Portfolio Review

3/16/2015


Upgrades and downgrades

With fourth-quarter earnings season now in the rear-view mirror, we are adjusting our stance on a handful of stocks. These moves are our first rank changes since the Feb. 9 issue.

Focus List additions

We are upgrading Corning ($23; GLW) to the Focus List, mostly because of the stock's improving operating momentum, modest expectations, and low valuation. Per-share profits, revenue, and cash from operations all rose at least 24% last year, while free cash flow surged more than 150% to a record $3.04 billion. Although profit estimates have risen in the past 30 days, the consensus still seems conservative, with per-share earnings projected to grow 10% in the March quarter but just 1% for the year.

At less than 15 times trailing earnings, the stock trades 27% below the median for S&P 1500 electronic-components stocks. Shares also seem unduly cheap relative to operating cash flow and free cash flow. Corning, a supplier of glass for electronic devices, is also a Long-Term Buy.


Nvidia ($23; NVDA) has already carved out a strong position in mobile devices and personal computers for its semiconductors that power graphic displays. Now it is tilling new fields of growth in the automobile and data-center markets. More than 7.5 million cars use Nvidia's semiconductors, up 60% from a year ago, and the company is designing technology that could help pave the path for self-driving cars.

Shares have rallied 10% since Nvidia's January-quarter report but still look attractive at 16 times trailing earnings, a 20% discount to their five-year average and 28% below the median for S&P 1500 semiconductor makers. Nvidia is being added to the Focus List. The stock is also a Long-Term Buy.

Focus List removals

F5 Networks' ($113; FFIV) Quadrix Overall score has dipped to 79, hurt by a weak Performance rank of 28. The stock has fallen out of favor since the company provided December-quarter results on Jan. 21. We still like its growth prospects; the lowest analyst estimates call for per-share profits rising 17% in the March quarter on sales growth of 11%.

The fundamentals look solid, with operating cash flow rising in five straight quarters and 12-month free cash flow up 12% to $548 million. However, we like other technology stocks better (such as Corning and Nvidia, reviewed above), and we do not want excessive tech exposure. For that reason, we are removing F5 from the Focus List, though it remains a Buy and a Long-Term Buy.


Union Pacific's ($114; UNP) stock has risen 28% since we added it to the Focus List in February 2014, more than double the S&P 500's 11% gain. That rally has pushed its Value score down to 45 and its trailing P/E ratio up to 20 — 10% above its 10-year average and in line with S&P 1500 railroads.

Due to its slightly expensive valuation, Union Pacific no longer ranks among our very favorite stocks for 12-month returns and is being removed from the Focus List. However, it still looks attractive from most other angles. Operating cash flow rose in eight of the past nine quarters, and profit margins are expanding. Earning an Overall rank of 89, Union Pacific is no longer a Focus List Buy, though the stock retains its ratings of Buy and Long-Term Buy.

Long-Term Buy List addition

CDW ($36; CDW) is joining the Long-Term Buy List. Earning an Overall score of 97, CDW supplies hardware and software products to more than 250,000 companies, government agencies, educational institutions, and health-care facilities. Sales growth has accelerated in the past couple years, and CDW is improving its returns on assets and investment. Operating cash flow grew 19% in 2014, providing plenty of capital for dividend growth and stock buybacks. Rising analyst estimates project 14% higher per-share profits for the year.

Long-Term Buy List removal

EMC ($26; EMC) is being dropped from the Long-Term Buy List. The company's Overall score has fallen to 71, hurt by subpar ranks for Momentum, Earnings Estimates, and Performance. The stock is cheap, earning a Value rank of 84 and trading at 13 times estimated 2015 earnings, but profit estimates have been under pressure since EMC provided disappointing guidance with its December-quarter results. The company could be vulnerable to worse-than-expected pricing pressure as new technologies take aim at core product lines. EMC also decided to keep its 80% stake in VMware ($81; VMW), removing a potential catalyst that might have pushed shares higher. EMC is now rated B (average) and should be sold. VMware is rated B (average).

Apple counts on watch to become next big hit

Apple ($122; AAPL) unveiled its Apple Watch, available in three different models priced from $349 to upwards of $17,000. With a battery life of 18 hours, the Apple Watch can send messages and track users' exercise — but it can only connect to the internet with the help of an iPhone. Apple will begin taking preorders on April 10, ahead of the April 24 launch.

Separately, Apple partnered with HBO to launch an online streaming service called HBO Now, which will stream HBO shows and movies on Apple devices. In other news, Apple will replace AT&T ($33; T) in the Dow Jones Industrial Average on March 19. Apple is a Focus List Buy and a Long-Term Buy. AT&T is rated C (below average).

Corporate roundup

Kroger ($75; KR) said January-quarter earnings per share jumped 33% to $1.04, topping the consensus by $0.14. Revenue advanced 9% to $25.21 billion, slightly ahead of the consensus. Same-store sales rose 6.0% excluding fuel — Kroger's 45th straight quarter of growth. For fiscal 2016 ending January, Kroger expects per-share profits of $3.80 to $3.90, implying 8% to 11% growth, versus the consensus of $3.72 at the time of the announcement. Same-store sales are projected to rise 3% to 4%. Kroger is a Focus List Buy and a Long-Term Buy.


Skyworks Solutions ($92; SWKS) joined the S&P 500 Index on March 11, after the close of trading. Skyworks is a Buy and a Long-Term Buy.


Mylan ($59; MYL) shares rallied to a record high after the drugmaker launched three new generic treatments and rumors surfaced that rival Teva Pharmaceutical Industries ($58; TEVA) may try to acquire the company. Mylan is a Buy and a Long-Term Buy.


Southwest Airlines ($44; LUV) reported 6.0% higher traffic and 3.6% higher capacity for February. Passenger revenue per available seat mile increased 1.0%. Southwest Airlines is a Long-Term Buy.


The Federal Reserve blessed the capital-return plans for 28 of 31 U.S. banks. Among those approved were three banks on our Long-Term Buy List. J.P. Morgan Chase ($60; JPM) expects to hike its quarterly dividend 10% to $0.44 per share, payable July 31. U.S. Bancorp ($44; USB) plans to increase its quarterly dividend 4% to $0.255 per share, payable in July. Wells Fargo ($54; WFC) seeks to raise its quarterly dividend 7% to $0.375 per share in the June quarter. All three of our recommended banks also announced plans to repurchase their stock.


Rank Changes

Corning ($23; GLW) and Nvidia ($23; NVDA) are being added to the Focus List, replacing F5 Networks ($113; FFIV) and Union Pacific ($114; UNP), which remain Buys and Long-Term Buys. CDW ($36; CDW) is being added to the Long-Term Buy List, while EMC ($26; EMC) is being dropped from the list.


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