Portfolio Review

3/23/2015


Pay-TV update

The Federal Communications Commission paused its review of Comcast's ($59; CMCSa) pending $45 billion acquisition of Time Warner Cable ($157; TWC), casting doubt on whether the deal will be completed by the end of March, as Comcast executives assured investors last month. The FCC's examination of AT&T's ($34; T) proposed $48.5 billion acquisition of DirecTV ($86; DTV) has also been postponed. Regulators await a court ruling that will determine the disclosure of programming contracts.

The FCC had sought to give third parties limited access to the contracts in order to assess potential effects of the deals. TV companies wish to keep the programming agreements secret. Comcast is a Buy and a Long-Term Buy. DirecTV is rated B (average). AT&T is rated C (below average).


Apple ($128; AAPL) entered talks with TV programmers about launching a TV service that would feature roughly 25 channels for a price of $30 to $40 per month. The service would be available on all Apple devices and include broadcasters ABC, CBS, and Fox, as well as popular networks such as ESPN and FX. For now, Apple is not in discussions with Comcast's NBCUniversal, though a 2011 federal agreement legally binds Comcast to offer programming to internet services if its rivals are also doing so. Apple could announce the service in June and launch as soon as September. Apple is a Focus List Buy and a Long-Term Buy.


Apple's proposal for a slimmed-down TV package comes as cable companies see increasing pressure to unbundle their networks and channels. Time Warner's ($87; TWX) HBO will become the first cable channel to sell itself outside of the traditional pay-TV bundle, targeting the 10 million households with broadband internet but not pay TV. Time Warner has struck deals with Apple and Cablevision ($18; CVC) for its April launch of a streaming service called HBO Now. Time Warner is rated B (average).

The shoe still fits — stick with Foot Locker

Foot Locker ($61; FL) told investors it expects sales to reach $10 billion by 2020, implying compound average growth of 6%. That guidance implies same-store sales will rise at a mid-single-digit clip. Operating and profit margins are also expected to expand. The retailer's efforts to remodel its stores have paid off in higher profitability and productivity. Just 20% of Foot Locker stores and 25% of Champs stores have been remodeled so far, offering a long runway for future improvement.

Foot Locker faces some risks in softer trends for mall traffic and its high exposure to the fickle fashion tastes of its core customers, teenagers. Nike ($98; NKE), accounting for roughly two-thirds of Foot Locker's revenue, is building its own retail presence, which could create a new source of competition. But Foot Locker is a crucial business partner for Nike, and we don't expect Nike to sabotage that relationship.

Rising analyst estimates project 10% higher per-share profits on 3% revenue growth in fiscal 2016 ending January. At less than 16 times estimated year-ahead earnings, the stock trades 17% below the median for consumer discretionary stocks in the S&P 1500 Index. Foot Locker is a Focus List Buy and a Long-Term Buy. Nike is rated B (average).

Technology review

Google ($566; GOOGL) CFO Patrick Pichette, a seven-year veteran at the company, announced his retirement at the age of 52. Pichette's retirement date is not yet set, though Google expects to find his replacement over the next six months. One of the top questions on investors' minds is how the new CFO will handle Google's growing trove of cash, currently $64.40 billion. Operating cash flow has grown more than 10% in seven straight quarters, and Google generated more than $11 billion in free cash flow in each of the past four years. If Google returned just $5.5 billion of that cash to investors as a dividend, the annual distribution would amount to roughly $8 per share.

Google's ability to produce prodigious amounts of cash helps us overlook its Quadrix Overall score of just 64. Its trailing P/E ratio of 22 drops to 19 after excluding net cash of nearly $86 per share. Moreover, Google's price/operating cash flow ratio matches its five-year median and is 35% below the median for S&P 1500 internet-software stocks. In other news, Google is reportedly discussing the acquisition of InMobi, a mobile-advertising company based in India that could be worth around $2.5 billion. Google remains a Buy and a Long-Term Buy.


Citing weakness in personal computers, Intel ($31; INTC) slashed its March-quarter revenue guidance to roughly $12.8 billion from its prior target of $13.7 billion. The company produced sales of $12.76 billion in the year-ago quarter. Intel said businesses remain reluctant to replace aging desktop personal computers (PCs). Meanwhile, foreign-currency trends and economic weakness have depressed results in Europe. Global PC shipments are projected to fall up to 9% in the March quarter from December-quarter levels, according to BlueFin Research Partners. Last month, rival research firm IDC lowered its 2015 PC outlook to a 5% decline. Intel is rated A (above average).


The soft PC market, coupled with concerns about rising competition from Samsung Electronics, has led analysts to trim Micron Technology's ($28; MU) profit estimates. Using the lowest analyst estimate, the stock trades at less than nine times estimated earnings for fiscal 2015 ending August. Micron shares have slumped 8% so far this month, but expectations may now be overly modest, with analysts forecasting per-share profits of $0.78 in the February quarter, down 8% despite 2% higher revenue. Scheduled to post results on April 2, Micron remains a Buy and a Long-Term Buy.


Lam Research ($77; LRCX) shares fell after an analyst report said Samsung Electronics has delayed ordering a "meaningful level" of semiconductor equipment as it slows its expansion. Samsung is one of three semiconductor firms that each account for more than 10% of Lam's revenue. Lam is a Focus List Buy and a Long-Term Buy.

Health-care update

CVS Health ($103; CVS) said it expects biosimilars — close, but not exact, copies of biotechnology drugs — to drive down costs 40% to 50%. This projected decline dwarfs the more than 20% to 30% discounts that many analysts had been anticipating. The comments reflect the determination of CVS and other pharmacy-benefit managers to aggressively contain costs as alternatives to pricey treatments become available.

Early this month, the Food and Drug Administration approved the first biosimilar drug in the U.S., a white-blood-cell-boosting treatment made by Novartis ($100; NVS) that is a near replica of Amgen's ($167; AMGN) Neupogen. Not to be outdone, Amgen expects to launch up to five biosimilars of its own in the U.S. by 2019.

Separately, two studies, one funded by CVS, found that pricey hepatitis C drugs made by Gilead Sciences ($100; GILD) and AbbVie ($60; ABBV) are actually cost-effective means of treating the disease. CVS is a Buy and a Long-Term Buy. Gilead is a Long-Term Buy. Amgen is rated A (above average). AbbVie is rated B (average). Novartis is rated C (below average).

Financial roundup

Wells Fargo ($56; WFC) CFO John Shrewsberry told CNBC he expects a "good year" for loan growth, helped by the improving job outlook for individuals and strong deal activity for companies. Wells Fargo is a Long-Term Buy.


J.P. Morgan Chase ($62; JPM) agreed to purchase servicing rights on $45 billion of mortgages from Ocwen Financial ($9; OCN). J.P. Morgan is a Long-Term Buy.


Rank Changes

No changes were made this week in Dow Theory Forecasts.


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