Portfolio Review

8/15/2011


An upgrade and two downgrades

Fertilizer maker CF Industries ($150; CF) is benefiting from a strong spring planting season and persistently low prices for natural gas, a key ingredient in its products. In the June quarter, CF earned $6.87 per share excluding special items, up 137% and 16% above the consensus. The company said low grain supplies should support both unusually high demand this fall and aggressive planting activity in 2012. CF expects historically high prices to continue for the rest of the year, with fat profit margins already fixed through forward sales. The company earns a Quadrix Overall score of 99, supported by scores above 70 in all six categories, and the maximum 100 in both sector-specific scores. Despite CF's growth and fundamental strength, the shares trade at 10 times trailing earnings, a 58% discount to the company's peer group and 40% below its own five-year average P/E ratio. CF is being initiated as a Long-Term Buy.


Medical-device maker Stryker ($49; SYK) has seen both its Quadrix scores and operating momentum erode in recent months. Cash provided by operations has declined year-over-year in four consecutive quarters, with a 40% decline in the six months ended June. Despite that weakness, the stock trades at a premium to the industry average as measured by price/sales, price/book, and price/operating cash flow. Stryker is being dropped from the Long-Term Buy List.


Texas Instruments' ($27; TXN) Quadrix Overall score has dipped to 64, while both of its sector-specific scores have fallen below 45. Sales and profit growth slowed in four consecutive quarters before turning negative in the June quarter. Consensus profit estimates for this year and next year have declined over the last month, and weakness across many facets of the semiconductor market make us less confident that TI can bounce back. TI is being dropped from the Long-Term Buy List.

Top 15 Utilities changes

This week we are making two swaps in the Top 15 Utilities portfolio. TECO Energy ($17; TE) and Westar ($24; WR), which have seen their Quadrix scores deteriorate in recent weeks, no longer seem likely to deliver the type of profit growth we seek. Neither stock is cheap, and subscribers tracking the Top 15 Utilities portfolio should sell TECO and Westar and buy American Electric Power ($35; AEP) and CMS Energy ($18; CMS).

AEP operates 10 utilities serving about 5.3 million customers in the Midwest, the South, and the Appalachians. The company yields an above-average 5.3%, and Wall Street projections for 3% growth in per-share profits this year and next year seem conservative. CMS serves 1.8 million electric and 1.7 million gas customers in Michigan. The combination of a generous 4.7% yield and projected 7% profit growth in 2010 and 2011 suggests solid total-return potential, yet CMS shares trade at a substantial discount to both their peer group and their own history.

June-quarter results

DirecTV ($43; DTV) earned $0.91 per share in the June quarter, versus $0.60 in the year-ago quarter, excluding a stock transaction made by former Chairman John Malone in the year-earlier period. Wall Street had projected per-share profits of $0.85. Revenue climbed 13% to $6.60 billion, powered by 46% growth from DirecTV's business in Latin America. DirecTV added just 26,000 net subscribers in the U.S., down from 100,000 in the same quarter last year, as it conceded market share to phone companies. But Latin America continues to excel, gaining 472,000 net subscribers, up 14%. DirecTV is a Focus List Buy and a Long-Term Buy.


Walter Energy ($76; WLT) shares fell after the coal miner reported per-share earnings of $2.36 excluding special items in the June quarter, up 9% but missing the consensus estimate of $4.07. Although revenue surged 88% to $773 million, it, too, fell well short of analysts' expectations. The company blamed poor weather conditions and difficult geology in Alabama for the disappointing results. The 2011 and 2012 profit consensus estimates have dipped in the wake of the poor quarter and are likely to continue falling. However, Walter shares sold off sharply and now trade at just seven times the lowest 2012 estimate. Walter remains a Focus List Buy.


DISH Network ($23; DISH) said earnings per share rose 32% to $0.75 in the June quarter but missed the consensus by $0.04. The profit shortfall was tied to the loss of 135,000 net subscribers, many lured away by telecommunications companies' aggressive discounts. DISH typically undercuts rivals with low prices, but it departed from that strategy during the quarter as average revenue per user increased 7% to $78.06. Sales, rising 13% to $3.59 billion, slightly topped Wall Street's target. DISH is a Buy.


In the June quarter, Apache ($102; APA) grew per-share profits 31% to $3.22 excluding special items, exceeding the consensus by $0.13. Total production increased 16% to 749,000 barrels of oil equivalent per day on gains of 2% for oil, 27% for natural gas, and 81% for natural gas liquids. Revenue rose 46% to $4.34 billion. Apache also said it made two new oil discoveries in Egypt. The stock is rated a Buy and a Long-Term Buy.

Corporate digest

Kraft Foods ($34; KFT) announced plans to split into two publicly traded companies by the end of 2012. Kraft will spin off its North American grocery operations, a slow-growth business that generates about $16 billion in annual revenue from such brands as Oscar Mayer lunch meat, Maxwell House coffee, and Kraft cheese. The second company will operate Kraft's global snacks business, delivering about $32 billion in annual sales from snacks and confectionary products in the U.S., Europe, and developing markets. Kraft Foods is rated C (below average).


Traffic at Wal-Mart Stores' ($50; WMT) U.S. locations dipped 2.6% from February to June, reported Bloomberg, citing an internal company memo. That equates to 82.8 million fewer visits than Wal-Mart saw in the five-month period last year. Wal-Mart Stores is a Long-Term Buy.

Financials shaken

Shares of U.S. banks tumbled on the first day of trading after Standard & Poor's downgraded the U.S. Treasury's credit and have since recovered only some of those declines. Big banks are better capitalized now than they were during the 2008 financial crisis, and a widespread meltdown seems unlikely. But some of the largest banks still face plenty of problems.

American International Group ($24; AIG) accused Bank of America ($8; BAC) of "massive" mortgage fraud in a new $10 billion lawsuit. In addition, Bank of America's agreement to pay $8.5 billion to compensate for faulty mortgages is being challenged by AIG, New York's attorney general, and other investors who call the settlement too small.

Wells Fargo ($25; WFC) agreed to pay $590 million to settle litigation over mortgage securities. Wells Fargo might also be forced to repurchase $1.8 billion in toxic mortgages, in addition to $2.2 billion in June-quarter claims. Bank of America is rated C (below average). Wells Fargo is rated B (average).

Rank Changes

CF Industries ($150; CF) is being initiated as a Long-Term Buy. Stryker ($49; SYK) and Texas Instruments ($27; TXN) are being dropped from the Long-Term Buy List. We are also slightly lowering the target weights of all recommended stocks, raising Vanguard Short-Term Investment-Grade's ($10.78; VFSTX) to 24.2% of the Buy List and 26.3% of the Long-Term Buy List.


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