Portfolio Review

9/13/2010


List review

Based on Quadrix scores, second-quarter results, profit-estimate trends, and near-term operating prospects, we are making several rank changes in the paragraphs below. CSX ($53; CSX), reviewed in Income Spotlight, is being added to the Focus List.

As a reminder, our Buy List is a fairly diversified portfolio limited to our top 20 to 30 picks for year-ahead returns. The Focus List represents our very favorite 12 to 17 stocks from the Buy List. Long-Term Buys represent our top picks for 24-month to 48-month returns.

Upgrades

Advance Auto Parts ($56; AAP) is being upgraded to a Focus List Buy. The company operates more than 3,460 retail stores that sell auto parts and accessories. The retailer complements that established business with a push into supplying parts to commercial garages. The strategy appears to be working, with per-share earnings exceeding consensus estimates by 19% in the March quarter and 13% in the June quarter.

Free cash flow surged 46% in the 12 months ended June, while operating cash flow jumped 35%. Wall Street sees per-share profits growing 27% this year on 8% higher revenue, followed by 14% profit growth in 2011. At 16 times trailing earnings, the stock trades roughly in line with its five-year average P/E ratio and seems attractively valued relative to its growth potential. Advance Auto, already a Long-Term Buy, is being added to the Focus List and Buy List.


Apple ($258; AAPL) is being upgraded to a Focus List Buy. The company has parlayed strong brand recognition and a series of successful product launches into outstanding operating momentum. Sales jumped 48% over the last year, accelerating in the last two quarters, while per-share profits have soared 83%.

The stock price alone might scare off investors, especially considering that Apple shares trade at 21 times trailing earnings, roughly double Hewlett-Packard’s ($40; HPQ) P/E of nine and Dell’s ($12; DELL) 11. But Apple’s impressive growth warrants a premium to other hardware companies, and the current P/E is still 29% below its five-year average. Strip out Apple’s $26-per-share in cash, and the trailing P/E falls to 19. Apple, already a Long-Term Buy, is being added to the Focus List and Buy List. Hewlett-Packard is a Buy and Long-Term Buy. Dell is rated B (average).

Downgrades

BMC Software ($38; BMC) is being dropped from the Focus List but remains a Buy and a Long-Term Buy. BMC isn’t particularly cheap (14 times trailing earnings) or especially fast-growing (estimated per-share-profit growth of 7% this year and 8% next year). In addition, the Quadrix Overall score has fallen to 77 from 92 at the end of May. However, BMC earns extra consideration because of its attractive business niche and cash-flow trends.

The provider of software used to manage corporate data centers could exceed modest profit expectations, as its products help customers lower costs, a benefit that should support steady demand. And while we don’t recommend buying stocks based on their takeover potential, BMC operates in an area seeing consolidation and could become an acquisition target.


Intel ($18; INTC) is being removed from the Focus List but remains a Buy and a Long-Term Buy. The shares have slumped more than 10% since the company issued a strong earnings announcement and positive guidance in July. Since then, analysts have projected a slowdown in personal-computer sales, and Intel warned that September-quarter sales and profit margins would fall below the targets it had set just a month earlier.

Uncertainty about Intel’s computer-related end markets could weigh on the stock in the near term. But Intel’s valuation of just nine times projected 2010 earnings suggests the stock’s price already reflects plenty of bad news. Consensus per-share-profit estimates have fallen over the last month and now reflect growth of 158% in 2010 and 1% in 2011. Intel has topped the consensus by at least 13% in each of the last four quarters, and the 2011 target appears unduly low.


AmerisourceBergen ($28; ABC) is being dropped from the Focus List, although the stock remains a Buy and Long-Term Buy. Amerisource distributes pharmaceuticals and other medical products. The shares have advanced 8% so far this year, and the stock still represents a decent value. At 13 times trailing earnings, Amerisource trades 24% below its five-year average P/E ratio.

However, Amerisource’s share-price momentum has stalled in the last two months, hurt in part by a slowdown in the economic recovery. Amerisource no longer ranks among our top 12 to 18 picks, and we will be scrutinizing September-quarter results closely. But the stock remains a good holding for one- and three-year returns.


McKesson ($59; MCK), a distributor of pharmaceuticals and surgical supplies, is being dropped from the Buy List. The stock remains a Long-Term Buy. June-quarter results were unimpressive, and we are not confident in a near-term rebound in operating momentum. In the six months ended June, the company’s free cash flow and operating cash flow declined relative to year-ago levels.

But the long-term growth picture remains intact. Operating profit margins are edging higher as the use of generic drugs becomes more prevalent. Analysts forecast 6% higher per-share earnings in fiscal 2011 ending March, followed by 10% growth in fiscal 2012. Trading at 13 times trailing earnings, 24% below the five-year average P/E ratio, McKesson remains a Long-Term Buy.


NII Holdings ($38; NIHD), a provider of wireless services to businesses in Latin America, is being removed from the Focus List and Buy List. The stock has risen 13% so far this year, while the S&P 1500 Index is down slightly. Free cash flow rose year-over-year in each of the last six quarters. But NII’s Quadrix scores are deteriorating in nearly all categories. The Overall score has slipped to 67 after starting the year at 97. NII is being dropped from the Monitored List and should be sold.

Corporate roundup

U.S. retailers posted 3.3% higher same-store sales in August, topping the consensus estimate of 2.5%, based on an index of 27 retail stocks. Ross Stores ($52; ROST) grew same-store sales 5%, topping the analyst forecast of 2.9%. TJX ($41; TJX) said same-store sales rose 2%, shy of the 2.4% consensus. Ross is a Focus List Buy and a Long-Term Buy. TJX is a Buy and a Long-Term Buy . . . U.S. regulators cleared Abbott Laboratories ($50; ABT) to market a new hepatitis B test. Separately, a study funded by Abbott found that weight-loss drug Meridia increases the risk of heart attacks and strokes in patients who already have heart disease. Later this month, U.S. regulators will discuss the fate of the drug, which has been already banned in Europe. Abbott is a Buy and a Long-Term Buy . . . Hewlett-Packard ($40; HPQ) outlasted Dell ($12; DELL), winning the bidding war for 3PAR ($44; PAR) for roughly $2.07 billion, or $33 per share. Dell initially bid $18 per share for the data-storage company on Aug. 16, which represented a lofty 87% premium at the time. H-P is a Buy and Long-Term Buy. Dell is rated B (average) . . . Shares of Oracle ($24; ORCL) rallied 6% when the database company announced the hiring of ousted H-P CEO Mark Hurd as a co-president and board member. H-P, concerned that its trade secrets will fall into the hands of a competitor, has asked a court to block the hiring and sued Hurd, who signed a two-year confidentiality agreement when he resigned in August. Oracle is a Long-Term Buy . . . BP ($37; BP) has finally secured with a new blowout preventer a ruptured oil well that leaked more than 4 million barrels of oil into the Gulf of Mexico since the April explosion aboard Transocean’s ($53; RIG) Deepwater Horizon drilling rig. BP plans to continue drilling a relief well, through which mud and cement will be pumped to plug the well for good. BP estimates that costs related to the spill have reached $8 billion. BP and Transocean are rated B (average).

  RANK CHANGES

Advance Auto Parts ($56; AAP) and Apple ($258; AAPL) are being added to the Focus List and the Buy List, and CSX ($53; CSX) is being added to the Focus List. AmerisourceBergen ($28; ABC), BMC Software ($38; BMC), and Intel ($18; INTC) are being dropped from the Focus List but remain Buys and Long-Term Buys. McKesson ($59; MCK) is being dropped from the Buy List but remains a Long-Term Buy. NII Holdings ($38; NIHD) is being dropped from coverage.


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