Portfolio Review


Express Scripts off the Focus List

After reporting solid September-quarter results but a cloudy outlook, Express Scripts ($55; ESRX) is being removed from the Focus List, though it remains a Buy and Long-Term Buy. Excluding special items, per-share earnings rose 29% to $1.02, exceeding the consensus by $0.03. Revenue, boosted by the April acquisition of Medco Health Solutions, jumped to $27.00 billion, versus $11.57 billion in the same quarter last year and the consensus of $27.49 billion.

Despite pricing pressures, profit margins rose, helped by growth in generic prescriptions. But the shares slumped after management called the consensus estimate for 2013 earnings per share — which implies 22% growth — "overly aggressive."  Express Scripts provided no outlook for 2013, though it does see drug utilization continuing to decline. Still, Express Scripts seems capable of leveraging its position as the largest pharmacy-benefit manager in the U.S. into solid profit growth.

Top 15 Utilities change

Cleco ($42; CNL) has no operating momentum, with four consecutive sales declines and two profit declines, and earns a return on equity below that of the average electric utility. Yet the shares have held up well in recent months. Late last month, the company declared September-quarter profits above estimates and raised its guidance. Higher guidance aside, we're not excited about the company's long-term potential. And after a 19% return over the last year, the shares are no longer cheap. Investors should sell Cleco.

Idacorp ($44; IDA) replaces Cleco in the Top 15 Utilities portfolio. In each of the last two quarters, the company grew sales 8% and per-share operating profits at least 82%, topping the profit consensus by more than 18% in both quarters. Despite its strong operating momentum, Idacorp trades below 14 times trailing earnings, 12% below the median electric utility and 18% below its own three-year average P/E ratio. Idacorp can't keep up such torrid growth, but it seems capable of exceeding the market's modest expectations (2% sales growth and 2% lower profits in 2013).

Earnings roundup

CVS Caremark ($47; CVS) grew September-quarter earnings per share 21% to $0.85 excluding special items to top the consensus by $0.01. Revenue advanced 13% to $30.23 billion. Management now believes it can retain at least 60% of prescriptions gained from a contract dispute between Walgreen ($34; WAG) and Express Scripts — up from its prior target of at least 50%. That confidence, combined with a previously announced accelerated stock buyback, prompted CVS to raise and narrow its 2012 outlook for per-share profits. The new profit guidance topped the consensus, implying growth of at least 21%. CVS Caremark is a Focus List Buy and a Long-Term Buy. Walgreen is rated A (above average).

CF Industries ($206; CF) earned $5.85 per share in the September quarter excluding special items, up 13% and $0.15 above the consensus. Sales slipped 3% but also exceeded the consensus. CF expects U.S. farmers to plant 97 million acres of corn in 2013, up from the 96.4 million acres planted in 2012, which had been the biggest planting of the fertilizer-intensive crop in 75 years. With its facilities running close to capacity, CF also announced plans to spend $3.8 billion to expand production at plants in Iowa and Louisiana. The stock rallied on the results and remains a Focus List Buy and a Long-Term Buy.

Chevron ($110; CVX) reported per-share profits of $2.69 per share in the September quarter, down 31% and $0.14 short of the consensus. Profits slumped 17% to $5.14 billion at the upstream business, hurt by softer prices and a rash of maintenance projects and weather- and politics-related well shut-ins that contributed to a 3% slip in production. In other news, plaintiffs from a protracted environmental case in Ecuador announced plans to sue Chevron in Argentina and Columbia, hoping to recover part of a $19 billion verdict awarded in 2011. Chevron has accused prosecutors of bribery and fraud. Chevron is a Buy and a Long-Term Buy.

Exxon Mobil ($91; XOM) said earnings per share fell 2% to $2.09 in the September quarter, easily surpassing the consensus estimate of $1.95. Profit declines of 29% at the upstream business and 21% at the chemicals unit were nearly offset by the refining segment, which more than doubled its income. Total production fell 7.5%. Exxon is a Buy and a Long-Term Buy.

Macy's ($41; M) earned $0.36 per share in the October quarter, implying 13% growth and topping the consensus by $0.06. Total revenue grew 4% to $6.08 billion, while same-store sales climbed 3.7%. For the month of October, Macy's reported 4.1% higher same-store sales to exceed the consensus of 3.1%, even as more than 200 stores experienced some form of disruption from Hurricane Sandy. With consumer sentiment reaching its highest level in more than four years, retailers expect holiday sales to climb 4%, which would mark the fastest holiday growth since 2007, according to a survey conducted by the consultant BDO. Macy's is a Focus List Buy and a Long-Term Buy.

Qualcomm ($60; QCOM) grew September-quarter earnings per share 11% to $0.89 excluding special items, $0.07 above the consensus. Sales surged 18% to $4.87 billion. For the December quarter, management sees per-share profits of $1.08 to $1.16, versus the consensus of $1.00 and $0.97 in the prior year's quarter. The company projects sales will climb 20% to 30%, well ahead of the consensus target of 13% growth. Qualcomm is a Buy and a Long-Term Buy.

Mobile-device update

Apple ($580; AAPL) said it sold 3 million tablets in the debut weekend of its iPad mini and iPad 4, exceeding analysts' expectations and falling in line with initial sales of the iPad 3 in March. Component costs for the iPad mini base model represented an estimated 57% of the tablet's retail price, according to IHS iSuppli. Apple hopes the new products will help protect its dominant position in the tablet market. Apple's share of all tablets shipped in the September quarter fell to 50% from 66% in the June quarter, according to researcher IDC. Apple is a Focus List Buy and a Long-Term Buy.

Components of Microsoft's ($30; MSFT) Surface tablet reportedly cost 44% of the retail price, allowing for a higher gross profit margin than Apple's tablets. Coming off the recent release of Surface, Microsoft is reportedly exploring the production of its own smartphone. Microsoft is a Buy and a Long-Term Buy.

Staff members of the U.S. Federal Trade Commission advised the agency's commissioners to sue Google ($682; GOOG) for allegedly blocking smartphone rivals from using certain patents. The FTC launched a formal probe into Google's practices in June. Google is a Focus List Buy and a Long-Term Buy.

Rank Changes

Express Scripts ($55; ESRX) is being dropped from the Focus List but remains a Buy and a Long-Term Buy. On our Top 15 Utilities portfolio, Idacorp ($44; IDA) is replacing Cleco ($42; CNL).

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