Portfolio Review

3/9/2009


Upgrades and downgrades
Dolby Laboratories ($28; DLB), boasts strong Quadrix® scores (92 Overall, 98 in Quality, and 96 in Financial Strength) and a solid growth profile. Spending on discretionary consumer products has come under pressure. But Wall Street’s 2009 growth targets for sales (5%) and per-share profits (3%) look too conservative for a company that saw profits rise at least 38% in each of the past three years. Moreover, Dolby’s long-term outlook remains bright as countries converting to digital broadcasting are choosing Dolby audio technology. In other news, founder Ray Dolby is stepping down as chairman and Bill Jasper is stepping down as CEO, though both will remain on the board. Dolby, already a Buy, is being added to the Focus List.


PepsiCo ($48; PEP), a longtime Forecasts favorite known for its steady growth and defensive characteristics, has seen its Quadrix scores deteriorate in recent months. The Overall score has dipped to 58, well below the 80 we seek for most Buys and Long-Term Buys, and operating results for 2009 are not likely to boost those scores. Concerns about the economy weigh on projections, and Wall Street expects roughly flat sales and profits this year. PepsiCo, not cheap relative to the market at 13 times projected 2009 earnings, is being downgraded to Neutral.


Microsoft ($16; MSFT) has promised to maintain its research spending despite other planned cost cuts, which bespeaks a forward-thinking attitude and bodes well for long-term results. However, this year’s prospects look less rosy. Consensus estimates project a 6% decline in per-share profits in the year ending June, and continued weak demand for personal computers could make it difficult for Microsoft to meet even that modest target. The stock looks cheap at nine times the consensus for fiscal 2009 ending June and offers solid rebound potential for investors willing to hold for the next 24 to 36 months. Microsoft remains a Long-Term Buy but is being dropped from the Buy List.


Sprint Nextel ($3; S) has rallied sharply this year, helped by better-than-expected results in the December quarter. While profit estimates have risen over the last month, the consensus still projects losses in each of the next three years. We would not buy this company; but given its momentum in stock price and profit estimates, neither would we bet against the trend. Sprint Nextel is being upgraded to Neutral from Underperform.

Financial update
Financial companies continue to lead the stock market down, with the worst of the bunch treading water by diluting their stock and asking for more federal aid.

American International Group ($0.43; AIG) lost $14.17 per share in the December quarter, far more than the $1.25 per share it lost in the same period last year, and worse than consensus projection of a $0.37-per-share loss. On the brink of a credit downgrade, AIG got a fresh $30 billion federal loan and eased restrictions on previous loans. AIG is rated Neutral.


Citigroup ($1; C) agreed to convert $25 billion in preferred shares from an earlier federal loan into common stock, giving the U.S. up to a 36% equity stake. Citigroup will also offer an equity exchange to private investors holding preferred stock with a conversion price of $3.25 per share. In other news, Citigroup suspended its annual dividend of $0.04 per share. Citigroup will also replace a majority of its board with independent directors, though CEO Vikram Pandit will keep his job. Citigroup is rated Neutral.


Bank of America ($4; BAC) said its balance sheet includes $886.2 billion in loans, with the book value an estimated $44 billion above market value. Bank of America is rated Neutral.

Quarterly earnings
NII Holdings’ ($11; NIHD) profits plunged 93% to $0.05 per share in the December quarter, well short of the consensus of $0.43, on a 5% revenue gain. Weakness in Latin American currencies weighed on results. Excluding the currency issues, NII’s revenue and operating income before depreciation and amortization rose 24%. The company expects to add at least 1.275 million subscribers this year, projecting 21% to 22% growth. NII is a Focus List Buy . . . Dell ($9; DELL) earned $0.29 per share excluding special items in the January quarter, down 6% but $0.03 above the consensus. Sales fell 16% to $13.43 billion. Dell is rated Neutral . . . General Motors ($2; GM) lost $9.65 per share in the December quarter excluding special items, down from a gain of $0.08 in the year-earlier period. Revenue dropped 33%. GM’s European unit plans to spin off German arm Opel, retaining a majority stake in the new company. The European segment said it needs $4.2 billion in government aid to prevent layoffs and plant closures. GM is rated Underperform.

Dividends and splits
2009 is shaping up as a historically bad year for dividends. Dividend payments from S&P 500 Index companies fell 24% in January, and Standard & Poor’s expects a decline of at least 13% for the year, which would be the biggest decrease since 1942.

General Electric ($6; GE) lopped off 68% of its quarterly dividend, now $0.10 per share, saving about $9 billion a year. GE is rated Neutral and should not be purchased . . . Gannett ($2; GCI) shrank its quarterly dividend 90% to $0.04 per share. International Paper ($5; IP) chopped its quarterly payout 90% to $0.025 per share and agreed to sell 143,000 acres in the southeastern U.S. to the American Timberlands Fund I LP in exchange for $220 million and a 20% stake in the partnership. Canadian miner Teck Cominco ($3; TCK) suspended its dividend. Vornado Realty Trust ($32; VNO) plans to pay its March dividend with 60% stock, 40% cash. REITs are not allowed to cut their payout ratios, and others have taken similar steps to conserve cash flow.

Against the wind: Three monitored companies have bucked the trend and boosted their dividends. Qualcomm ($33; QCOM) raised the quarterly dividend 6% to $0.17 per share, Colgate-Palmolive ($57; CL) hiked its quarterly payout 10% to $0.44 per share, and Kimberly-Clark ($46; KMB) raised its quarterly dividend 3% to $0.60 per share. Qualcomm is a Long-Term Buy. Gannett, International Paper, Colgate-Palmolive, Kimberly-Clark, Teck, and Vornado are rated Neutral . . . Time Warner ($7; TWX) plans to spin off its cable unit March 12, when Time Warner Cable will pay a special cash dividend of $10.27 per share and execute a 1-for-3 reverse stock split. Parent Time Warner also plans to carry out a reverse 1-for-3 stock split March 27. Time Warner is rated Neutral. The Forecasts will initiate coverage of Time Warner Cable after it starts trading.

Handling health-care reform
President Obama’s plan to reform the health-care system is designed to alleviate exploding health-care costs and come to the aid of 46 million uninsured Americans. To help pay for the reform, the president proposed cutting federal payments to hospitals, insurers, drug companies, and home health agencies. While the final bill could end up being far less onerous than Obama’s aggressive proposal, health-care stocks of all stripes sank on the news.

While biotechnology companies typically do not fall prey to such scares, Biogen Idec ($45; BIIB) has dropped 15% over the last month. Genentech ($82; DNA) is roughly flat, buoyed by an outstanding takeover offer of $86.50 per share. Even in its current form, the bill should have little effect on medical-devices makers such as St. Jude Medical ($32; STJ) and Stryker ($33; SYK), but the stocks sold off anyway. Biogen and St. Jude are Focus List Buys and Long-Term Buys. Stryker is a Buy and a Long-Term Buy. Genentech is a Long-Term Buy.

Recent weakness in AstraZeneca ($31; AZN) shares stems from more than political concerns. Documents unsealed in connection with patient lawsuits allege the company knew the Seroquel antipsychotic was linked to diabetes and also overstated the drug’s effectiveness. For now, AstraZeneca remains a Buy and a Long-Term Buy.


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