Portfolio Review: January 18, 2016
Lincoln National downgraded
As we continue to cull the Forecasts' buy lists of our least-favorite stocks, Lincoln National ($42; LNC) is dropping off the Long-Term Buy List. The insurer's gross profit margin and return on equity have eroded in recent quarters. We had viewed Lincoln, earning a Quadrix Overall rank of 96, as a beneficiary of rising interest rates. But 10-year Treasury bond yields have retreated to their lowest level since October, meaning Lincoln's profit margins may not enjoy the tailwind we anticipated. Its shares have slumped 17% in the opening days of 2016, and analyst profit estimates for the current year are trending lower. Lincoln is now rated A (above average).
Shire plays Daddy Warbucks in expanding orphan portfolio
Shire ($180; SHPG) agreed to acquire Baxalta ($40; BXLT) for $32 billion in cash and stock, ending its dogged, public pursuit of the drugmaker over the past six months. Baxalta will bolster Shire's portfolio of orphan drugs, which tend to enjoy tax incentives, easier approval, longer patent exclusivity, and faster growth than traditional pharmaceuticals.
Shire insists the deal's cash component will not affect Baxalta's tax-free status in the wake of its June spin-off from Baxter International ($35; BAX). Shire expects to complete the transaction, which includes a break-up fee capped at 1% of Shire's market value, by the middle of the year.
At first blush, the deal doesn't look much more expensive than Shire's original bid of roughly $30 billion in early August. But keep in mind that Shire's stock has dropped more than 30% since news of that offer first surfaced, increasing the deal's cost. Shire will exchange $18 in cash and 0.1482 of its American depositary shares for each share of Baxalta.
Shire spent months trying to convince Baxalta executives of the merger's merits, yet some of its own investors remain unconvinced, pushing the stock down on the announcement. Baxalta primarily makes treatments for rare blood conditions, a business that could face increasing pressure from rivals developing new drugs.
Shire is paying about 16 times Baxalta's estimated 2016 earnings before interest, taxes, depreciation, and amortization, roughly in line with other large pharmaceutical deals. The company also has a successful track record for integrating acquisitions. Shares trade at 16 times trailing earnings, a 24% discount to the average S&P 1500 Index pharmaceutical stock, and remains a Long-Term Buy. Baxter International is rated C (below average).
Lear outlines 2016 outlook
Lear ($108; LEA) said it expects 2016 sales of $18.5 billion to $19.0 billion, below the consensus of $19.19 billion at the time of the announcement, though management is known for issuing conservative guidance. Lear's sales target implies growth of 2% to 4%. Management said it expects 2016 free cash flow of about $800 million, up 7%. The company sees global vehicle production rising 3% this year, driven by growth in India (up 9%), China (up 5%), and North America (up 4%). Lear is a Focus List Buy and a Long-Term Buy.
Jones Lang LaSalle's ($140; JLL) buying spree continues in 2016, with the announcement of two more acquisitions. The company acquired ACREST, which offers asset-management services for retailers in Germany, and Cobertura, which operates in Portugal's prime residential sector. Jones Lang LaSalle is a Focus List Buy and a Long-Term Buy.
Southwest Airlines ($40; LUV) said traffic rose 8.6% on 8.3% higher capacity in December. Southwest Airlines is a Buy and a Long-Term Buy.
Walgreens Boots Alliance ($80; WBA) grew November-quarter earnings per share 32% to $1.03 excluding special items, topping the consensus estimate by $0.07. Revenue surged 48% to $29.03 billion, mostly driven by the Alliance Boots acquisition. Walgreens is rated A (above average).
In the opening weeks of 2016, copper prices tumbled to levels last seen in 2009. Shares of miner Freeport-McMoRan ($4; FCX) have fallen in sympathy, plunging 45% in the past month to reach their lowest level since 2000. Cash from operations slumped 46% to $3.73 billion in the 12 months ended September. The balance sheet contains just $338 million in cash, versus $20.7 billion in debt, including $906 million in current debt and $259 million maturing this year. Making matters worse, Moody's has placed Freeport's credit rating under review for a downgrade. To conserve cash, Freeport suspended its dividend and slashed capital spending in December; co-founder James Moffett was also forced to resign from his post as executive chairman. Freeport earns an Overall score of 6 in Quadrix and is rated C (below average).
Disney pushes further into China
Disney ($98; DIS) announced plans to open Shanghai Disney Resort, its first theme park in mainland China, on June 16. Disney owns a 43% stake in the $5.5 billion resort that involved more than a decade of planning. An analyst at Macquarie Capital sees the park generating $1.4 billion in annual revenue for Disney by 2018. Disney produced $52.47 billion in revenue for fiscal 2015 ended September, with $16.16 billion coming from parks and resorts.
The timing of the resort's opening is not ideal, as China grapples with a slowing economy. But Disney released several movies in 2015 that became blockbusters in China, and its momentum could continue in 2016 with the latest Star Wars installment. The parks and resorts unit is one of several businesses helping Disney cope with the prospect of slowing growth at its cable networks. The unit has generated three-year annualized growth of 8% for revenue and 17% for operating income. Other strong areas for Disney include studio entertainment (three-annualized growth of 8% for sales and 40% for operating income) and consumer products (11%, 23%). Disney is a Long-Term Buy.
iPhone worries sink Apple shares
Apple ($97; AAPL) shares have lost 14% in the past month, retreating toward their lowest level since Oct. 2014. The sell-off coincides with mounting concerns over the near-term outlook of the iPhone, representing 66% of Apple sales in fiscal 2015 ended September. Apple has cut order forecasts to iPhone suppliers in the past couple months, according to The Wall Street Journal. In a separate report by DigiTimes, Taiwan-based iPhone suppliers say Apple's March-quarter orders will miss expectations by 10% to 30%.
Several suppliers have also given downbeat reports in recent weeks, including Hon Hai Precision Industry, which assembles the majority of iPhones. Shares of our recommended iPhone suppliers have fallen in sympathy, with Skyworks Solutions ($62; SWKS) and Jabil Circuit ($20; JBL) both losing more than 15% in the past month. Last month Jabil, which draws on Apple for about one-quarter of its revenue, raised its guidance for fiscal 2016 ending August but refused to discuss order trends. Meanwhile, analyst estimates for Skyworks are declining, though even the most bearish estimates still call for 7% higher per-share profits in fiscal 2016 ending September on 4% higher revenue. Skyworks shares trade at a reasonable 11 times the lowest profit estimate.
The iPhone's strength in China remains unclear. Shipments to China for non-Android smartphones rose 33% in the December quarter, according to the China Academy of Telecommunications Research. Most of those devices were likely iPhones. Chinese officials also say total smartphone shipments rose 18% for the year. That's far higher than industry researcher IDC's projection of 1% growth, and it's worth noting that Chinese official data has warranted investor skepticism in the past.
In other news, Apple may seek to acquire Time Warner ($71; TWX) in order to push further into the streaming-TV market, according to the New York Post. With a market value of $58 billion, Time Warner has come under pressure from investors, frustrated by its lagging share price since the company rejected a takeover offer from Twenty-First Century Fox ($26; FOXa) in June 2014. Apple and Jabil are Focus List Buys and Long-Term Buys. Skyworks is a Buy and a Long-Term Buy. Time Warner is rated A (above average). Twenty-First Century Fox is rated B (average).
Lincoln National ($42; LNC) is being dropped from the Long-Term Buy List. Vanguard Short-Term Corporate Bond ($79; VCSH) now accounts for 23.8% of the Long-Term Buy List.