Portfolio Review

2/23/2015


Utility upgrades and downgrades

We are making changes to the Top 15 Utilities portfolio this week. Spectra Energy Partners ($54; SEP) and WGL ($54; WGL) are coming onto the list, replacing DTE Energy ($85; DTE) and Empire District Electric ($25; EDE).

Spectra Energy Partners, a master limited partnership (MLP), operates oil and natural-gas-liquids pipelines and natural-gas storage facilities. The company generates more than 90% of its revenue from fees to reserve capacity in its pipes or tanks. Over the last year, Spectra generated growth of 15% in revenue and more than tripled distributable cash flow. The MLP yields 4.3%.


WGL, which serves more than 1.1 million natural-gas customers in and around Washington, D.C., raised its dividend 5% early this month, marking the 39th consecutive year of higher dividends. The utility now yields 3.4%. WGL also operates natural-gas storage facilities that serve its regulated utilities, as well as nonregulated storage/pipeline and construction businesses.


DTE generated solid growth last year, but the consensus projects 11% lower sales and flat per-share profits this year. Despite its low growth expectations, DTE trades roughly in line with its peer-group median on most valuation ratios.


In the wake of an ugly December quarter, Empire District's Quadrix® Overall score has slipped to 38. The consensus per-share-profit target for this year has fallen 11% since the earnings announcement; analysts now expect 2% lower sales and 10% lower profits in 2015.

The Top 15 Utilities portfolio, which contains a diversified mix of utilities and companies in adjacent industries, is designed to provide a yield comparable to the average utility stock, with superior growth potential. No single utility stock offers the mix of growth and value needed to earn a place on the Forecasts' buy lists, but the Top 15 Utilities portfolio provides safety in numbers.

Investors who crave utility exposure should purchase equal-dollar amounts of all 15 stocks.

Alaska Air hits air pocket

Alaska Air Group's ($64; ALK) stock entered February up 72% over the prior 12 months. But shares have slid 6% so far this month, likely hurt by several factors. Snowstorms in many parts of the U.S. have caused the cancellation of a flurry of flights. Oil prices have rebounded in recent weeks, causing Alaska to raise its March-quarter guidance for fuel costs. The company also said promotions on checked luggage will reduce operating revenue by at least $10 million in the March quarter.

Yet management raised its 2015 guidance for capacity growth to 9.5% from its prior target of 8%, as Alaska plans to add more jets to its fleet. With that growth, Alaska Air now expects nonfuel unit costs to decline for the year. At 10 times estimated year-ahead earnings, the stock trades 17% below the average for S&P 1500 Index airlines. Alaska Air, earning a maximum Overall rank of 100, is a Focus List Buy and a Long-Term Buy.

Keeping watch on Apple

Apple ($129; AAPL) reportedly ordered 5 million to 6 million units of its Apple Watch ahead of the device's April launch. The Apple Watch represents the company's first entirely new product line since the iPad was introduced in April 2010. Some analysts question consumers' willingness to spend at least $350 on a watch, though initial analyst estimates project Apple selling from 12 million to 26 million units this year.

One potential selling point is that the Apple Watch will let users make purchases with Apple Pay, the mobile-payment service that continues to gain momentum. Apple Pay, accepted by more than 2,000 banks, just landed a new customer: the federal government. Starting in September, Apple Pay will be accepted at national parks. Apple is also trying to make Apple Pay available for federal payment cards, which handle tens of millions of transactions each year.

In other news, Apple is reportedly in the initial stages of designing an electric vehicle. It's unclear whether Apple would want to dive into such a capital-intensive industry, though ideas for other new products could sprout from the exercise of building a prototype vehicle. Apple is a Focus List Buy and a Long-Term Buy.

Oil gains some footing

U.S. oil prices have risen more than 19% since West Texas Intermediate (WTI) set a 70-month low on Jan. 28. That bounce comes as U.S. oil drillers move to curtail activity. The number of U.S. rigs has fallen in 10 straight weeks and currently sits at a three-year low.

January saw a 28% drop in the number of oil wells drilled in the continental U.S. from levels in June, before oil prices started falling. But despite the cutbacks, production of crude oil declined just 9% as companies focused drilling efforts on their largest wells. About 417.9 million barrels of crude oil are being stored in the U.S., the most in at least 80 years, says the Energy Information Administration.


Schlumberger ($88; SLB) shares rallied 6% in February, though we view the stock as best suited for investors with two- to four-year time horizons. The Quadrix® Overall rank has slumped to 64, hurt by subpar ranks for Momentum (34), Earnings Estimates (2), and Performance (26). At 16 times trailing earnings, the stock trades 26% below its five-year average. But Schlumberger is expected to post sales and profit declines this year, and analysts keep trimming their profit estimates for both 2015 and 2016. Schlumberger remains a Long-Term Buy.

Corporate roundup

Lear ($109; LEA) hiked its quarterly dividend 25% to $0.25 per share, payable March 23. The company has now raised its dividend more than 15% in three straight years. Lear also increased its stock-buyback plan to $1 billion, set to run through 2017. Management lowered the share count 22% in the past three years, paying an average price of $58 per share. The new plan is enough to repurchase 11% of outstanding shares at their current price. At the end of 2014, Lear had $339 million remaining on its prior buyback program. Lear, yielding 0.9%, is a Focus List Buy and a Long-Term Buy.


Gilead Sciences ($104; GILD) agreed to charge a group of medical insurers in Germany $46,625 for each 12-week round of treatment with hepatitis C drug Sovaldi. Gilead had originally priced Sovaldi at about $68,228 in Germany, compared to $84,000 in the U.S. The deal illustrates that Gilead's willingness to offer aggressive discounts extends beyond the U.S. border. Earlier this month, Gilead warned that discounts for its hepatitis C drugs will average 46% in the U.S. this year, compared to 22% in 2014. Prescription trends for Gilead's hepatitis C drugs have been encouraging so far this year. Gilead has captured an estimated 83% market share for hepatitis C drugs in the U.S. Gilead is a Long-Term Buy.


Rank Changes

We are making no changes to our recommended lists. In the Top 15 Utilities portfolio, Spectra Energy Partners ($54; SEP) and WGL ($54; WGL) are being added, while DTE Energy ($85; DTE) and Empire District Electric ($25; EDE) are being dropped.


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