Portfolio Review

12/13/2010


List review

Headlines tend to tell only the single best or worst part of a story. Investors who make buy or sell decisions based on headlines may be neglecting important information. Below we review two television providers plagued by a worrisome headlines about viewers cutting the pay-TV cord.

The number of pay-TV subscriptions fell for the first time ever in the June quarter, then dipped again in the September quarter. And in a survey of 2,500 consumers, 7% had canceled their basic cable, while 12% cut premium cable or satellite TV. Pay-TV companies claim cord-cutting has not caused the declines, instead blaming the economy.


DirecTV ($39; DTV) does not lack for confidence, projecting it will add a net 200,000 U.S. subscribers in the December quarter, building on 174,000 adds in the September quarter. DirecTV has built a base of affluent customers capable of paying for premium services through the downturn.

The company sees its current count of 24.3 million subscribers, which includes the U.S. and majority-owned operations in Latin America, growing to about 30 million by 2013. By then DirecTV expects its per-share earnings to top $5, versus the 2010 consensus of $2.37. Strong trends in free cash flow, up in 10 of the last 12 quarters, could fund management's plan to repurchase a third of its stock by 2013. DirecTV, trading at less than 13 times the 2011 profit estimate of $3.15 per share, is a Focus List Buy and a Long-Term Buy.


In the nine months ended September, Comcast ($21; CMCSa) lost 622,000 video customers but added nearly 1.5 million Internet and voice customers, and another million digital-video customers. In addition to the cord-cutting issue, two others have vaulted Comcast into the headlines:

1) The charging of access fees to Level 3 Communications ($1; LVLT). Comcast calls such fees routine efforts to recoup the costs of transmitting  third-party content, while Level 3 sees them as an unfair “toll booth.”

2) Ongoing regulatory review of Comcast's $30 billion deal to take a 51% stake in NBC Universal. A combination of high-profile opposition and the merger partners' 90-day extension of their agreement could presage snags in the regulatory approval process, though Comcast still expects to close the deal by the end of the year.

The consensus projects per-share-profit growth of 15% in 2011 after a gain of just 1% this year. However, Comcast faces a unique blend of political and business-related pressures. And after a 22% rally since the end of August, the current valuation (14 times the 2011 profit estimate) suggests Comcast may face selling pressure if it encounters unexpected headwinds. Comcast shares may be volatile in the near term, but patient investors should find this Long-Term Buy provides solid two- to three-year returns.

TI joins Focus List

Texas Instruments ($33; TXN), already a Buy and Long-Term Buy, is being added to the Focus List because of its operating momentum and attractive valuation. In a midquarter update released Dec. 7, the semiconductor giant narrowed its December-quarter guidance range, saying it expects per-share earnings of $0.61 to $0.65 on revenue of $3.43 billion to $3.57 billion — versus per-share earnings of $0.52 and revenue of $3.5 billion in the year-earlier period.

The stock has surged since early September but seems reasonably valued at 13 times expected 2011 earnings — a discount to the average semiconductor stock in the S&P 1500 Index. Texas Instruments also trades at a discount to its five- and 10-year historical norms. And while a return to the five-year median P/E ratio of 19 seems unlikely in the near term, the stock would trade for $39 if 2011 earnings meet expectations and the P/E moves to the three-year median of 15.4. Texas Instruments, with a 97 Overall Quadrix® score and both of its sector-specific scores above 80, represents a top pick for 12-month and 36-month returns.

Microsoft Kinects with gamers

Microsoft ($27; MSFT) has sold more than 2.5 million Kinect motion-controlled sensors for its Xbox 360 game console since the device's Nov. 4 launch. Kinect lets users play video games without a hand-held controller. While early reviews have been mixed, retailers are reporting shortages. Microsoft expects to sell 5 million units by year-end, up from an initial forecast of 3 million.

Despite its popularity, Kinect will probably not have a huge financial impact. In fiscal 2010 ended June, the entertainment and devices division generated about 13% of total sales but less than 3% of operating income.

Competition from inexpensive games played on mobile devices and the massive growth potential of tablet computers have investors concerned. But Microsoft shares appear to discount those concerns — the stock trades at 10 times expected earnings in fiscal 2011 and earns a Quadrix Value score of 90. Microsoft is a Buy and a Long-Term Buy.

AGL buying Nicor

AGL Resources ($35; AGL) agreed to acquire Nicor ($49; GAS) for $2.4 billion in stock and cash. For each Nicor share, investors will receive $21.20 in cash and 0.8382 shares of AGL Resources. The deal equates to $53 per share, a 13% premium to Nicor's price before the announcement. Together, the companies would form one of the biggest U.S. natural-gas distributors, generating $5 billion in annual revenue and serving 4.5 million customers. AGL is a component of our Top 15 Utilities portfolio and earns an A rating in our Utility Update.

Retailers see holiday green

Sales at stores open for one year or more climbed 6% in November, well ahead of the 3.6% consensus estimate, based on an index of 27 retailers tracked by Thompson Reuters. Online sales jumped 24% for the month, according to comScore.

Ross Stores ($65; ROST) reported 6% higher same-store sales in November, exceeding the consensus estimate of 2.8%. TJX ($45; TJX) said same-store sales advanced 3% in November. Walgreen's ($36; WAG) same-store sales increased 3.2%, above the consensus of 2.9%. Ross is a Focus List Buy and a Long-Term Buy. TJX is a Buy and a Long-Term Buy. Walgreen is rated A (above average).

Corporate review

J.P. Morgan Chase ($39; JPM) and its affiliates face a $6.4 billion lawsuit filed by a Bernie Madoff trustee, who claims that J.P. Morgan, as Madoff's primary bank for 20 years, was “willfully blind to the fraud” perpetrated by the investment adviser. This and other legal issues could weigh on J.P. Morgan in the near term, but the stock remains a Buy and a Long-Term Buy . . . The European Union has approved AstraZeneca's ($48; AZN) Brilinta blood thinner, which still awaits approval in the U.S. The Food and Drug Administration is expected to make its decision Dec. 16. In other news, European regulators are investigating allegations that AstraZeneca colluded to block the sale of generic versions of Nexium, a heartburn drug that generated $3.74 billion in revenue over the past three quarters, 15% of the company's total sales. AstraZeneca is rated A (above average) . . . Groupon rebuffed Google's ($587; GOOG) $6 billion offer for the Website that offers retail deals in more than 300 markets. Google is rated A (above average) . . . Newmont Mining ($63; NEM) unit PT Newmont Nusa Tenggara and Indonesia valued a 7% stake in the unit, set to be sold this year, at $272 million. Newmont is a Focus List Buy and a Long-Term Buy  . . . Leveraging technology acquired through its $7.4 billion takeover of Sun Microsystems, Oracle ($29; ORCL) said its newest server set a speed record for running database software, surpassing hardware made by IBM ($144; IBM) and Hewlett-Packard ($42; HPQ). Both IBM and H-P dispute Oracle's results. Oracle is a Long-Term Buy . . . Seeking to expand its Russian beverage business, PepsiCo ($65; PEP) agreed to buy a 66% stake in Wimm-Bill-Dann Dairy & Juice for $3.8 billion. PepsiCo is rated A (above average) . . . BMC Software ($46; BMC) acquired GridApp, which makes software that manages corporate databases. Terms were not disclosed.  BMC Software is a Buy and a Long-Term Buy . . . The U.S. Treasury, parting with the last of its stake in Citigroup ($5; C), sold 2.4 billion shares for $10.5 billion. The government earned a profit of roughly $12 billion on its $45 billion investment in the bank. Citigroup is rated C (below average).

Rank Changes
Texas Instruments ($33; TXN) is being added to the Focus List. The stock's weighting on the Buy List and Long-Term Buy List is rising slightly. For details, see the linked table.

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