Portfolio Review

6/8/2015


New Buy, plus a downgrade

HCA Holdings ($81; HCA) is joining the Buy and Long-Term Buy lists. At the end of March, the company operated 168 hospitals and 113 freestanding surgery centers. Strong volume trends supported 9% sales growth in the 12 months ending March and fattened operating profit margins. HCA carries a heavy debt load, with net debt totaling $28.86 billion. However, interest expense is well covered. Operating cash flow advanced 48% in the 12 months ended March, while free cash flow jumped 95% to $2.80 billion. The stock has rallied 10% so far in 2015 and 53% over the past year but still scores above 70 in Quadrix for price/sales and price/cash flow. At 16 times trailing earnings, the stock trades 26% below the median for S&P 1500 health-care facilities.


Corning ($21; GLW) is being removed from the Buy List. The stock has slumped 7% since posting mixed March-quarter results and raising concerns over the level of glass inventory in the supply chain. The Overall score has slipped to 70, hurt by slowing operating momentum and poor profit-estimate trends. With a Value rank of 85 and trailing P/E ratio of 13, the stock looks cheap but no longer qualifies as a top pick for 12-month returns. Corning remains a Long-Term Buy.

M&A: The games rivals play

The total value of U.S. deals announced in May set an all-time monthly record of $243 billion, topping the previous high of $226 billion for the same month in 2007, according to Dealogic. Recent activity probably reflects companies scrambling to put cheap debt to work ahead of expected interest-rate increases. Momentum for deal activity continued into June with a number of developments:

Teva Pharmaceutical Industries ($61; TEVA) purchased a 1.8% interest in generic-drug maker Mylan ($72; MYL). In response, Mylan told Teva to either make a formal bid or "stop playing games with our company."

Mylan previously rejected Teva's $40.1 billion bid, equating to roughly $82 per share. However, Teva may seek to acquire more of Mylan's stock. The Netherlands, where Mylan is based, allows shareholders with a 3% stake to put items on the agenda at investor meetings. Mylan plans to host a shareholder meeting early in the September quarter to vote on its proposed acquisition of Perrigo ($196; PRGO). Note that Perrigo took a page from Mylan's playbook by announcing two acquisitions since Mylan launched its own hostile takeover. Teva says its takeover offer is contingent on Mylan not buying Perrigo.

If Teva buys a 4.6% stake it may be able to challenge Mylan's takeover defense in court. Moreover, a hedge fund run by John Paulson raised its stake in Mylan to at least 4.6% in April and has put pressure on management to consider Teva's offer. Pending further developments, Mylan remains a Buy and a Long-Term Buy.


Aetna ($117; AET) and Cigna ($140; CI) have reportedly entered preliminary talks to acquire Humana ($214; HUM) after the smaller rival tested the waters regarding a potential sale. The takeover negotiations come in the wake of statements by officials at Aetna and Anthem ($164; ANTM) expressing interest in pursuing a large deal. Humana has missed the consensus profit estimate in three straight quarters and faces investor pressure to explore a sale.

With a stock-market value of $32.54 billion, Humana ranks fifth among U.S. managed-care companies. Humana has more than 3.1 million Medicare Advantage members, representing 18% of the U.S. market and 35% of the company's total medical membership. Only UnitedHealth Group ($118; UNH) has more Medicare Advantage members, with 3.4 million. Aetna is a Focus List Buy and a Long-Term Buy. Anthem, Cigna, and UnitedHealth are rated A (above average).


Intel ($33; INTC) agreed to acquire Altera ($52; ALTR) for about $16.7 billion in cash, or $54 a share. That price tag represents a 10.5% premium to Altera's share price prior to the announcement — and a 56% premium to where the stock traded before reports of a potential deal first surfaced in March. Altera rejected an earlier offer from Intel, also valued at about $54 a share, in April, angering some investors.

In 2013, Intel signed Altera to a 12-year contract to manufacture the latter's programmable semiconductors. The pending acquisition will boost Intel's presence in data centers and gain access to a new market in wireless equipment, helping it weather weakness in personal computers. Intel is rated A (above average). Altera, formerly rated B (average), is being dropped from coverage.

Airlines update

Southwest Airlines ($38; LUV) retreated from plans announced last month to expand capacity 7% to 8% this year after investors reacted negatively to the upward revision. Southwest says it now plans to stick to its prior growth target of 7%, though the company also announced a three-day sale with some deeply discounted fares. Southwest Airlines is a Long-Term Buy.


Alaska Air Group ($66; ALK) said traffic increased 10% in May on a 12% jump in capacity. The airline's load factor, which measures the proportion of airline capacity actually used, slipped to 84.5% from 85.7% in the year-ago quarter. Alaska Air is a Focus List Buy and a Long-Term Buy.

Corporate roundup

United Rentals ($92; URI) shares have fallen 12% since an analyst downgrade and comments from CEO Michael Kneeland at an investor conference. Kneeland said May sales were softer than anticipated, as utilization rates and pricing have come under pressure in the oil-and-gas-production industry. Despite these concerns, shares seem unduly cheap at 12 times trailing earnings, 24% below their three-year average and 35% below the median for S&P 1500 industrial stocks. United Rentals, with an Overall score of 97, remains a Focus List Buy and a Long-Term Buy.


J.P. Morgan Chase ($67; JPM) has reportedly begun to slash 5,000 jobs across all major segments, moves that will reduce its work force 2% by 2016. The bank eliminated 8,000 mortgage positions last year. Separately, J.P. Morgan said June-quarter trading revenue is on pace to hold roughly flat from the year-ago quarter. J.P. Morgan is a Buy and a Long-Term Buy.


Nvidia ($22; NVDA) said its revenue from cloud computing, growing 60% to 70% annually, should reach $1 billion over the next two to three years. In related news, Nvidia launched a video-game console that exclusively streams games over the internet, rather than requiring discs or downloads. Nvidia is a Long-Term Buy.


Apple ($130; AAPL) is expected to announce a streaming-music service at a developers conference this month, reported The Wall Street Journal. Apple wants the service, expected to cost around $10 a month, to cannibalize its iTunes business, which generates annual sales of $30 from the average user. Apple is a Focus List Buy and a Long-Term Buy.


Rank Changes

HCA Holdings ($81; HCA) is being initiated as a Buy and a Long-Term Buy. Corning ($21; GLW) is being dropped from the Buy List but remains a Long-Term Buy.


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