Portfolio Review: August 31, 2015
Ameriprise, Magna, Kroger downgraded
Magna International ($48; MGA) is being downgraded from the Focus, Buy, and Long-Term Buy lists. Hurt by the strong U.S. dollar, Magna's sales slumped 8% in the first half of 2015 and cash from operations has declined at least 20% in three straight quarters. The eroding operating momentum affected Magna's Quadrix Overall score, which has dipped to 83 from 96 at the end of April.
Among auto-parts suppliers, we prefer Lear ($100; LEA), which has consistently delivered operating growth despite facing many of the same headwinds. Lear also enjoys superior Quadrix scores for Momentum, Value, and Overall. Magna's stock is up 85% since we first recommended it in January 2013, ahead of the 32% gain for the S&P 1500 Index. Magna is now rated A (above average) and should be sold. Lear remains a Focus List Buy and a Long-Term Buy.
Kroger ($35; KR) is being dropped from the Focus List but remains a Buy and a Long-Term Buy. Amid the market's recent weakness, Kroger's stock has performed poorly, shedding 11% of its value so far in August. Given Kroger's defensive nature, we expected a better relative performance.
Despite recent weakness, the shares remain up 9% so far in 2015 and 40% over the past 12 months, stretching their valuation somewhat. At 19 times trailing earnings, the stock trades 36% above its five-year average. But it seems likely to keep generating strong growth, with the consensus expecting Kroger to report July-quarter earnings per share of $0.39, up 11%. Kroger will post results on Sept. 11.
On Friday we removed Ameriprise Financial ($112; AMP) from the Buy and a Long-Term Buy lists. Ameriprise earns an Overall rank of 96 after delivering solid June-quarter results in a tough environment for asset managers. But given the market's recent tumult, we don't see industry conditions improving any time soon for the company. Ameriprise has been dropped from coverage and should be sold.
Southern buying AGL
Southern Co. ($44; SO) has agreed to pay $66 per share in cash for AGL Resources ($61; GAS). The deal is worth $12 billion, including the assumption of debt, and equates to a 38% premium to AGL's price at the time of the announcement. The combined company will have 9 million customers, making it the second-largest utility in the country. AGL, a component of the Top 15 Utilities portfolio, jumped 28% on the news.
AGL trades 8% below the deal price, but you shouldn't wait around to collect those gains. Utility mergers often take a long time to complete. In addition, regulators can get picky about utility deals, like the long-awaited pact between Exelon ($31; EXC) and Pepco Holdings ($23; POM) that was rejected this month — nearly a year and a half after the merger announcement. Southern and AGL have very little overlap in their businesses, and regulators probably won't get in the way. Regardless, investors shouldn't consider such merger-related price gains riskless. Subscribers mimicking the Top 15 Utilities portfolio should sell AGL. In the Sept. 7 issue, we'll announce a replacement.
Big trouble in not-so-little China
Turmoil in China has roiled stocks around the globe in the past week. Fresh concerns emerged that growth is slowing at a faster pace than previously expected after China turned in its worst report for factory activity in 77 months. Seeking to improve liquidity and reduce the risk of deflation, Chinese officials responded by cutting interest rates for the fifth time since November and reducing reserve requirements for banks. But investors are starting to worry that government intervention may no longer stabilize China's stock market or coax growth out of the economy.
The U.S. exports less than 1% of its gross domestic product to China. But some U.S. companies have significant exposure to the country, while many more are indirectly affected. For instance, commodity prices have slumped in recent weeks on anticipation of lower Chinese growth, which should lower costs for manufacturers around the globe.
China's troubles may also spur the U.S. Federal Reserve to postpone raising short-term interest rates. Many experts have expected the Fed to begin raising rates in September. A delay could have negative consequences for U.S. banks, including J.P. Morgan Chase ($63; JPM), U.S. Bancorp ($41; USB), and Wells Fargo ($52; WFC). Sustained low interest rates would keep pressure on net interest margins, delaying the profitability gains baked into profit targets for many banks. J.P. Morgan is a Buy and a Long-Term Buy. U.S. Bancorp and Wells Fargo are rated Long-Term Buy.
Hoping to ease investors' concerns, Apple ($110; AAPL) CEO Tim Cook said the company's growth in China has remained robust so far in the September quarter. iPhone activations in China accelerated in the past few weeks, while Apple's App Store in China has seen its strongest sales of the year. China accounted for 23% of Apple's sales in the 12 months ended June. Cook's comments helped boost shares of both Apple and Skyworks Solutions ($86; SWKS), a key supplier of iPhone components. Apple is a Focus List Buy and a Long-Term Buy. Skyworks is a Buy and a Long-Term Buy.
Foot Locker surprises again
Foot Locker ($71; FL) reported July-quarter earnings per share of $0.84, up 31% excluding special items to top the consensus by $0.15. Total revenue increased 3%, also exceeding the consensus, and rose 10% at constant currency. Same-store sales jumped 9.6%. Foot Locker's European operations helped drive growth, while the apparel business also showed signs of improving. Store traffic increased, as did average selling prices. Foot Locker says customers remain willing to pay up for premium footwear, so pricing growth seems unlikely to decelerate in the second half of the year.
The retailer maintained its full-year sales guidance, calling for same-store sales to rise at mid-single-digit rates — but added that results could come in near the high end of that range. Management expects per-share profits to grow by double-digits in the second half of the year. Rising analyst estimates currently call for growth of 13% in the October quarter and 12% in January quarter. Looking further out, management says the turnaround in apparel should help boost companywide profit margins.
Despite the strong results, Foot Locker shares fell, seemingly caught up in the market's broad sell-off. At 18 times trailing earnings, Foot Locker shares trade roughly in line with the median for S&P 1500 apparel retailers, despite the company's superior growth prospects. Foot Locker is a Focus List Buy and a Long-Term Buy.
Today we're dropping Magna International ($48; MGA) from the Focus, Buy, and Long-Term Buy lists. Kroger ($35; KR) is coming off the Focus List but remains a Buy and a Long-Term Buy. On the Aug. 21 hotline we dropped Ameriprise Financial ($112; AMP) from the Buy List, Long-Term Buy List, and from coverage. In the Top 15 Utilities portfolio, AGL Resources ($61; AGL) is being sold. We'll provide a replacement next week.