Portfolio Review: October 26, 2015
Upgrade and downgrade
Cisco Systems ($28; CSCO) is being upgraded to a Long-Term Buy. The stock scores above 70 for all six Quadrix categories, contributing to an Overall rank of 92. Shares have crept higher since Cisco reported solid July-quarter results and currently trade within 7% of their eight-year high set in March. Yet Cisco's cheap valuation represents its biggest appeal. At 12 times estimated year-ahead earnings, it fetches a 26% discount to the median S&P 1500 communications-equipment stock.
Cisco, a technology bellwether, also enjoys improving operating momentum. Per-share profits rose 7% in fiscal 2015 ended July on 4% revenue growth. A maker of networking equipment, Cisco is launching new product lines in a bid to keep its business customers from migrating to software that runs on cheaper hardware. For the October quarter, Cisco expects per-share profits to climb 2% to 6% and sales to rise 2% to 4%. Cisco, yielding 3.0% was previously rated A (above average).
We are removing HCA Holdings ($71; HCA) from the Focus List and Long-Term Buy List after the hospital operator warned for the September quarter and issued disappointing profit guidance for the full year. HCA preannounced that September-quarter earnings per share slipped 1% to $1.17, missing the consensus by $0.05. Sales increased 7% to $9.86 billion, roughly in line with analyst expectations. HCA also narrowed its 2015 outlook for earnings per share to $5.20 to $5.25, versus the consensus of $5.29.
As implied by the sales results, HCA experienced strong volumes. But it was forced to deploy more contract workers, elevating labor costs and squeezing profits. More troubling, HCA also reported treating a higher proportion of uninsured patients, lowering the likelihood it can collect payment for services provided. Earlier this month the Obama administration reported slowing enrollment for its health plans, which could signal that improvement in patient mix is nearing an end. However, the health-reform trend alone doesn't explain why HCA saw more uninsured patients.
Rising volumes and labor costs could imply higher utilization rates at hospitals, a potentially good problem for rivals such as Community Health Systems ($41; CYH). The bigger question is whether HCA sounded the alarm of a systemic problem regarding uninsured patients. About 83% of HCA's beds are located in states not expanding Medicaid, versus 63% for Community Health, suggesting the latter has less exposure to uninsured patients.
HCA's warning coincides with gradually deteriorating Quadrix scores. Its Overall and Momentum scores have slipped below 70. Community Health earns a slightly better Overall rank of 75. Although Community Health ranks just 64 in Momentum, its Value score of 98 implies a very low bar to clear when it reports September-quarter results on Nov. 2. We will be closely following Community Health's upcoming results. For now, the stock, reviewed on page 5, remains a Buy and a Long-Term Buy. HCA is now rated B (average) and should be sold.
Earnings roll call
Lam Research's ($71; LRCX) stock rallied after the company posted strong September-quarter results, impressed investors with its outlook, and announced plans to acquire rival KLA-Tencor ($64; KLAC) in a cash-and-stock deal worth $10.6 billion. Lam said per-share profits jumped 90% to $1.82 excluding special items, topping the consensus by $0.11. Revenue increased 39% to $1.60 billion, matching the consensus. The midpoint of Lam's December-quarter earnings-per-share guidance range is $1.42, implying 19% growth and exceeding the consensus of $1.30 at the time of the announcement.
The KLA deal represents a 24% premium to the smaller company's stock price prior to the announcement. Upon completion, Lam expects to control 42% of the market for wafer-fabrication equipment. The announcement coincides with Intel's ($33; INTC) decision to spend up to $5.5 billion to convert a semiconductor plant in China to make memory chips. The move will likely force Intel to boost capital spending next year, benefitting semiconductor-equipment makers. Unlike Lam, KLA counts Intel among its three biggest customers, accounting for more than 10% of annual sales. Lam is a Buy and a Long-Term Buy. Intel is rated A (above average).
Robert Half International ($52; RHI) said the improving U.S. labor market contributed to higher demand for its staffing and consulting services in the September quarter. The company grew earnings per share 16% to $0.73 in the September quarter, matching the consensus estimate and marking the 22nd straight quarter of double-digit growth. Revenue advanced 7% to $1.31 billion, as 13% growth in the U.S. more than offset an 11% decline in international markets. Stock buybacks reduced the share count by 1% from the June quarter. Robert Half, earning an Overall rank of 92, is a Buy and a Long-Term Buy.Â
U.S. Bancorp's ($41; USB) per-share profits advanced 4% to $0.81, meeting the consensus. Revenue rose 3%, narrowly above analyst expectations. Average total loans increased 3%, as 10% growth for commercial loans offset flat growth for mortgages. Net interest margin, the spread between the interest paid on deposits and the interest charged for loans, was lower than in the year-ago quarter but crept higher versus the June quarter. Shares rose on the results. U.S. Bancorp is a Long-Term Buy.
FDA rejects Shire dry-eye drug
The U.S. Food and Drug Administration refused to approve lifitegrast, Shire's ($207; SHPG) experimental treatment for dry eyes, until the drugmaker conducts an additional clinical study. Lifitegrast, viewed by some analysts as Shire's next blockbuster, has received mixed results in studies so far. About 29 million U.S. adults suffer from dry-eye disease, according to Shire, which plans to resubmit its application for the drug by next March.
The lifitegrast setback comes at a time of rising speculation that Shire may abandon its efforts to acquire Baxalta ($32; BXLT), a drugmaker for rare blood disorders. The company's all-stock offer, announced on Aug. 4, valued Baxalta at roughly $30 billion. However, Shire's stock has slid 23% since the company declared its intent to acquire Baxalta. Shire would need to issue more shares than originally planned to maintain the original bid's value — which didn't satisfy Baxalta in the first place.
Shire continues to meet with Baxalta's shareholders after making little headway with its management. However, Shire might be better served pursuing a smaller target.
Shire likely updated investors on its takeover plans on Oct. 23, after our deadline, when it was expected to post September-quarter results. Analyst estimates held firm in the 60 days leading up to the report, with the consensus projecting earnings per share of $2.89, down 1% on 2% higher sales. Shire remains a Long-Term Buy
Apple ($114; AAPL) CEO Tim Cook says 6.5 million Apple Music subscribers are paying for its streaming music service. An additional 8.5 million subscribers remain in the free trial period, running three months. Once the trial expires, Apple charges $9.99 a month for individuals and $14.99 for families. Rival Spotify, which launched its music service in 2008, claims to have 75 million active users, including 20 million who pay. Separately, Apple plans to begin shipping its revamped Apple TV set-top box later this month. In other news, a U.S. judge ordered Apple to pay $234 million to the University of Wisconsin-Madison in a patent lawsuit claiming the company improperly used the university's technology in iPhones and iPads. Apple is a Focus List Buy and a Long-Term Buy.
Comcast ($61; CMCSa) announced plans to launch Seeso, a subscription-based video service for ad-free comedy shows and movies, in January. The service is priced at $3.99 a month. Comcast is a Focus List Buy and a Long-Term Buy.
HCA Holdings ($71; HCA) is being dropped from the Focus, Buy, and Long-Term Buy lists. Cisco Systems ($28; CSCO) is being added to the Long-Term Buy List. Vanguard Short-Term Corporate Bond ($80; VCSH) now accounts for 24.1% of the Buy List and 22.7% of the Long-Term Buy List.