Portfolio Review

6/22/2015


Takeover beat

CVS Health ($104; CVS) said it will purchase Target's ($82; TGT) pharmacy business for $1.9 billion. The deal includes about 1,660 in-store pharmacies and 80 medical clinics, giving CVS more than 9,500 locations. Target's pharmacy business generated about $4.2 billion in sales but virtually no profit last year. CVS expects its scale will help create cost savings at the acquired pharmacies and clinics.

The deal will give CVS a 25% stake of the U.S. prescription market. It may also push supermarkets, struggling to gain prescription share, to explore deals of their own. Kroger ($73; KR) commanded 3% of the prescription market last year with $8.6 billion in sales. In related news, CVS says the deal will reduce 2015 stock repurchases by $1 billion to about $5 billion. Kroger is a Focus List Buy and a Long-Term Buy. CVS is a Buy and a Long-Term Buy. Target is rated A (above average).


Abbott Laboratories ($49; ABT), Mylan's ($71; MYL) largest shareholder, pledged to back the generic drugmaker's unsolicited bid to acquire Perrigo ($188; PRGO) in a deal worth about $33 billion. In February, Mylan issued Abbott 110 million shares in exchange for Abbott's branded-generics and specialty units for developed markets outside of the U.S. Abbott holds a 14.5% interest in Mylan after selling nearly one-third of its stake in April. So far, Perrigo has shrugged off the advances of Mylan, which is trying to complete the deal in order to thwart the plans of its own unwanted suitor,  Teva Pharmaceutical Industries ($60; TEVA). Mylan is a Buy and a Long-Term Buy. Abbott is rated B (average).


Johnson Controls ($52; JCI) says it will explore selling its automotive-seating unit, which generated sales of $17.01 billion in the 12 months ended March. Johnson's seating business, potentially worth $7.5 billion to $10.0 billion, is the biggest player in the $60 billion global market for automotive seating. At first glance, Lear ($116; LEA) seems like an obvious potential acquirer. But Lear's own 12-month seating revenue tops $12 billion, and a deal involving Lear could run afoul of antitrust regulators.

Lear may also be reluctant to double down in an area with significantly smaller profit margins — its electrical unit generates operating margins of nearly 13%, versus 5% for seating. Moreover, Lear suggested in April it would prefer smaller niche deals, especially those that could expand its business in Asia. All in all, Lear would probably be more interested in acquiring a portion of Johnson's seating unit — the Chinese operations, for example — if Johnson is willing to break up the business.

Magna International ($58; MGA) may be interested in acquiring part or all of Johnson's seating business. It has a stronger balance sheet than Lear, with more cash than debt. Magna's 12-month cash from operations totaled $2.61 billion, more than double Lear's. Magna agreed to sell its interiors business in April but seems upbeat about the growth prospects in seating. Management said last month it would consider making "a very sizable" acquisition. Both Lear and Magna are Focus List Buys and Long-Term Buys.


Russian antitrust officials postponed their ruling on Schlumberger's ($90; SLB) pending $1.7 billion purchase of a 46% stake in Eurasia Drilling. In January, Schlumberger agreed to buy an interest in Russia's largest driller, with the option to acquire the rest of the firm three years later. A decision could come later this summer. Schlumberger is a Long-Term Buy.


Comcast ($60; CMCSa) is reportedly among several companies discussing the possible acquisition of T-Mobile US ($40; TMUS) from Deutsche Telekom, which owns a 66% stake in the company. With a market value of $32.23 billion, T-Mobile produced sales of $30.47 billion in the 12 months ended March. Comcast is a Buy and a Long-Term Buy. Sprint is rated C (below average).

Merger madness spreads to health insurers

A spate of mergers among hospitals now has health insurers exploring the same strategy to gain market share and improve their negotiating leverage. Takeover interest centers on three companies:

Aetna ($124; AET) has been approached by UnitedHealth Group ($120; UNH) about merging, according to The Wall Street Journal. Aetna has shown interest in exploring deals, though it may not have envisioned its role as the acquisition target. Aetna CEO Mark Bertolini's contract includes a $131 million payout should he lose his job in a takeover.

Humana ($201; HUM) is looking to sell itself, drawing the interest of several insurers, including Cigna ($155; CI) and Aetna. With growth in commercial-health plans stagnating, Medicare has become an attractive business as the Baby Boomer population ages. Humana has a leading 7.5 million Medicare customers, representing 83% of its total medical membership, as shown in the nearby table.

Cigna ($155; CI) reportedly rejected two of Anthem's ($165; ANTM) takeover offers, the latest valued at about $45 billion, after months of discussions. Cigna may also catch the eye of UnitedHealth.

Aetna is a Focus List Buy and a Long-Term Buy. Anthem, Cigna, and UnitedHealth are rated A (above average).

Breakdown of top U.S. health insurers
------------- Medical Members (In Thousands) -------------
12-Month
Sales

($)
Company (Price; Ticker)
U.S.
Commercial
Medicare
Medicaid
Other
Total
Aetna ($124; AET)
19,859
1,716
2,095
23,670
59,102
Anthem ($165; ANTM)
29,919
1,426
5,622
1,570
38,537
75,066
Cigna ($155; CI)
13,312
489
66
787
3,060
35,885
Humana ($201; HUM)
1,258
7,538
339
9,135
50,621
UnitedHealth ($120; UNH)
29,430
7,135
5,040
4,160
45,765
134,522


Corporate roundup

Consistent with its capital-return plan disclosed in March, U.S. Bancorp ($45; USB) raised its quarterly dividend 4% to $0.255, payable July 15. U.S. Bancorp is a Long-Term Buy.


Macy's ($70; M) has agreed to let Men's Wearhouse ($64; MW) open tuxedo-rental shops in 300 Macy's stores. The shops will carry the Macy's brand but be operated by Men's Wearhouse. In other news, Macy's faces pressure from investors to sell some of its real estate and then lease back the property. Other retailers have announced similar moves this year, causing their shares to rally. Macy's is a Long-Term Buy.

Stick with United Rentals

United Rentals ($91; URI) shares have been volatile in recent weeks as investors try to handicap the effect of oil prices on equipment rentals. In June, activist firm Jana Partners announced it has taken a 6% stake in United Rentals, citing the company's leading position in the rental-equipment market. Days later an analyst at Macquarie downgraded the stock to Underperform on concerns United Rentals will be forced to lower its guidance as weakness in both the production and processing/refining portions of the energy industry could pressure rental rates and equipment utilization.

Also problematic, Oshkosh ($46; OSK) cut its guidance for fiscal 2015 ending September, partly due to poor weather hurting sales of aerial work platforms. United Rentals relied on aerial work platforms for 33% of its equipment-rental revenue last year.

We are standing by United Rentals, earning a Momentum rank of 88, Value rank of 90, and Overall rank of 98. The stock trades at just 11 times the consensus 2015 profit estimate of $8.22 per share. Even the low profit estimate of $6.65 per share implies a P/E below 14, versus the median forward P/E of 18 for S&P 1500 industrial stocks. United Rentals is a Focus List Buy and a Long-Term Buy.


Rank Changes

No rank changes are being made this week in Dow Theory Forecasts.


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