Portfolio Review: January 11, 2016

1/11/2016


3 downgrades

With the Dow Industrials' breakdown below the December low, we are raising cash by downgrading our least favorite names on the Buy and Long-Term Buy lists.

Community Health Systems ($24; CYH) has been unable to recover from its nasty fall in October. The hospital operator's shares fell 16% in the month before it declared September-quarter earnings, hurt by a broad health-care sell-off and a warning from rival HCA Holdings ($66; HCA). Then Community shed another 35% of its value on Oct. 22, the day it announced profits well below consensus targets for the September quarter. We hoped for a rebound, but as of Jan. 6, the shares had dipped below Oct. 22 levels. The consensus projects a 22% decline in per-share profits for the December quarter, followed by growth of 8% in 2016, a target we no longer know if Community can meet. Rather than wait for December-quarter results, we'll cut our losses. The company, with a Quadrix Overall score of 61, is being dropped from the Buy and Long-Term Buy lists and from coverage.


Cisco Systems ($26; CSCO) shares remain cheap at 11 times the analyst profit consensus for the year ending July 2016. However, we've become less confident that the price/earnings multiple will improve in the next two to three years, or that Cisco can exceed Wall Street's modest growth targets. In November, Cisco projected weaker-than-expected January-quarter results, citing a strong U.S. dollar and lower orders, pressures the company said would ease this year. After that, the Quadrix® Overall score dipped below 80 and has yet to recover. In response to Cisco's guidance, analysts lowered estimates for both fiscal 2016 and 2017. The consensus projects roughly flat sales and 3% higher profits this year, followed by 4% sales growth and 6% profit growth next year. Cisco generates 40% of its sales overseas, and continued weakness in China and other emerging markets has eroded our faith. Cisco is being dropped from the Long-Term Buy List and is now rated A (above average) on the Monitored List.


J.P. Morgan Chase ($63; JPM) is being dropped from the Buy List but remains a Long-Term Buy. This downgrade stems more from our desire to raise cash than from worries about the company. The consensus projects a return to revenue growth this year, with per-share profits up a modest 4%. With the worst of J.P. Morgan's legal problems left in its wake and the Federal Reserve's December interest-rate hike reducing market uncertainty, the financial giant looks like a good bet to meet expectations. However, the potential for a bear market adds risk to firms like J.P. Morgan, which rely on both investment performance and trading volume for profits. That added risk left the stock slightly less appealing for the year ahead, and as such a sensible downgrade when we decided to raise cash.

Higher airfares could lift airline shares

Southwest Airlines ($43; LUV) increased fares for nearly all U.S. one-way flights by $3, following a similar move made by Delta Air Lines ($49; DAL). Southwest tends to dictate the direction of prices in the U.S. airline industry. Not surprisingly, other carriers, including Alaska Air Group ($78; ALK), JetBlue ($22; JBLU), American Airlines Group ($41; AAL), and United Continental Holdings ($55; UAL), also instituted fare hikes. Southwest's last substantial fare boost occurred in June.

The moves may help temporarily quell concerns about whether airlines have the discipline — and ability — to keep airfares up. Low oil prices have made it extraordinarily tempting to expand capacity in recent quarters, often faster than the rise in traffic.

For instance, Alaska Air's traffic increased 9.3% in 2015, its strongest growth since 2011, but capacity surged 10.6%, a pace not seen since 1995. For the month of December, Alaska Air said traffic rose 9.9% on 12.2% capacity growth. The company's load factor declined 170 basis points (1.7%) for the month and 100 basis points for the year.

Alaska Air is a Focus List Buy and a Long-Term Buy. Southwest Airlines is a Buy and a Long-Term Buy. JetBlue is rated Best Buy in our sister publication Upside.

Health-care review

CVS Health ($96; CVS) won a contract to serve as pharmacy-benefit manager for about 3.8 million members of WellCare Health Plans ($77; WCG). WellCare previously used UnitedHealth Group ($115; UNH) as its PBM. CVS is a Buy and a Long-Term Buy. UnitedHealth is rated A (above average).


Gilead Sciences ($100; GILD) said an experimental hepatitis B drug performed well in two late-stage trials. The company plans to file for the drug's approval in the U.S. and European Union in the March quarter. In other news, the U.S. Food and Drug Administration gave Gilead priority review of an experimental hepatitis C combination drug. The FDA is expected to reach its decision by June 28. Gilead is a Focus List Buy and a Long-Term Buy.


Seeking to expand its portfolio of drugs that treat rare diseases, Shire ($195; SHPG) is reportedly in advanced talks to acquire Baxalta ($39; BXLT) in a deal worth about $32 billion in cash and stock, excluding debt. Baxalta makes treatments for cancer, hemophilia, and immune-system diseases. Baxalta has insisted that any deal must include a cash component, which could threaten the tax-free status of the company's June spin-off from Baxter International ($37; BAX). Shire's $30 billion all-stock offer was rejected in July. Amidst the takeover talks, Baxalta agreed to pay Danish biotechnology company Symphogen up to $1.6 billion to co-develop six cancer drugs. The deal is likely too small to jeopardize merger talks with Shire. Shire is a Long-Term Buy. Baxter is rated C (below average).

Corporate roundup

Disney's ($100; DIS) The Force Awakens has generated more than $740 million in box-office sales in the U.S., ranking second all-time behind Avatar, which topped $760 million. The newest Star Wars movie ranked sixth globally, with $1.5 billion in sales, in the days before opening in China. Disney is a Long-Term Buy.


Fidelity Investments selected Visa ($75; V) and U.S. Bancorp ($41; USB) as its new credit-card partners. The move ends Fidelity's 12-year relationship with American Express ($64; AXP) and Bank of America ($16; BAC). U.S. Bancorp also agreed to acquire Fidelity's co-branded credit-card portfolio, carrying roughly $1.6 billion of loans. U.S. Bancorp is a Long-Term Buy. Amex and Bank of America are rated A (above average). Visa is rated B (average).


Volkswagen ($28; VLKAY) could face tens of billions of dollars in civil fines; the U.S. Justice Department filed a $48 billion lawsuit against the automaker on behalf of the Environmental Protection Agency, though such suits normally settle for a fraction of the requested amount. The U.S. may also bring criminal charges against Volkswagen. The stock is rated B (average).

Technology update

Alphabet ($759; GOOGL) paid $380 million to acquire startup Bebop Technologies, founded by Diane Greene, a director at Alphabet who has received an executive position as part of the deal. Bebop provides cloud-based services. Alphabet is a Focus List Buy and a Long-Term Buy.


Apple ($101; AAPL) agreed to pay $347 million to end a dispute with Italian officials over claims the company allegedly failed to pay about $970 million in taxes from 2008 to 2013. In other news, Apple raised prices for iPhones and iPads in Germany to recoup new fees companies must pay content producers. Apple, yielding 2.1%, is a Focus List Buy and a Long-Term Buy.


Nvidia ($32; NVDA) showed off new technology designed to power self-driving cars. Volvo plans to test the automotive system in some of its vehicles next year. Nvidia is a Long-Term Buy.


Rank Changes

J.P. Morgan Chase ($63; JPM) was dropped from the Buy List but remains a Long-Term Buy. Cisco Systems ($26; CSCO) was dropped from the Long-Term Buy List and is now rated A (above average). Community Health Systems ($24; CYH) is being dropped from the Buy and Long-Term Buy lists, and from coverage. Vanguard Short-Term Corporate Bond ($79; VCSH) now accounts for 21.4% of the Buy List and 21.2% of the Long-Term Buy List.


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