Portfolio Review


Two new buys and a downgrade

CA ($28; CA) is being initiated as a Buy and a Long-Term Buy. CA designs security and storage software that helps manage technology infrastructure. Improved sales growth and fatter profit margins have propelled operating income at least 15% higher in each of the last three quarters.

Share buybacks helped lower the share count 4% over the last year and 10% over the last three years. CA raised its quarterly dividend 25% in May — the first hike since 1997 — then followed up with a 400% bump to $0.25 per share in January.

CA topped the consensus per-share-profit estimate by 20% in the December quarter. The consensus for the fiscal year ending March 2012 has since climbed 3% to $2.22 per share, implying 15% growth. The consensus projects 11% growth in fiscal 2013. CA shares have rallied 37% this year yet still trade at just 13 times trailing earnings, 11% below their three-year average.  Yielding 3.6%, CA earns a Quadrix Overall score of 93.

Universal Health Services ($42; UHS) operates more than 231 hospitals, psychiatric-health clinics, and ambulatory surgical centers. In the wake of the November 2010 acquisition of Psychiatric Solutions, more than 85% of Universal's locations focus on behavioral health, a higher-margin business less dependent on government payments than acute care. Going forward, psychiatric services should account for nearly half of Universal's revenue.

In 2011, sales, per-share profits, and operating cash flows all rose more than 35%, as the psychiatric acquisition offset weakness in acute care. Behavioral-care demand remains solid, while acute-care admissions should rise as the economy continues to recover. The consensus projects per-share-profit growth of 11% this year and 14% annually over the next five years, manageable targets for Universal Health Services.

At 10 times estimated year-ahead earnings, the stock trades at an 18% discount to the median health-care facilities firm in the S&P 1500 Index. Universal Health also trades at a discount of at least 27% to its five-year average price/earnings and price/operating cash flow ratios. Universal Health Services, being initiated as a Buy, seems capable of topping $55 per share over the next 12 to 18 months.

BMC Software ($40; BMC) is being dropped from the Buy List and Long-Term Buy List, as the stock no longer ranks among our favorite names in the technology sector. The stock has surged more than 20% so far this year, reflecting bargain-hunting and decent December-quarter results. BMC shares remain quite cheap versus historical norms, but the discount versus industry peers has narrowed considerably.

Recent profit-estimate trends have not been encouraging, and an earnings or sales disappointment for the March quarter would not be a big surprise. The Quadrix Overall score has dropped to 82, with below-average scores for Momentum, Earnings Estimates, and Performance. With better software names available, BMC is being dropped from our buy lists and our Monitored List. 

Health-care update

The Supreme Court is reviewing the universal health-care law that would require all Americans to carry health insurance by 2014 or pay a penalty. One point of contention is whether the federal government can require individuals to purchase a product from a private company. A final decision will likely arrive by July. The Supreme Court has not struck down a major regulatory act from Congress since the 1930s.

Managed-care providers stand to benefit from universal health care, expected to create an estimated 25 million more customers. The composition of Aetna's ($47; AET) medical membership includes 83% on commercial plans and 8% through Medicare; commercial plans represent 75% of UnitedHealth Group's ($55; UNH) medical enrollment, while Medicaid is 10%. The Congressional Budget Office projects $627 billion in new federal spending over 10 years once the law goes into effect in 2014. Insurers have already begun to prepare for the new rules. Aetna plans on spending $50 million to upgrade software and computers to handle the higher workload. Aetna is a Focus List Buy and a Long-Term Buy. UnitedHealth Group is a Buy and a Long-Term Buy.

A study on St. Jude Medical's ($44; STJ) Riata defibrillator leads found multiple defects in two-thirds of the 105 failure reports examined. Defects in the leads — wires connecting a defibrillator to the patient's heart — ranged from melted conductors to accidental shocks and short-circuiting. St. Jude recalled the Riata leads after discovering that the wires are prone to breaking through insulation.

The cardiologist leading the study said, "This is the most difficult and challenging device problem I've seen in 40 years.” But according to one analyst, some doctors are becoming more comfortable using St. Jude's newer Durata lead. St. Jude is a Long-Term Buy.

FCC sends DISH signal

The Federal Communications Commission said it will write new rules to make satellite airwaves easier to convert to land use, indirectly supporting DISH Network ($33; DISH), which seeks a regulatory waiver to do just that. The satellite-TV provider says it plans to offer mobile broadband service, which would probably require a network capable of reaching 30% of the population of its service area within three years and 70% within seven years. Building a network would cost DISH billions, but partnering with an existing wireless carrier could make the project more feasible. The FCC is likely to either approve DISH's waiver or release new rules that open the door for DISH's plans in the next six to nine months. DISH is a Buy and a Long-Term Buy.

Chevron oil spill

Brazilian oil regulator Silvio Jablonski accused Chevron ($107; CVX) of "critical noncompliance” but stopped short of calling the company negligent in the November oil spill. Jablonski added that the spill did not cause any "discernable damage” to the environment but warned that Chevron's drilling contract could be revoked. Brazil's largest oil workers union is also suing the company, seeking to cancel its right to operate in the field where the spill occurred. Chevron is being dropped from the Focus List, partly because of the noise surrounding Brazil but mostly because we see names outside the energy sector as more timely. Chevron, a Buy and a Long-Term Buy, remains one of our favorite energy picks.

Rank Changes

CA ($28; CA) is being initiated as a Buy and a Long-Term Buy. Universal Health Services ($42; UHS) is being initiated as a Buy. Cisco Systems ($21; CSCO) and Macy's ($40; M) are being added to the Focus List. Chevron ($107; CVX) and MasterCard ($431; MA) are being dropped from the Focus List, though they remain Buys and Long-Term Buys. BMC Software ($40; BMC) is being dropped from the Buy List and Long-Term Buy List. Vanguard Short-Term Investment-Grade ($10.74; VFSTX) now accounts for 6.9% of the Buy List and 10.2% of the Long-Term Buy List.

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