Portfolio Review

8/10/2010


Based on Quadrix scores, valuations, June-quarter results, and growth prospects, we’re making several rank changes this week. Microsoft ($26; MSFT), reviewed in Income Spotlight, is being added to the Buy List. Lubrizol ($96; LZ), reviewed in Analysts' Choice, is being added to the Long-Term Buy List. Below we review three additional upgrades, three downgrades, and five stocks with recent earnings reports or problematic Quadrix scores.

Upgrades

The economic recovery has given CSX ($54; CSX) a full head of steam. Since reporting a strong June quarter (sales up 22% and earnings from continuing operations up 51%), consensus profit estimates for 2010 and 2011 have risen at least $0.17. A combination of 13% volume growth and a 6.5% increase in core pricing drove the impressive top-line growth, indicating demand has strengthened.

CSX trades at a discount to the average railroad stock based on price/earnings, price/sales, and price/cash flow ratios. The consensus projects per-share profits will rise 34% this year and 15% next year, yet the stock trades at 14 times expected 2010 earnings. CSX, with an Overall score of 94, is being added to the Buy List and the Long-Term Buy List.


While most of the largest financials continue to wallow in a sea of bad loans and weak operating momentum, J.P. Morgan Chase ($41; JPM) has apparently righted its ship. The retail-banking and credit-card units rebounded from March-quarter losses to turn profits in the June quarter. Citing a 28% decline in charge-offs relative to the March quarter, the financial giant earned $0.87 per share excluding special items in the June quarter, up 211% and $0.20 above the consensus.

With a Quadrix Overall score of 91 and at least 70 in both sector-specific scores, J.P. Morgan is the most fundamentally strong of the diversified financial giants. Despite that superiority, J.P. Morgan trades at just 11 times projected 2010 earnings. J.P. Morgan Chase is being added to the Buy List and the Long-Term Buy List.


Texas Instruments ($25; TXN), a global semiconductor maker with leading positions in digital signal processors and analog devices, is being added to the Long-Term Buy List. The stock earns the maximum Quadrix Overall score of 100, reflecting a modest valuation and strong operating momentum. The company has delivered three straight quarters of much-improved results, with per-share earnings tripling on a 42% sales gain for the June quarter.

Consensus profit estimates for the September and December quarters have increased since the earnings release, and Texas Instruments is now expected to deliver per-share earnings of $2.48 for 2010 and $2.57 for 2011. Trading at less than 10 times the 2011 estimate, Texas Instruments represents an attractive pick for 24- to 48-month returns.

Downgrades

CVS Caremark ($31; CVS) is being dropped from the Focus List, Buy List, and Long-Term Buy List. Its Overall score has sunk to 64, dragged down by Performance and Earnings Estimates scores below 20. At 11 times trailing earnings, a 36% discount to the five-year average, the stock remains a good value, and a bounce to $33 would not be surprising in the near term. But the stock no longer qualifies as one of our top picks. While a new contract with Aetna ($28; AET) represents good news for the pharmacy-benefit-management unit, retail-drugstore results have begun to deteriorate. CVS Caremark is now rated B (average).


Hospira ($52; HSP) is being dropped from the Focus List, Buy List, and Long-Term Buy List. A mediocre Overall score of 60 reflects deteriorating scores for Momentum (35) and Earnings Estimates (19). For the June quarter, Hospira reported marginal growth in sales and cash flow from operations, hinting that market conditions will become more challenging in the second half of the year. And while management said that back orders are up “substantially,” it declined to give a dollar amount. Hospira is now rated B (average).


Johnson & Johnson ($59; JNJ) is being dropped from the Long-Term Buy List. J&J’s outstanding track record has been tarnished by quality-control problems with several consumer medications. More important, profit growth is slowing and seems unlikely to reaccelerate soon. Like other drugmakers, J&J faces constant pressure from generic rivals looking to cannibalize sales of its blockbuster drugs. The Overall score has dipped to 54, and none of the Quadrix category scores are above 80. J&J is now rated B (average).  

Stock reviews

Shares of BMC Software ($36; BMC) slumped 6% on a somewhat disappointing June quarter. In fact, BMC has missed consensus profit estimates in each of the last two quarters, both of which saw revenue growth of less than 3%. Nevertheless, BMC remains a Focus List Buy. BMC, which sells products designed to run data centers, reported impressive order growth for the second consecutive quarter.

At 10.5 times free cash flow, the stock is cheaper than about 60% of U.S.-traded stocks. Sales should pick up in the next couple quarters, helped by a server partnership with Cisco Systems ($24; CSCO). BMC is a Focus List Buy and a Long-Term Buy. Cisco is rated B (average).     


NII Holdings ($40; NIHD) earned $0.44 per share, down 44% and $0.12 short of the consensus, marking the third miss in as many quarters. However, revenue and EBITDA (earnings before interest, taxes, depreciation, and amortization) topped estimates. Operating revenue jumped 29%, and net revenue per subscriber climbed 7% to $47. NII raised its full-year guidance for revenue, net subscriber additions, and operating income.

Despite the earnings miss, analyst profit estimates have risen since the announcement, and the company enjoys strong growth prospects. In addition to expansion in Brazil, NII stands to grab a bigger slice of Mexico’s airwaves at a considerable discount to market rates, though rival telecom companies have criticized the government’s handling of a spectrum auction. NII remains a Focus List Buy.


Stryker ($48; SYK) shares sold off on disappointing June-quarter operating results. Sales lagged Wall Street expectations, hurt by weakness in orthopedic implants. Quadrix scores for Performance and Earnings Estimates have slumped to the low 20s, and the Overall score is only 76.

While the recent quarter raised some questions, results have generally been solid. In the last three quarters, Stryker delivered sales growth of at least 6.5% and per-share earnings growth of at least 11%. The shares appear cheap versus their history as measured by price/earnings, price/sales, and price/cash flow ratios. Stryker is a Buy and a Long-Term Buy.


McKesson ($62; MCK) earned $1.10 per share in the June quarter, up 4% and a penny above the consensus. Revenue rose 3%. McKesson reiterated its profit guidance for fiscal 2010 ending March with a midpoint of $4.82 per share, for 5% growth. McKesson is a Buy and a Long-Term Buy.


Energen’s ($45; EGN) per-share profits climbed 20% to $0.91 in the June quarter, excluding a noncash write-off. Revenue advanced 9% to $334 million, as 18% growth at the energy-production unit offset a decline at the natural-gas utility. Energen is a Long-Term Buy.

RIM unveils new phone

Trying to keep pace with Apple’s ($262; AAPL) iPhone, Research In Motion ($56; RIMM) introduced the BlackBerry Torch, a smart phone featuring a touch screen, slide-out keyboard, and new operating system. The announcement was overshadowed by threats from Saudi Arabia and United Arab Emirates to ban BlackBerry services because the phone’s encryption prevents third parties from monitoring activity. RIM maintains that it will not dilute its phones’ security features. Research In Motion is a Buy and a Long-Term Buy. Apple is a Long-Term Buy.

  RANK CHANGES

Microsoft ($26; MSFT) is being added to the Buy List. J.P. Morgan Chase ($41; JPM) and CSX ($54; CSX) are being added to the Buy List and Long-Term Buy List. Texas Instruments ($25; TXN) and Lubrizol ($96; LZ) are being added to the Long-Term Buy List. CVS Caremark ($31; CVS), Hospira ($52; HSP), and Johnson & Johnson ($59; JNJ) are being dropped from our buy lists. The Vanguard Short-Term Investment-Grade ($10.82; VFSTX) fund now represents 25.0% of the Buy List and Focus List and 28.7% of the Long-Term Buy List.


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