Portfolio Review

1/12/2015


Two downgrades

We are removing Halliburton ($39; HAL) from the Buy and Long-Term Buy lists. Our decision to stick with the stock through the end of 2014 was not premised on a quick rebound in oil prices — but we did expect some stabilization. U.S. oil prices have fallen about 10% so far this year and natural gas is also down sharply over the past month. Halliburton's Overall rank has fallen to 82 from 95 at the end of July.

Although the stock trades at just 11 times projected 2015 earnings, we have little confidence in the current consensus as analysts continue to trim their estimates. It is difficult to predict how things will play out in the oilfield-services industry, but we expect Halliburton's Quadrix scores to keep falling, at least in the near term. Halliburton is not a stock we would buy today and should be sold. Halliburton is now rated B (average).


Norfolk Southern ($103; NSC) is being removed from the Long-Term Buy List. The stock's Overall rank has fallen to 66 from 86 at the end of September, hurt by slowing operating momentum and poor trends in analyst-estimate revisions. The stock has dipped 6% in the opening days of 2015, yet its valuation is not particularly enticing at 16 times trailing earnings, a 6% premium to the five-year average. Up 9% since we first recommended the shares as a Long-Term Buy in March 2014, Norfolk should be sold. The stock is now rated B (average).

We're still buying United Rentals

In April, United Rentals ($89; URI) expanded its presence in the shale oil industry by acquiring National Pump for $780 million. Investors applauded the deal at the time, but it has become a source of consternation since oil prices began to tumble in the fall of 2014. United Rentals shares have fallen 25% from their all-time high in September, most recently declining on an analyst downgrade.

A survey of construction-equipment dealers suggested weak oil prices will crimp investment in energy projects. United Rentals said in December that just 11% of September-quarter revenue came from the oil-and-gas industry, though some analysts note that equipment demand currently has a stronger relationship to rig counts than in the past.

Despite the disappointing share-price action, analyst profit estimates for the December quarter and 2015 have actually risen in the past 60 days. U.S. nonresidential construction (45% of the company's sales) increased 5% year-over-year in November, consistent with United Rentals' October comments that the construction recovery is still gaining momentum. In December, management expressed confidence that it could raise rental rates 3% to 4% this year. In addition, United Rentals says a lot of its energy equipment can be rented to customers in other sectors. United Rentals remains a Focus List Buy and a Long-Term Buy.

Health review

CVS Health ($96; CVS) awarded preferred formulary status to Gilead Sciences' ($99; GILD) hepatitis C treatments Sovaldi and Harvoni. CVS will exclude AbbVie's ($67; ABBV) newly approved hepatitis C treatment in all but a handful of cases. Less than a month ago, Express Scripts ($85; ESRX) formed a similar pact with AbbVie, discontinuing coverage of Gilead's hepatitis C drugs in most cases. It is unclear what type of price concessions the pharmacy-benefit managers extracted from Gilead and AbbVie. Express Scripts covers about 90 million people, CVS about 65 million. Based on one estimate, the global market for hepatitis C drugs could jump 42% to $18.5 billion in 2015. Sovaldi generated sales of $8.55 billion in the first nine months of 2014, accounting for 49% of Gilead's revenue.

Seeking to diversify its drug portfolio, Gilead agreed to pay up to $470 million for a liver-disease treatment program from Phenex Pharmaceuticals, a privately held biotechnology company based in Germany. Gilead shares rose on both reports and have rallied 11% from their December low. Gilead is a Long-Term Buy. CVS is a Buy and a Long-Term Buy. Express Scripts is rated A (above average). AbbVie is rated B (average).


Mylan ($56; MYL) launched in the U.S. a generic version of Novartis' ($92; NVS) Diovan, a drug that treats hypertension and generated U.S. sales of about $2 billion in the 12 months ended September. Mylan is a Buy and a Long-Term Buy. Novartis is rated C (below average).


This flu season could be the most severe in years, with 43 states experiencing high levels of the illness, according to the U.S. Centers for Disease Control and Prevention. Costs for treating the flu could hurt the profitability of health insurers' Medicaid businesses. Medicaid represents just 9% of Aetna's ($89; AET) 23.6 million medical members. At less than 13 times estimated 2015 earnings, Aetna shares trade 23% below the median for S&P 1500 health insurers. Aetna, earning an Overall score of 95, is a Buy and a Long-Term Buy.


After buying the remaining stake in Boots Alliance for more than $15 billion in cash and stock, Walgreen changed its name to Walgreens Boots Alliance ($77; WBA) and now trades under the ticker WBA. The company said same-store sales rose 6.1% in December, or 4.4% excluding the effect of one more Saturday and one less Tuesday, with pharmacy sales up 9.0% (6.1%) and front-of-store sales up 2.5% (no impact from calendar-day shift). Walgreens is rated B (average).

Corporate roundup

Alaska Air Group ($60; ALK) said traffic grew 9.1% on a 12.3% jump in capacity in December. Traffic growth exceeded 9% for all three months of the December quarter, accelerating from 5.6% growth in the first nine months of 2014. Alaska Air is a Focus List Buy and a Long-Term Buy.


In a research note, analysts at Goldman Sachs ($187; GS) called on J.P. Morgan Chase ($59; JPM) to split itself up. The analysts say the Fed's recent proposal requiring higher capital reserves makes J.P. Morgan's traditional and institutional banking businesses worth more apart than they are together.

In other news, J.P. Morgan agreed to pay about $100 million to settle an investor lawsuit that claims 12 large banks manipulated prices in the foreign-exchange market. The settlement, the first among the 12 banks, still requires court approval. In November, J.P. Morgan agreed to pay $1.01 billion to end separate probes by U.S. and European regulators into its alleged role in rigging foreign-exchange prices. J.P. Morgan is a Long-Term Buy. Goldman is rated B (average).


Rank Changes

Halliburton ($39; HAL) is being dropped from the Buy and Long-Term Buy lists. Norfolk Southern ($103; NSC) is being dropped from the Long-Term Buy List. The Vanguard Short-Term Corporate Bond ($80; VCSH) exchange-traded fund now makes up 5.8% of the Buy List and 12.5% of the Long-Term Buy List.


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