Portfolio Review: May 16, 2016
A new stocks and 3 rank changes
Our analysis of first-quarter reports, as well as changes in Quadrix scores, have driven us to make several rank changes this week.
Citrix Systems ($83; CTXS) joins the Buy and Long-Term Buy lists. Earning an Overall score of 96, Citrix offers clients secure, remote access to software applications. For the 12 months ended March, Citrix posted 84% growth in per-share profits from operations, 6% for revenue, and 27% for operating cash flow. Operating profit margins have expanded in four straight quarters, while return on equity has also marched higher, reflecting management's cost-savings efforts. Shares look cheap relative to the median S&P 1500 application-software stock based on trailing P/E (a 20% discount), forward P/E (25%), and price/operating cash flow (38%). The company plans to spin off its GoTo business, which includes business-meeting software, as a separate, public company in the second half of 2016.
Biogen ($267; BIIB) scores in the top one-fourth of our research universe for five of six Quadrix categories, contributing to an Overall rank of 94. The exception is a dreary Performance score of 16. However, the shares have climbed 1% since Biogen's March-quarter report, a stretch when the S&P 500 slipped 2%. Biogen topped consensus estimates for earnings per share and sales in the March quarter. Both operating cash flow and free cash flow rose more than 30%. Management also said patient-discontinuation rates have stabilized for blockbuster drug Tecfidera, which treats multiple sclerosis. Many patients stopped using Tecfidera last year after the U.S. Food and Drug Administration said the drug was linked to a rare but possibly fatal brain infection. Biogen is being added to the Focus List and is also a Long-Term Buy.
Our ideal stock enjoys strong operating momentum, rising analyst estimates, and encouraging share-price momentum — all while trading at a low valuation. Apple ($93; AAPL) now meets just one of those criteria and is being removed from the Focus List. Its per-share profits slumped 18% on 13% lower sales in the March quarter; both metrics could keep falling by double-digits over the next two quarters. Apple's Momentum, Earnings Estimates, and Performance scores have slipped into the bottom quarter of our research universe, pushing its Overall score down to 71.
Apple no longer ranks among our top picks for 12-month returns, but for now we are keeping the stock on the Buy and Long-Term Buy lists. Although iPhone sales in the U.S. and China remain crucial to Apple's results, the company is gaining ground in India. iPhone sales have jumped 56% in India this year, according to industry researcher Canalys, taking a 29% share of smartphones priced above $300, up from 11% for the same period last year. At 10 times trailing earnings, shares trade 27% below their five-year median P/E ratio and 43% below the median S&P 1500 technology stock.
We are dropping Gilead Sciences ($84; GILD) from the Focus List in the wake of the drugmaker's disappointing March-quarter results. Operating momentum slowed, as Gilead's hepatitis C drugs face pricing pressure from increased competition. Gilead could be hard-pressed to deliver organic growth in the June and September quarters. However, Gilead remains a Buy and a Long-Term Buy, due to its outstanding Quadrix scores and exceptionally low valuation. Gilead scores above 90 for four of six Quadrix categories, contributing to an Overall score of 98. The shares trade at seven times estimated 2016 earnings, ranking among the cheapest 5% of stocks in our research universe.
After sitting on the sidelines in recent years, Gilead finally seems determined to make a significant acquisition to augment growth. The company plans to pursue deals that strengthen its portfolio of treatments for cancer, liver disease, and inflammatory disorders. With an average trailing P/E ratio of 22, the S&P 1500 biotechnology industry looks expensive relative to the broader index, which has an average P/E of 21. But the industry is getting cheaper — its average stock has lost 14% this year, versus an average return of 5% including dividends for stocks in the broad index.
Kroger's ($35; KR) stock has slumped 13% since February, missing out on the S&P 500 Index's 7% rally. Concerns have centered on the possibility that food deflation could cut into sales and that softer volumes reported by other supermarkets will spread to Kroger. However, Kroger has reportedly seen some success in keeping its prices higher than its rivals. Kroger further calmed these fears by reaffirming its full-year guidance for per-share profits and same-store sales. Management continues to expect inflation of 1.0% to 2.0% in fiscal 2017 ending January, noting that inflation should gradually rise later this year. Kroger shares rallied on the announcement. The stock is a Buy and a Long-Term Buy.
Loans in danger of souring are becoming more common at many U.S. banks. Wells Fargo ($49; WFC) said criticized loans — a broad classification that includes both loans with potential weakness and those virtually worthless — surged to nearly $30 billion at the end of March, up more than 60% from the end of 2015. These criticized loans now account for 9% of the financial giant's commercial and industrial loan portfolio. J.P. Morgan Chase's ($62; JPM) criticized loans increased 45% to $21.2 billion during the quarter, largely due to the company's exposure to the energy sector. Both J.P. Morgan and Wells Fargo are Long-Term Buys.
Alaska Air Group ($68; ALK) was expected to join the S&P 500 Index on May 12, replacing SanDisk, which was expected to be acquired by Western Digital ($37; WDC) the same day. Alaska Air had expressed interest in joining the index for more than a year. Alaska Air is a Focus List Buy and a Long-Term Buy. SanDisk is being dropped from coverage.
A longstanding legal spat between Alphabet ($731; GOOGL) and Oracle ($40; ORCL) returned to court in May. Oracle claims Alphabet's Android operating system infringes on Java copyrights. In 2012 a jury ruled in favor of Oracle, but a judge later overturned the verdict. Oracle could seek more than $9 billion in damages — well above the $7.4 billion it spent in 2010 to acquire Sun Microsystems, which had developed Java. Oracle says Android has generated $42 billion in sales.
Alphabet's Overall score has fallen to 62 from 84 at the end of February. Admittedly, we view an Overall score below 70 as problematic and highly unusual for a stock on the Focus List. But few companies can match Alphabet's operating momentum. Just 20 other S&P 500 companies grew per-share profits, revenue, and cash from operations at least 10% over the past 12 months. For now, Alphabet remains a Focus List Buy and a Long-Term Buy. Oracle is rated B (average).
Nvidia ($36; NVDA) showed off a new graphics semiconductor that runs at twice the speed of its predecessor, while consuming a third of the power. Nvidia says it spent three years and billions of dollars developing the new semiconductor, aimed at high-end personal computers used for video games and, potentially, virtual-reality goggles. Nvidia was slated to report January-quarter results on May 12, after our deadline. Nvidia is a Long-Term Buy.
Citrix Systems ($83; CTXS) is being initiated as a Buy and a Long-Term Buy. Biogen ($267; BIIB) is joining the Focus List, while Apple ($93; AAPL) and Gilead Sciences ($84; GILD) are being dropped from the Focus List but remain Buys and Long-Term Buys. After these changes, Vanguard Short-Term Corporate Bond ($80; VCSH) ETF will account for 19.6% of the Buy List and 19.8% of the Long-Term Buy List.