Portfolio Review


Rank changes

After delivering a weak earnings report and outlook, Advance Auto Parts ($71; AAP) is being removed from the Buy and Long-Term Buy lists. For the three months ended July 14, the retailer's per-share profits slipped 8% to $1.34 as sales slumped 1% to $1.46 billion, down 1%. The consensus had projected earnings of $1.39 per share on $1.48 billion in revenue. Same-store sales slipped 2.7%, as cautious consumers delayed purchases of maintenance products. Management slashed its 2012 guidance for earnings per share to $5.25 to $5.35, implying growth of just 3% to 5%.

The stock has recovered the ground lost from the sluggish results. But this marks the second disappointing report in as many quarters, and we see more attractive investment opportunities elsewhere. Advance Auto should be sold. The stock is also being dropped from coverage.

Fifth Third Bancorp ($14; FITB) is being added as a Long-Term Buy. With its branches concentrated in the Midwest, the regional bank maintains a sturdy balance sheet and a big base of deposits. On pace to grow annual sales for the first time since 2008, Fifth Third has steadily improved its operating profit margins, and its return on assets has rebounded to pre-recession levels. The pipeline for commercial loans appears solid for the September quarter, and the bank could also get a lift from a housing rebound.

In March, the Federal Reserve vetoed Fifth Third's plan to raise the quarterly dividend, even though the bank passed the regulator's stress test. In June, Fifth Third resubmitted its dividend proposal and expects a response later this month.

Shares trade at 10 times trailing earnings, a 31% discount to the median regional-bank stock in the S&P 1500 Index. The price/book value ratio of 1.0 is well below the 10-year average of 2.0. The stock yields 2.2% and scores above 75 in Quadrix for five of six categories.

Earnings update

Agilent Technologies ($40; A) earned $0.79 per share in the July quarter excluding special items, up 3% but $0.04 short of the consensus. Revenue increased 2% to $1.72 billion, also below the consensus. Orders slumped 1%. Management described a challenging environment where deals are taking longer to close and customers are postponing delivery of orders. For the October quarter, Agilent gave a per-share profit midpoint of $0.81, versus the consensus of $0.93 at the time of the announcement, and a sales midpoint of $1.77 billion, versus the consensus of $1.87 billion. For now, modestly valued Agilent remains a Focus List Buy and a Long-Term Buy.

Cisco Systems ($17; CSCO) grew per-share profits 18% to $0.47 per share excluding special items in the July quarter, squeezing by the consensus by a penny. Sales rose 4% to $11.69 billion, also ahead of the consensus estimate, as both equipment sales and services showed growth. For the fiscal year ended July, operating per-share earnings rose 14% on a 7% sales gain, while cash flow from operations jumped 14%. Cisco hiked its quarterly dividend 75% to $0.14 per share, payable Oct. 24. The company now plans to return at least half of its annual free cash flow to investors through dividends and stock buybacks. The higher dividend equates to a current yield of more than 3.2%. Cisco is a Buy and a Long-Term Buy.

AGCO ($43; AGCO) shares fell after rival Deere ($75; DE) reported mixed July-quarter results and gave a disappointing outlook. Deere grew earnings per share 17% to $1.98 on sales of $9.59 billion, up 15%. The consensus had projected earnings of $2.31 per share on revenue of $9.53 billion. Dry soil conditions caused Deere to cut its industry outlook for farm-machinery sales in both Asia and Europe. AGCO relied on Asia for less than 5% of sales for the 12 months ended June, though Europe, Africa, and the Middle East accounted for 52% of revenue. AGCO, which posted strong June-quarter results on July 26, is a Focus List Buy. Deere is rated A (above average).

Financial roundup

American Express ($56; AXP) said global billings rose 6% in July after adjusting for currency fluctuations, down from 9% growth in the June quarter, as the weak economy continues to weigh on small businesses and corporate spending. American Express added that it likely took share of U.S. billings from MasterCard ($428; MA) and Visa ($130; V) in the first half of 2012. Amex, modestly valued at 13 times trailing earnings, is a Focus List Buy and a Long-Term Buy. Visa is a Buy and a Long-Term Buy. MasterCard is rated B.

J.P. Morgan Chase ($37; JPM) filed restated March-quarter results to reflect trading losses that some of its employees had hidden. As the bank told investors last month, profits fell by $459 million from the previously reported $5.38 billion. The bank conceded that its financial reporting had suffered from a "material weakness" for failing to identify the full extent of the losses earlier. Separately, a U.S. judge gave J.P. Morgan preliminary approval to pay $100 million to settle a class-action lawsuit that accused the bank of improperly raising the minimum monthly payment on thousands of credit-cardholders. A hearing for the settlement is scheduled for November. J.P. Morgan Chase is a Long-Term Buy.

Microsoft update

In the shrinking video-game industry, Microsoft's ($30; MSFT) Xbox took the crown as the top-selling video game console for the 19th straight month, according to researcher NPD Group. The number of Xbox units sold fell 27%, while industry-wide hardware sales slumped 32%. Microsoft could breathe new life into the struggling industry by releasing a new version of the Xbox in 2013, according to Business Insider.

Microsoft is preparing for a critical second half of 2012. The company plans to release its Windows 8 operating system on Oct. 26, fueling speculation that its Windows Phone 8 and Surface tablet could also hit stores around that time. Nokia ($3; NOK) is designing a new Windows-based phone that could launch this fall. Microsoft's move into building tablets has angered some partners, including Acer, though Dell ($12; DELL) and Hewlett-Packard ($19; HPQ) plan to release Windows tablets in late October, reports DigiTimes. During the holidays, a dozen temporary Microsoft stores will pop up across the country. Microsoft shares have treaded water in recent months but a breakout above the April high near $33 would be a bullish development for both the stock and the broad market. Microsoft, trading at 10 times expected current-year earnings, is a Buy and a Long-Term Buy. Dell and H-P are rated B (average).

Rank Changes

Fifth Third Bancorp ($14; FITB) is being initiated as a Long-Term Buy, and Advance Auto Parts ($71; AAP) is being dropped from coverage.

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