Buy Lists Revamped, Portfolio Review
Buy lists revamped
Based on December-quarter results, Quadrix® scores, relative valuations, and growth prospects for 2010 and beyond, we’re making several rank changes:
• On our Focus List, representing our favorite 12 to 17 year-ahead picks, we’re dropping CA ($23; CA), Oceaneering International ($62; OII), and Transocean ($81; RIG) while adding Raytheon ($57; RTN) and Travelers ($53; TRV).
• On our Buy List, a fairly diversified portfolio limited to our best ideas for 12-month returns, we’re dropping Accenture ($41; ACN) and Oceaneering while adding four names — Abbott Laboratories ($55; ABT), Research In Motion ($71; RIMM), TJX ($41; TJX), and Varian Medical Systems ($51; VAR). To accommodate this switch, the Buy List’s position in Vanguard Short-Term Investment-Grade ($10.71; VFSTX) is being reduced slightly and target weights are being adjusted.
• On our Long-Term Buy List, a portfolio of investment-grade stocks composed of our top picks for 24- to 48-month returns, we’re dropping Accenture and Chevron ($73; CVX). We’re adding Raytheon and Varian.
Research In Motion is being added to the Buy List. Maker of the popular BlackBerry wireless device, Research In Motion enjoys a unique niche with business users who want mobile access to e-mail. Sales have climbed 51% over the last four quarters, and double-digit growth seems likely through at least fiscal 2011 ending February. Moreover, the stock trades at an attractive valuation relative to its own history and other players in smartphones.
Investors should also consider a couple caveats. First, the stock tends to be volatile. Second, the company’s competitive position remains a concern as it charts a new course in the consumer market, which could potentially erode the attractive margins of the business market. Even so, Research In Motion earns an Overall score of 98, reflecting superior operating momentum and a robust balance sheet. The consensus calls for earnings growth of 41% for the February quarter.
Varian Medical is being added to the Buy List and Long-Term Buy List. The company’s primary business revolves around the hardware and software products used in radiation treatment of cancer. Even amid the worst of the economic downturn, Varian maintained sales and earnings momentum. A weaker-than-expected rebound in hospital spending could trigger volatility in the stock, but Varian appears leveraged to lasting growth drivers. Cancer is becoming more prevalent, as is the use of radiology to treat the disease.
Varian has produced higher free cash flow and wider operating margins in the past three quarters. A sturdy balance sheet features cash of more than $5 per share and minimal debt. The stock is not especially cheap, though it seems fairly valued at 18.5 times trailing earnings — 23% below the five-year average. Consensus per-share-profit estimates for fiscal 2010 have been rising and now project 7% growth.
Abbott, an addition to the Buy List, and Travelers, an addition to the Focus List, are reviewed in Dividend Spotlight.
Raytheon, profiled in Analysts' Choice in last week’s issue, is being added to the Focus List and Long-Term Buy List. The defense contractor appears less vulnerable to budget cuts than most rivals. On Feb. 26, Raytheon won a contract worth $886 million with the U.S. Air Force to improve the accuracy of information sent from satellites. The dividend has risen every year since 2004, and repurchases reduced the share count by nearly 6% last year.
TJX, already a Long-Term Buy, is being added to the Buy List. The discounter is capitalizing on the growing number of value-conscious consumers. A recent survey found that almost two-thirds of U.S. shoppers would visit stores with lower prices, even if they were less convenient. Consensus estimates project per-share earnings will climb 12% to $3.17 for fiscal 2011 ending January. At 13 times that estimate, the stock remains reasonably valued.
Accenture is being dropped from the Buy List and Long-Term Buy List, reflecting a drop in its Quadrix scores, relatively sluggish earnings-estimate trends, and somewhat disappointing November-quarter results. The stock remains reasonably valued at 15 times expected fiscal 2010 earnings. But IBM ($127; IBM) is both cheaper and better-positioned for growth, and Accenture no longer represents one of our top picks in the technology sector.
CA remains a Buy and Long-Term Buy. But the software maker no longer ranks among our very favorite year-ahead picks, so the stock is being dropped from the Focus List. The stock’s Quadrix scores for Earnings Estimates and Performance have moved below 35. CA has traded mostly sideways for six months but seems capable of reaching $27 over the next year.
Chevron is being dropped from the Long-Term Buy List. The energy giant’s Overall Quadrix score has dropped to 57, significantly lower than any Buy or Long-Term Buy. The Value score is 89, and Chevron trades at less than 10 times expected 2010 earnings. But the stock trades above its five- and 10-year norms based on trailing price/earnings, price/sales, and price/cash flow ratios.
Oceaneering is being dropped from the Focus List and Buy List, reflecting lower Quadrix scores and diminished operating momentum. The stock remains a Long-Term Buy, as growth prospects over the next three to four years remain bright. With the Overall score down to 72, the stock no longer ranks among our top 12-month picks.
Transocean is being dropped from the Focus List, partly because of a weaker-than-expected December quarter. The stock remains a Buy and Long-Term Buy, as the stock’s modest valuation suggests a share-price rebound is likely over the next 12 months and beyond. While no longer among our very favorites, Transocean seems capable of reaching $95 to $100 over the next 12 months.
GameStop ($17; GME) shares slumped after the company’s chief financial officer resigned to accept a position at Wal-Mart Stores ($54; WMT). Reportedly, the outgoing CFO and GameStop’s management said the departure did not relate to accounting, but investors were worried that she quit after just six months on the job. Also weighing on the stock are concerns regarding the migration of video games to digital downloads.
While such concerns are legitimate, the stock seems unduly cheap considering GameStop’s solid balance sheet, strong free cash flow, and potential for improved sales growth over the next 12 to 18 months. The stock, trading at roughly seven times the lowest Wall Street profit estimate for the year ending January, is being maintained as a Buy based on its potential for a rebound to $21 to $24.
NII Holdings ($38; NIHD) reported per-share earnings of $0.35 for the December quarter, well below the consensus of $0.58. Operating earnings rose 11% excluding interest and currency-related charges, and revenue advanced 25% to $1.24 billion. The company’s subscriber count jumped 20% from a year earlier. At 17 times trailing earnings, the stock trades at a 36% discount to the five-year average.
NII has limited exposure in Chile, recently jolted by a massive earthquake. With roughly 43,700 Nextel handsets in commercial service, Chile accounted for less than 1% of 2009 revenue. But Chile figured into NII’s expansion efforts for the next couple years, and the company has not said how the disaster will affect those plans. NII is a Focus List Buy.
The U.S. Navy awarded General Dynamics ($74; GD) an $825 million contract modification to continue work on a pair of cargo ships. The company also won a separate deal worth $114 million to purchase materials for a Navy destroyer. General Dynamics is a Buy and a Long-Term Buy . . . Baxter International ($58; BAX) agreed to purchase ApaTech with an initial cash payment of $240 million and could spend up to $90 million more if the company hits certain sales milestones. A maker of synthetic bone-graft material for orthopedic and dental surgery, ApaTech generated sales of about $60 million last year. Baxter is a Long-Term Buy . . . Coca-Cola ($53; KO) said it will purchase the North American business of Coca-Cola Enterprises ($26; CCE), its largest distributor. Under terms of the deal, Coke will assume $8.88 billion in debt and relinquish a 34% stake in the bottler valued at more than $3 billion. Coke believes the deal can generate $350 million in savings over four years and boost the flexibility of its distribution system. A similar motivation drove PepsiCo ($64; PEP) to pay $7.8 billion for two of its own bottlers. Both Coke and Pepsi seem capable of delivering double-digit profit growth this year and next year, and we are upgrading them to A (above average).