Portfolio Review

12/22/2014


Peeking ahead: guidance reviews

Aetna ($87; AET) expects 2015 per-share profits of at least $6.90, implying minimum growth of 3% — short of the consensus of $7.17 at the time of the announcement. However, the company has a history of issuing conservative initial guidance. Aetna expects operating revenue to rise 7% or more next year to at least $62 billion. A key challenge for Aetna is the risk that an improving economy will spark higher utilization of medical services an1d squeeze profit margins. In pricing its commercial plans, Aetna says it has taken a conservative approach that favors profitability over growth. Looking further out, Aetna expects to earn at least $10 per share on $80 billion of revenue by 2018, which equates to annual growth of 13% or more. Aetna is a Buy and a Long-Term Buy.


CVS Health ($94; CVS) shares rallied to a record high after the company outlined its 2015 outlook and announced plans to return more cash to shareholders. CVS expects 2015 per-share profits of $5.05 to $5.19, implying growth of 13% to 16%. The consensus stood at $5.11 at the time of the announcement. Management also projects free cash flow of $5.9 billion to $6.2 billion, up about 4%. In light of its strong cash generation, CVS hiked its quarterly dividend 27% to $0.35 per share, payable Feb. 2. CVS also approved an additional $10 billion in share repurchases, tacked onto an existing plan with $2.7 billion remaining. In all, CVS is approved to buy back 12% of outstanding shares. CVS is a Buy and a Long-Term Buy.

Airline stocks flying high again

Airline stocks have performed well despite the stock market's recent turbulence, with Southwest Airlines ($40; LUV) rising 15% over the last three months and Alaska Air Group ($56; ALK) gaining 19%, while the S&P 1500 Index declined 1%. Operating momentum for both airlines continued in November. Southwest reported 6% higher traffic and 4% capacity growth, while Alaska posted 9% growth for both metrics.

Southwest CEO Gary Kelly said he expects Southwest's fuel costs to be $2.30 to $2.40 a gallon next year, including the airline's hedges. Southwest's fuel cost $3.01 a gallon in the first nine months of 2014, down 4% from the year-earlier period. Southwest has hedged about 30% of projected fuel needs for the December quarter and 40% for 2015. Alaska Air's hedges cover about 50% of expected fuel usage next year. Fuel represents roughly one-third of operating costs for both airlines.

Of course, the big question is whether airlines will eventually pass on some of their fuel savings to passengers. The International Air Transport Association, a group that represents about 250 airlines around the world, expects airfares to drop 5% in the coming year — while the industry's after-tax profits surge 26% to $25 billion. Alaska Air is a Focus List Buy and a Long-Term Buy. Southwest Airlines is a Long-Term Buy.

Gilead price complaints pile up

The big price tags Gilead Sciences ($102; GILD) affixed to hepatitis C treatments Sovaldi and Harvoni never stay out of the news for long. Philadelphia's transit agency seeks class-action status in a lawsuit against Gilead over the price of hepatitis C treatment Sovaldi. The agency says it has paid more than $2.4 million for Sovaldi, which produced $8.55 billion in sales for Gilead during the first nine months of the year, making it the most successful drug launch in history.

The complaint could trigger more lawsuits from prisons and other groups straining their budgets to treat the infected. Gilead could also be forced to offer more discounts, such as the nearly 50% price cut it gave to the U.S. Department of Veteran Affairs.

Yet there are reasons for optimism. Prescriptions for the newer Harvoni are trending ahead of Sovaldi's initial scripts, eight weeks into their respective launches. These results could be depressed as some potential customers wait on pricing information for a rival treatment by AbbVie ($67; ABBV), expected to be approved later this month. Some price erosion for Harvoni and Sovaldi seems likely. For convenience, at least, Gilead should come out on top: AbbVie's version requires six pills a day to Gilead's one. Gilead, earning a maximum Momentum score of 100, is a Long-Term Buy. AbbVie is rated B (average).

Corporate roundup

B/E Aerospace ($56; BEAV) has spun off KLX ($41; KLXI), which provides consumable products and distribution services in the aerospace and energy markets. Investors received one share of KLX for every two shares of B/E. B/E Aerospace, which retains its aircraft-interiors business, remains a Buy and a Long-Term Buy. KLXI is not on our buy lists, but we suggest subscribers hold the stock for now.


With U.S. regulators demanding a higher capital cushion for large, complex banks, J.P. Morgan Chase ($60; JPM) said it will raise its capital ratio to shore up an estimated $21 billion shortfall. Of the eight massive U.S. banks reviewed, J.P. Morgan is the only one facing a shortfall under the proposed rules, expected to be phased in starting 2016. Separately, the bank expects trading revenue to decline 4% in the December quarter after adjusting for the sale of its physical-commodities unit.

In related news, J.P. Morgan's investment bank reportedly generated a leading $17.1 billion of revenue for the first nine months of 2014. Lastly, three months after completing treatment for throat cancer, CEO Jamie Dimon said his latest tests were negative. J.P. Morgan is a Long-Term Buy.


The U.S. Federal Communications Commission restarted its clock for reviewing a pair of huge pending acquisitions. Regulators are gathering public comments for Comcast's ($55; CMCSa) proposed $45 billion purchase of Time Warner Cable ($144; TWC) and AT&T's ($33; T) $48.5 billion bid to buy DirecTV ($83; DTV). Although U.S. senators from Pennsylvania are pressing the FCC to approve the Comcast deal quickly, regulators have not ruled out more delays. Complicating these reviews, several media companies have balked at turning over confidential programming agreements that would help regulators assess potential effects of the deals. A U.S. appeals court is examining this issue.

In related news, Comcast disclosed financial data for the portion of the company to be spun off if the Time Warner deal gets cleared. For the nine months ended September, Midwest Cable grew operating income 2% to $802 million on revenue of $3.46 billion, up 3%. Comcast is a Buy and a Long-Term Buy. AT&T and DirecTV are both rated B (average).


Google's ($506; GOOGL) mobile-search contract with Apple ($109; AAPL) could end as soon as January, potentially reducing gross revenue by $9.4 billion, according to one estimate. Separately, Google is reportedly considering a "buy" button for its Google Shopping service that would let shoppers place an order with a single click. The feature would keep users on Google's website longer, rather than directing them to merchants' sites.

In other news, the European Union's new antitrust chief, Margrethe Vestager, plans to meet with companies that have filed grievances against Google before deciding whether to pursue formal charges against Google. Google is a Buy and a Long-Term Buy.


Rank Changes

No changes were made this week in Dow Theory Forecasts.


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