Portfolio Review: March 13, 2017

3/13/2017


Rank changes

As the latest quarterly results filter through Quadrix and shift our views on certain stocks, we are making more tweaks to our buy lists this week.

Facebook ($138; FB) is being upgraded to the Long-Term Buy List. As the world's largest social network, Facebook boasts 1.2 billion active daily users, up 18% from a year ago. Its long-term prospects stand to benefit from the network effect: The increase in people on Facebook boosts the appeal for new people to join, increasing the difficulty for rivals to steal market share.

Facebook offers the stellar growth of a new start-up and the sturdy balance sheet of a blue-chip company. Sales growth has exceeded 30% in 24 consecutive quarters, a trend expected to continue into 2017.

Although Facebook earns a Quadrix Value score of just 34, the stock's forward P/E ratio of 25 is roughly in line with the median S&P 1500 internet software and services stock. Excluding net cash lowers Facebook's forward P/E to 23.5. The consensus calls for 44% higher per-share profits in the March quarter and 28% growth for the year. Facebook was previously rated A (above average).


Celgene ($123; CELG) joins our Buy List, after being upgraded to the Long-Term Buy List in the March 6 issue. S&P 1500 biotechnology stocks have averaged a total return of 8% in 2017, despite President Trump's pledge to curb rising drug prices. Scrutiny over drug prices is unlikely to dissipate any time soon. But Celgene appears better positioned than most peers, considering it has relied on higher volume — not price hikes — to drive recent growth.

The stock also looks attractive versus peers from other angles. In the past year, Celgene grew per-share profits 21% (its industry averaged 6% growth) and sales 21% (15%). The company's 12-month earnings per share are projected to climb 21%, ahead of the industry average of 5% growth. Shares also look unduly cheap, with a trailing P/E ratio of 21 (industry average is 25) and forward P/E of 17 (23). Celgene is a Buy and a Long-Term Buy.


Consistent with what we wrote in our last issue, Kroger ($29; KR) was dropped from the Long-Term Buy List on our March 3 hotline, due to a soft January-quarter report. Per-share profits fell 7% to $0.53, easing past the consensus. But same-store sales dipped 0.7% excluding fuel, the first decline since the April 2003 quarter.

We had expected the deflationary environment to weigh on results. But the decline in same-store sales was unexpected, suggesting that Kroger lost market share last quarter. This may be a difficult trend to reverse now that Wal-Mart Stores ($70; WMT) is experimenting with lower grocery prices. Also disappointing was Kroger's year-ahead profit guidance, implying flat to 2% growth if we exclude the extra 53rd week this year.

The stock has fallen 21% over the past 12 months. But Kroger, which split its shares in July 2015, remains up 75% since we first recommended them for purchase in March 2013. The S&P 500 rose 51% during that time. Kroger is now rated B (average) and should be sold. Wal-Mart is also rated B (average).

Competition tightens for skinny bundles

Perhaps only Alphabet's ($854; GOOGL) massive Google search business could cause investors to overlook the spectacular success of YouTube, acquired in 2006 for $1.65 billion. YouTube has grown viewership 10 times over since 2012, with users now watching more than 1 billion hours of videos a day.

Hoping to tap that massive audience, Alphabet plans to launch a premium-streaming service called YouTube TV, offering subscribers 40 channels of live TV for $35 a month. The so-called skinny bundle will include major networks such as ABC, NBC, CBS, Fox, and ESPN. Alphabet is reportedly in talks to add more channels, such as Comedy Central and AMC. No launch date has been publicly set.

The number of U.S. households subscribing to broadband TV but not cable is expected to climb 56% to 17.2 million this year, estimates industry researcher The Diffusion Group. That potential growth has attracted plenty of competition. DISH Network ($64; DISH), Sony ($31; SNE), and AT&T ($42; T) offer their own skinny bundles. Hulu soon plans to introduce its own service, and even Amazon.com ($851; AMZN) has considered entering the fray. Roughly 100 million households subscribe to traditional pay TV.

In related news, Alphabet reached a deal allowing Comcast ($37; CMCSa) subscribers to access YouTube videos through their cable boxes. Comcast made a similar pact with Netflix ($140; NFLX) in July. Separately, Comcast continued its strategy of investing in digital media by pumping $500 million into the initial public offering of Snap ($23; SNAP), maker of the popular messaging application Snapchat. Alphabet is a Focus List Buy and a Long-Term Buy. Comcast is a Buy and a Long-Term Buy. Amazon.com and AT&T are rated B (average).

Health-care roundup

House Republicans unveiled their long-awaited proposal to replace the Affordable Care Act. Like ACA, the new plan would require insurers to offer coverage to all Americans and not raise rates for those with a history of illness. Additionally, the state and federal exchanges would still exit. But the plan proposes to shrink Medicaid and reduce federal subsidies, likely leading to a reduction in the number of insured patients. That's bad news for hospitals and insurers such as Centene ($70; CNC).

More favorably, the plan would repeal taxes on insurers and medical-device makers. Critical information, such as estimated cost and the number of people it could ultimately cover, was not provided. And other details may change before the bill becomes law. The Republican proposal got a cool reception from some of the party's more conservative members, putting its future in doubt. Centene is a Focus List Buy and a Long-Term Buy.


Drug prices were not addressed by the bill but remain a popular topic nonetheless. In an interview with Bloomberg, the CEO of Gilead Sciences ($70; GILD) accused pharmacy-benefits managers of standing in the way of lower drug prices. PBMs, such as CVS Health ($81; CVS) and Express Scripts ($68; ESRX), negotiate drug prices on behalf of patients. Drugmakers offer rebates in order to get on PBMs' lists of covered drugs; PBMs usually take a cut of the rebates before giving the rest of the savings to customers. Gilead argued that higher list prices result in larger rebates for PBMs to pocket. In a rebuttal to Gilead, CVS said that escalating drug prices are due to drugmakers alone. CVS is a Long-Term Buy. Express Scripts and Gilead are rated B (average).


Separately, shares of drugmakers slipped after President Trump renewed his call to lower prices by tweeting that he's "working on a new system" to boost competition in the drug industry. Trump's comments flummoxed several biotechnology analysts, who have not seen any hints of what a "new system" may entail, reported The Wall Street Journal.


Rank Changes

Facebook ($138; FB) is being added to the Long-Term Buy List. Celgene ($123; CELG) is being added to our Buy List. On Friday, we sold Kroger ($29; KR) from the Buy and Long-Term Buy Lists.


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