Portfolio Review: February 6, 2017

2/6/2017


Rank changes

Sifting through some of the early earnings reports for the December quarter, we have reranked some of our top picks in the technology sector. Following impressive results and guidance, VMware ($87; VMW) is being upgraded to the Focus List. Reports for Citrix Systems ($71; CTXS) and F5 Networks ($132; FFIV) were less lustrous, causing us to remove both stocks from the Focus List, though they remain rated Buy and Long-Term Buy. These moves reduce the Focus List's technology exposure to 31% from 36%, which still remains higher than any other sector.

VMware earned $1.43 per share excluding special items in the December quarter, up 13% and $0.03 above the consensus estimate. Sales rose 9% to $2.03 billion, also ahead of the consensus, on growth across all major product segments and geographic markets. VMware said it completed 13 deals worth more than $10 million, a record, and also experienced strong renewal rates.

In a partnership with Amazon.com Web Services, VMware is rolling out new cloud-computing tools. The timing couldn't be better, considering that more customers are becoming comfortable using the public cloud. VMware's 2017 guidance also topped expectations, with management targeting 11% higher earnings per share on 7% revenue growth. The company announced a new $1.2 billion stock-buyback plan, in addition to $500 million remaining on its prior program. VMware is also a Buy and a Long-Term Buy.


Citrix has seen its Quadrix Overall score fall to 72 from 92 at the end of 2015, hurt by slowing operating momentum and unfavorable profit-estimate trends. But the stock looks cheap relative to peers and its own history from nearly all angles.

Citrix completed its GoTo spin-off on Jan. 31, which was immediately merged with LogMeIn ($107; LOGM). As a result, Citrix investors received 0.1718 shares of LogMeIn for each share of Citrix. GoTo is a virtual-meeting business that accounted for 20% of Citrix's revenue last year. Admittedly, LogMeIn has some appeal, but its valuation appears stretched. We continue to prefer Citrix, and investors who follow our buy lists should sell LogMeIn.


F5 named François Locoh-Donou as its new CEO, replacing John McAdam, who plans to retire on April 3. The appointment of Locoh-Donou, formerly COO of Ciena ($24; CIEN), could signal that F5 has decided not put itself up for sale, as published reports had suggested last summer. Regardless, we continue to like the stock on its own merits.

True, cash from operations fell 7% last quarter and is down 1% for 12-months ended December. But F5 has generated 12 straight quarters of rising per-share profits and 30 straight quarters of sales growth. Shares trade below five-year norms for trailing P/E, price/sales, and price/operating cash flow. The stock earns an Overall score of 89.

Earnings reviews

Consumer discretionary

For the December quarter, Comcast ($76; CMCSa) said per-share profits climbed 10% to $0.89 excluding special items, surpassing the consensus by two pennies. Revenue advanced 9% to $21.03 billion, also ahead of Wall Street expectations, on 7% growth for cable and 13% growth for NBCUniversal. Comcast added a net 80,000 video customers to end the year with 161,000 net adds, its first annual growth since 2006.

The company announced a 2-for-1 stock split that will take effect Feb. 17. Additionally, Comcast raised its quarterly dividend 15%, payable April 26. It also increased its stock-buyback plan to $12.0 billion, with $5.0 billion slated for use this year, enough to repurchase about 3% of outstanding shares. Comcast is a Buy and a Long-Term Buy.


Lear ($143; LEA) earned $3.80 per share on an adjusted basis in the December quarter, up 19% and $0.36 above the consensus. Sales fell 2% to $4.6 billion, missing the consensus. Seating sales fell 2% and were flat excluding currency shifts and commodity prices. At the electronics unit, now called E-Systems, sales were flat but rose 2% excluding foreign exchange and commodity prices. The company expects to generate $19.5 billion in sales next year, slightly above the consensus of $19.37 billion at the time of the announcement. While Lear shares fell on the earnings news, we still see upside to the 2017 per-share-profit estimate of $14.92, which implies just 6% growth. The stock is a Focus List Buy and a Long-Term Buy.

Health care

Biogen's ($282; BIIB) December-quarter earnings per share climbed 12% to $5.04 excluding special items, topping the consensus by $0.08. Sales crept 1% higher, hurt by slowing growth for Biogen's largest product, multiple sclerosis drug Tecfidera. Biogen also completed its spin-off of Bioverativ ($44; BIVV), a hemophilia-drug business that accounted for about 5% of revenue. Biogen shareholders received one share of Bioverativ for every two shares of Biogen. While Bioverativ is delivering impressive growth, we still prefer Biogen, which is rated Buy and Long-Term Buy. Subscribers following one of our recommended lists should sell Bioverativ.

Industrials

Ingersoll-Rand ($78; IR) said per-share profits slumped 11% to $0.84 excluding special items, missing the consensus by $0.08. Revenue increased 1% to $3.36 billion, while bookings rose 6%. Management blamed the disappointing results on elevated corporate costs and a higher tax rate due to geographic mix. Looking ahead to 2017, Ingersoll expects per share profits of $4.30 to $4.50, up 4% to 9%, on revenue growth of 2%. The consensus had projected per-share profits of $4.50 and 2% higher revenue at the time of the announcement. Ingersoll is a Long-Term Buy.


Southwest Airlines ($53; LUV) earned $0.75 per share excluding special items in the December quarter, down 17% but $0.05 above the consensus. Operating revenue rose 2% to $5.08 billion, also topping analyst targets. Credit much of the outperformance to post-election travel demand strong enough to boost prices for flights purchased with minimal advance notice. Business travel was also unusually strong in December. The stock is a Focus List Buy and a Long-Term Buy.

Technology

Alphabet ($815; GOOGL) said December-quarter earnings per share rose 8% to $9.36, missing the consensus by $0.28. Management blamed the disappointing results on a one-time tax adjustment of $320 million, while a higher tax rate also crimped earnings. Sales jumped 22% to $26.06 billion, above the consensus of $25.23 billion. Cash from operations surged 42% to $9.41 billion. Online-advertising rates continue to decline, as cost-per-click slumped 15%, worse than the 9% decline in the year-ago quarter. But paid clicks surged 36%, the strongest growth in more than four years. Alphabet is a Focus List Buy and a Long-Term Buy.


Apple's ($129; AAPL) per-share profits increased 2% to $3.36 in the December quarter, exceeding the consensus by $0.14. Revenue rose 3% to $78.35 billion, also ahead of expectations. Sales growth was driven by the iPhone, up 5%, the Mac, up 7%, and services, which includes the App Store and Apple Pay, up 18%. The iPhone's average selling price climbed to $695 from $690.50, reflecting rising popularity of the larger iPhone Plus models. Apple's March-quarter guidance was a bit light, with management targeting revenue growth of 2% to 6%, versus the consensus estimate of 7% growth at the time of the announcement. Apple is a Buy and a Long-Term Buy.

Corporate roundup

Novartis ($73; NVS) said its biosimilar version of Amgen's ($160; AMGN) blockbuster drug Enbrel will not reach the market this year. U.S. regulators have already approved Novartis' Erelzi to treat several diseases, but patent lawsuits between the two companies are delaying the drug's launch. Enbrel accounts for about one-third of Amgen's revenue. Amgen is a Buy and a Long-Term Buy. Novartis is rated C (below average).


FedEx ($186; FDX) says global online sales are expected to reach $2.4 trillion by 2018, up 26% from 2016, as the shipper urged the U.S. to upgrade the country's highways, bridges, and airports. FedEx is a Focus List Buy and a Long-Term Buy.


WGL Holdings ($81; WGL) agreed to be acquired by AltaGas ($24; ATGFF) for $6.42 billion, or $88.25 per share, a 12% premium to where its stock traded before the announcement. AltaGas expects to close the all-cash deal by June 2018. But WGL shares continue to trade well below the takeover price, reflecting regulatory concerns. Recall, Exelon ($35; EXC) needed nearly two years to complete its $6.8 billion acquisition of Pepco Holdings after utility regulators initially rejected that deal. WGL, a natural-gas utility, also raised its quarterly dividend 5% to $0.51 per share, payable May 1. We are holding WGL, a member of our Top 15 Utilities portfolio, for now as we consider our options. Exelon is rated B (average).


Rank Changes

VMware ($87; VMW) is being added to the Focus List; it was already a Buy and a Long-Term Buy. Citrix Systems ($71; CTXS) and F5 Networks ($132; FFIV) are being dropped from the Focus List but retain their Buy and Long-Term Buy ratings.


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