Portfolio Review


UnitedHealth buys into Brazilian market

UnitedHealth Group ($57; UNH) agreed to pay $4.9 billion for a 90% stake in Amil Participacoes, the largest health insurer in Brazil, along the way reaping $600 million in tax benefits. Amil has about 5.9 million members and operates 72 hospitals and clinics. It expects to grow sales 15% to $5 billion this year. By comparison, UnitedHealth is projected to increase sales 8% to $109.91 billion. UnitedHealth plans to acquire 60% of Amil's outstanding shares in the December quarter and another 30% in the first half of 2013. The deal should "slightly" boost UnitedHealth's profits next year.

Cuts to reimbursement rates under the health-reform law have pushed large insurers to search for new ways to grow. UnitedHealth is looking overseas, taking a different route than rivals Aetna ($42; AET) and WellPoint ($62; WLP), both of which during the summer announced acquisitions of Medicaid providers.

UnitedHealth said Oct. 8 its per-share earnings will grow at least 24% to $1.45 in the September quarter, well ahead of the consensus estimate of $1.25. The managed-care giant is slated to declare earnings Oct. 16. UnitedHealth Group is a Focus List Buy and a Long-Term Buy. Aetna is a Buy and a Long-Term Buy. WellPoint is rated B (average).

Corporate roundup

Southwest Airlines ($9; LUV) reported a year-over-year drop of 2% in revenue per passenger mile in September and a 1% decline in capacity. The disappointing news caused the airline's September-quarter estimates to continue their descent, and we will closely monitor quarterly results, due out Oct. 18. Earning a Quadrix Value score of 92 but an Earnings Estimates score of just 2, Southwest remains a Long-Term Buy for now.

Macy's ($40; M) said same-store sales rose 2.5% in September, below the consensus of 3.3%. Still, Macy's outpaced the 1.4% average growth for department stores tracked by Thomson Reuters. The retailer's online sales surged 39%. Macy's is a Focus List Buy and a Long-Term Buy.

The Federal Communications Commission let lapse a 20-year-old rule that forced cable companies to share channels with competitors. The exclusivity ban had fostered competition among pay-TV companies, creating opportunities for satellite providers such as DirecTV ($51; DTV) and DISH Network ($32; DISH). Comcast ($35; CMCSa), the largest U.S. content owner, should eventually benefit from the mandate's expiration. But for now, the cable company remains bound by a seven-year content-sharing agreement it accepted in order to take a majority stake in NBC Universal in 2011. The FCC decision does not extend to regional sports networks, which must still be shared. Comcast is a Long-Term Buy. DirecTV is a Focus List Buy and a Long-Term Buy.

Google ($744; GOOG) warned that costs related to restructuring its Motorola Mobility business will reach $300 million to $340 million in the September quarter. Google had previously estimated costs of $275 million when it announced plans to slash 4,000 jobs, about 20% of Motorola's work force. In other news, Google settled with a group of publishers over the digital scanning of roughly 20 million books, allowing the publishers to decide whether to make books available via Google. A lawsuit filed by the Authors Guild seeking $750 for each copyright violation is still ongoing. Google is a Focus List Buy and a Long-Term Buy.

A U.S. attorney from New York has sued Wells Fargo ($35; WFC) over alleged mortgage fraud dating back to May 2001, seeking "hundreds of millions of dollars" for the Federal Housing Administration. Wells Fargo denies the allegations, including that it knowingly underwrote more than 100,000 loans that failed to meet federal guidelines. The bank said its FHA delinquency rates have been below the industry average. Wells Fargo is a Focus List Buy and a Long-Term Buy.

Cisco underappreciated

Size matters. And Cisco Systems ($19; CSCO) is by far the biggest player in the networking-equipment game. According to researcher Infonetics, Cisco controls nearly three-fourths of the global market for routers for large businesses and two-thirds of the market for Ethernet switches. In addition, Cisco is the world's largest provider of networking services, a market projected to generate $25 billion in revenue in 2016, up from $17 billion in 2011. In recent quarters, Cisco has used its size to great advantage, discounting products to grab market share from smaller rivals with less financial flexibility.

The company has cut costs and de-emphasized lower-margin businesses, focusing on its core routing and switching units to make more efficient use of revenue and fatten the bottom line. Operating profit margins, pressured by economic weakness and restructuring from 2008 through 2010, are now trending higher, an impressive feat when you consider the price discounting.

Cisco has rebounded 26% from July lows but remains attractively valued at just 10 times trailing earnings, more than 36% below its three-year average P/E and its peer-group median. For that price, you get some operating momentum.  Over the last 12 months, Cisco's per-share profits rose 19%, while operating cash flow increased 14%. Sales growth, however, has been weak. The 5% growth projected for the October and January quarters would represent the strongest in more than two years.

Still, the consensus calls for profit growth of just 5% in the fiscal year ending July 2013 and 8% in fiscal 2014. Warnings from other technology companies have cast a pall on the sector. During the week before this issue went to press, the 10 largest tech stocks in the S&P 500 Index averaged declines of nearly 3%. However, Cisco is down less than 1%, the best performance of the bunch. Analyst profit estimates have risen over the last 60 days but still understate Cisco's growth potential. Cisco, yielding 3.0% after a 75% dividend hike in August, is a Buy and a Long-Term Buy.

Stick with Apple despite slide

Apple ($636; AAPL) shares have slipped nearly 10% since hitting an all-time high Sept. 21, when the iPhone 5 went on sale. Yet in some respects, Apple's outlook has never looked brighter. Despite problems with a mapping application, the iPhone 5 has garnered favorable reviews and seen robust demand. And new customers flock to the device — by one estimate, 70% of those buying an iPhone 5 this year have never before owned an iPhone. Researcher comScore expects Apple to expand its 17% share of the U.S. mobile-phone market this year.

Reports of component shortages, however, have tempered some expectations. Prices for certain semiconductors are spiking, suggesting a tight market. Further complicating matters, Foxconn, a key supplier based in China, has experienced labor unrest at its factories in recent weeks. The majority of initial iPhone 5 orders were likely delivered in September. But with demand still outstripping supply, shortages could persist throughout the December quarter.

The pullback leaves Apple shares trading at just 15 times trailing earnings, a 31% discount to the five-year average. Should Apple's P/E hold at 15 and the company meet the consensus profit estimate of $53.71 for fiscal 2013 ending September, the stock will rise 27% to $806 in the next 12 months. Apple is a Focus List Buy and a Long-Term Buy.

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