is a Long-Term Buy.


Rank Change

Dow Chemical ($50; DOW) is being dropped from the Focus List, Buy List, and Long-Term Buy List. Vanguard Short-Term Corporate Bond ETF ($80; VCSH) now accounts for 6.1% of the Buy List and 8.1% of the Long-Term Buy List.


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