Portfolio Review: September 11, 2017

9/11/2017


Rank changes

Responding to changes in Quadrix scores, valuations, and near-term profit outlooks, we are making several rank changes:

• On our Focus List, our favorite 13 to 17 picks for year-ahead returns, we're adding Facebook ($172; FB) and dropping CBS ($62; CBS) and Southwest Airlines ($52; LUV).

• On our Buy List, limited to our top year-ahead picks, Cognizant Technology ($71; CTSH) and FedEx ($212; FDX) are being added. Juniper Networks ($28; JNPR) is being dropped.

• On our Long-Term Buy List, which targets stocks with attractive 24- to 48-month prospects, we're adding Cognizant and Chemours ($48; CC). Juniper and Ingersoll-Rand ($84; IR) are being dropped.

Upgrades

Facebook traded at an all-time high above $175 on July 27, the day after it posted impressive June-quarter results. But it has been trading mostly sideways since then, even as full-year profit estimates for 2017 and 2018 have moved higher. At 26 times the 2018 consensus estimate, the stock trades at a 14% premium to the S&P 1500 internet software and services group — a reasonable valuation considering Facebook's superior growth prospects and $12 per share in net cash.

The social-media giant has delivered eight straight quarters of at least 40% revenue growth, with improved operating profit margins in each quarter. While growth is likely to slow, consensus expectations for per-share-profit growth of 25.5% for 2017 and 21.8% for 2018 seem achievable. Facebook, already a Buy and Long-Term Buy, is being added to the Focus List.


Cognizant Technology, a leading provider of outsourced technology services, has used acquisitions and internal growth to compile an impressive track record. Growth slowed in 2016 as demand from financial customers cooled. But sales and cash flow showed encouraging growth in the first half of 2017, and double-digit growth in profits seems likely over the next 18 months.

Cognizant has made progress reducing its dependence on H-IB visas, which allow foreigners to work in the U.S. for up to six years. Still, near-term changes to the program could weigh on margins, a risk that seems reflected in the stock's valuation. At 19 times expected current-year earnings, the stock trades at a discount to slower-growing  peers and its own historical norms. Cognizant is a Buy and a Long-Term Buy.


FedEx was dropped from the Focus List and Buy List in April, when the stock traded near $184 and its Quadrix Overall score had slumped below 80 on a mixed February quarter. The Overall score has rebounded to 95, as an encouraging May-quarter report boosted the Momentum and Performance scores.

FedEx earns a Value score of 80, reflecting across-the-board strength along with high marks for relative measures like P/E versus the three-year norm. Profit estimates have edged lower in recent weeks, but expectations of 10% to 15% profit growth over the next 18 months seem reasonable considering the global economy's strength. FedEx is a Buy and a Long-Term Buy.


Chemours, a 2015 spin-off of DuPont, holds leading positions in two markets. In titanium dioxide, a pigment used to deliver whiteness and opacity, Chemours says it is the No. 1 global producer by capacity, sales, and profitability. In fluoroproducts, used for refrigerants and propellants, the company claims it is the No. 1 global producer of both fluorochemicals and flouropolymers. 

Profit estimates for 2017 and 2018 have jumped over the past month, reflecting price hikes and solid demand growth. June-quarter sales rose 15%, with volumes up 15% and prices up 7%. Divestitures and currency represented a 7% headwind. Cash flow has surged and capital spending has dropped since the spin-off, pushing free cash to more than $2 per share over the last 12 months. Chemours is a Long-Term Buy.

Downgrades

CBS and Southwest Airlines no longer rank among our favorite 13 to 17 stocks, partly because both have seen their Overall Quadrix scores drop below 80. But both still rank among our favorite 25 to 30 stocks for year-ahead gains, so both remain on the Buy List. Both are also Long-Term Buys.

CBS could be weighed down by concerns regarding weakening advertising demand in the near term, but we expect the company's strength in content creation to gain notice over the next year. The stock, trading at less than 13 times expected 2018 earnings, seems capable of reaching $72 to $77 over the next year.


Southwest Airlines has slumped with the airline group, hurt by fears of a price war. On Sept. 6, Southwest lowered its estimate for September-quarter unit pricing, predicting it would be up slightly to down 1% — a cut from prior guidance of up 1%. The stock's Momentum, Performance, and Earnings Estimates scores have dropped below 30. While a downgrade off the Buy List is possible if pricing worsens, a rebound to $60 seems achievable over the next year.


Juniper Networks issued disappointing guidance with its June-quarter results, suggesting its sales momentum is at risk of stalling. Consensus estimates project just 3% sales growth for the September quarter, and reports from peers suggest telecom-related spending could worsen before it improves. Juniper is being dropped from the Buy and Long-Term Buy lists. The stock, now a B (average) on our Monitored List, should be sold.


Ingersoll-Rand has been under pressure since reporting June-quarter results, and the stock's Overall Quadrix score has dropped to 64. Profit estimates for the September and December quarters have dipped, and sales growth is expected to slow to 4% for both quarters. While the stock remains attractively valued relative to industry peers, it is expensive relative to its own historical norms. The stock, now a B (average) on our Monitored List, should be sold.

Cruise-ship report

Shares of Carnival ($67; CCL) and Royal Caribbean ($119; RCL) slumped amid concerns regarding Hurricane Irma. The storm is expected to be one of the strongest ever to hit the Caribbean, an important destination for cruise-ship operators. Both Carnival and Royal Caribbean have canceled cruises, but we expect the hit to earnings to be temporary. In other news, Royal Caribbean raised its quarterly dividend 25% to $0.60 per share, payable Oct. 11. Carnival remains a Focus List Buy and Long-Term Buy, while Royal Caribbean remains a Buy and Long-Term Buy.

Tech update

Apple ($162; AAPL) confirmed that it will host a media event on Sept. 12, when it's expected to show off its latest iPhone, Apple Watch, and Apple TV set-top box. Apple is a Buy and a Long-Term Buy.


Alphabet ($942; GOOGL) created a new holding company that will legally separate each of the company's businesses, including Google (internet search), Waymo (autonomous cars), and Verily (medical devices). Alphabet is a Focus List Buy and a Long-Term Buy.


In a move that takes aim at Alphabet's YouTube, Facebook ($172; FB) introduced a video service called Watch that lets users submit shows. Facebook is a Focus List Buy and a Long-Term Buy.


Rank Changes

Facebook ($172; FB) is being added to the Focus List, while CBS ($62; CBS) and Southwest Airlines ($52; LUV) are coming off the Focus List, though they remain Buys and Long-Term Buys. FedEx ($212; FDX) is joining the Buy List. Cognizant Technologies ($71; CTSH) is being added to the Buy and Long-Term Buy List, and Chemours ($48; CC) is being initiated as a Long-Term Buy. Juniper Networks ($28; JNPR) is being dropped from the Buy and Long-Term Buy lists, while Ingersoll-Rand ($84; IR) is being dropped from the Long-Term Buy List. After these changes, the Vanguard Short-Term Corporate Bond ($80; VCSH) ETF will account for 2.6% of the Buy List and 8.2% of the Long-Term Buy List.


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