Portfolio Review: June 27, 2016
Midyear tweaks to our buy lists
Driven by Quadrix scores, year-ahead profit outlooks, earnings-estimate trends, and share-price action heading into the upcoming reporting season, we are making several rank changes.
Mohawk Industries ($195; MHK) joins the Focus List. Mohawk, which holds a leading 23% share of the U.S. flooring market grew sales 6% and cash from operations 61% in the last year. In the last 12 months, Mohawk delivered sales of $8.36 billion, up 6%, and cash from operations of $1.10 billion, up 61% — both record highs. Over the past year, free cash flow has quadrupled to $561 million, Mohawk's highest level since 2009.
Housing starts jumped 10% in the first five months of 2016, and solid consumer sentiment should support continued spending on home renovations. For the June quarter, Mohawk expects earnings per share of $3.29 to $3.38, up 22% to 26%. Analyst estimates are rising, with the consensus projecting earnings of $3.36 on 15% revenue growth. Mohawk is also a Buy and a Long-Term Buy.
D.R. Horton ($31; DHI), the largest U.S. homebuilder, is being added to the Buy and Long-Term Buy lists. Unlike many builders, Horton aggressively targets first-time home buyers, a less-profitable but underserved market. Rising wages and pent-up demand for household formation among millennials could give this niche a long runway for future growth.
The stock offers outstanding operating momentum, rising analyst estimates, and a reasonable valuation. The consensus calls for 10% profit growth in the June quarter, followed by 28% growth in the September quarter. At 14 times trailing earnings, the stock trades in line with the median for S&P 1500 homebuilders and 36% below its own five-year average. The stock's Overall score, currently 97, has exceeded 90 in 12 straight months.
We are initiating coverage of Laboratory Corp. of America ($130; LH) as a Buy and a Long-Term Buy. The company stands to benefit from rising medical utilization. As one of two national diagnostics laboratories, LabCorp enjoys pricing power and scale advantages over regional labs.Â
The stock's Overall rank of 94 reflects scores of 66 or higher for five of six Quadrix categories. LabCorp reported organic volume growth and higher prices in the March quarter. The company raised its 2016 guidance in April, with the midpoint of its outlook projecting 9.5% higher revenue and nearly 11% profit growth. The stock trades at 15 times estimated 2016 earnings, 22% below the median for health-care-services stocks.
C.H. Robinson Worldwide ($72; CHRW) is being removed from the Focus List, Buy List, and Long-Term Buy List. The stock has been one of our top performers in 2016, returning 17% including dividends. But its Overall score has fallen to 65, reflecting slower operating momentum and rising valuation ratios. The largest U.S. freight broker, C.H. Robinson has noted overcapacity and soft demand in recent quarters. At 19 times trailing earnings and 18 times estimated 2016 profits, the stock trades above the median stock in the industrial sector and in the logistics industry. The stock no longer ranks among our favorite picks and should be sold. It is also being dropped from the Monitored List.
We are dropping Goodyear Tire & Rubber ($27; GT) from the Buy and Long-Term Buy lists. The stock has failed to bounce since its mixed March-quarter report. At the time, Goodyear reiterated its 2016 profit guidance but forecasted a smaller decline in raw-material costs than previously expected. Management tried to assure investors that price hikes and a better product mix would help offset higher-than-expected costs.
Instead, the announcement stoked fears that profit margins may be nearing a peak and that Goodyear may need to cut its guidance later this year. The stock's Overall score has also fallen to 75 from 94 at the end of March. Goodyear is being removed from coverage and should be sold.
At a semiannual shareholder meeting, Centene ($69; CNC) introduced its 2017 outlook, with sales projected to reach $45 billion, implying 14% growth. The consensus stands at $45.83 billion. Management also reaffirmed its 2016 guidance and said integration of its Health Net acquisition remains on track. Centene is a Focus List Buy and a Long-Term Buy.
Shire ($175; SHPG) strengthened its pipeline of gastrointestinal treatments by agreeing to pay Pfizer ($34; PFE) for the rights to an experimental bowel drug. Separately, U.S. regulators awarded breakthrough status to two of Shire's experimental drugs for rare gastric diseases. The breakthrough designation can help speed the development and review of treatments for serious diseases. Shire is a Long-Term Buy. Pfizer is rated B (average).
Kroger registers growth
Kroger ($34; KR) grew April-quarter earnings per share 13% to $0.70 per share, easing past the consensus by a penny. Total revenue rose 5% and same-store sales excluding fuel advanced 2.4%, though both metrics fell short of analyst expectations. Kroger grew cash from operations 17% and free cash flow 10% to $860 million. Although Kroger reported higher volumes, pricing weakness dragged on results. Kroger noted the weakest price inflation in six years and didn't seem confident of a near-term pickup. Management attributed the low inflation to the commodities markets rather than demand or competition.
Kroger reaffirmed its full-year guidance for same-store sales excluding fuel, projected to rise 2.5% to 3.5%; July-quarter results are currently tracking slightly below the midpoint of that range. But management turned more cautious on its profit outlook for fiscal 2017 ending January. It now expects per-share profits to reach only the bottom half of its original target of $2.19 to $2.28. The bottom half of that range implies 6% to 8% growth. The consensus was $2.25 at the time of the announcement. Kroger remains a Buy and a Long-Term Buy.
A Beijing regulator ordered Apple ($96; AAPL) to halt sales of the iPhone 6 and 6 Plus models in the city after determining they were too similar to a smartphone made by a local startup. Sales will continue for now, but the ruling could inspire more Chinese companies to challenge Apple's patents. Separately, India relaxed local-investment rules for foreign retailers, potentially paving Apple's way to open stores in the country. Finally, the Russell indexes are trimming their weighting of Apple shares, which could add short-tern pressure to the stock. Apple is a Buy and a Long-Term Buy.
Microsoft ($51; MSFT) agreed to acquire LinkedIn ($190; LNKD) for $26.2 billion, its biggest deal ever. Microsoft is rated C (below average).
Alaska Air Group ($60; ALK) CEO Brad Tilden says Virgin America's brand may be retained after its $2.6 billion acquisition, a departure from recent deals within the industry. The upscale Virgin America has built up a loyal following since its 2007 launch. Although U.S. regulators have asked both companies for additional information on the deal, Alaska Air expects to complete the takeover by early fall. Alaska is a Buy and a Long-Term Buy.
Disney's ($99; DIS) Finding Dory generated box-office sales of $135 million in its opening weekend, a record for an animated film. Separately, Disney's ESPN reportedly agreed to buy half of the Big Ten's media-rights package for $1.14 billion over six years. Disney is a Long-Term Buy.
Mohawk Industries ($195; MHK) is being added to the Focus List. D.R. Horton ($31; DHI) and Laboratory Corp. of America ($130; LH) are being initiated as Buys and Long-Term Buys. C.H. Robinson Worldwide ($72; CHRW) and Goodyear Tire & Rubber ($27; GT) are being dropped from our buy lists, and from coverage.