Portfolio Review


Health-care update

Plans by Mylan Laboratories ($31; MYL) to acquire Agila Specialties hit a roadblock when Indian officials postponed their decision on the deal. Officials cited concerns that many of India's facilities that make cancer drugs have fallen into the hands of foreign companies, often leading to higher prices for Indian patients. Agila, a maker of generic injectable drugs, operates six plants in India, two in Brazil, and one in Poland; a tenth facility is under construction in Singapore.

When Mylan announced in February its intent to pay at least $1.6 billion for Agila, it set a completion date for the end of this year. A deal still seems possible, though Mylan may be forced to give concessions on pricing, as well as the supply of drugs to India.

Agila would accelerate Mylan's expansion in other emerging markets, particularly Brazil (more than 25% of Agila's sales). It would also boost Mylan's nascent presence in India, a $13 billion market growing 14% a year. Looking ahead to Mylan's June-quarter report, the consensus expects earnings per share of $0.67, up 12%, on 3% higher sales. Mylan shares trade at 11 times trailing earnings, a 33% discount to the median for S&P 1500 pharmaceutical stocks and 41% below its own five-year average P/E. Mylan is a Focus List Buy and a Long-Term Buy.

The Obama administration extended until 2015 the deadline for large companies (more than 50 employees) to offer health insurance to their workers. Under the Affordable Care Act, companies will face penalties of up to $3,000 per employee for failing to offer comprehensive insurance.

With more than 90% of large employers already offering insurance, the direct impact of postponing this particular component is somewhat muted. But the delay underscores the logistical challenge of implementing the massive legislation and the uncertainties facing health-care companies — especially insurers as states scramble to roll out their health exchanges. Both Aetna ($63; AET) and UnitedHealth Group ($68; UNH) have bowed out of California's individual exchange. Cigna ($75; CI) has minimal exposure to the individual insurance market and plans to participate in exchanges for just five states. Cigna is a Long-Term Buy. Aetna is rated A (above average). UnitedHealth is rated B (average).

Abbott Laboratories ($35; ABT) pledged to lower prices of its baby-formula products by 4% to 12% in China, hoping to appease government officials who launched a probe into pricing practices used by foreign companies. Other makers of baby formula have announced similar price cuts. Abbott Laboratories, yielding 1.6%, is a Long-Term Buy.

Corporate roundup

Kroger ($37; KR) shares rose after the company agreed to pay about $2.5 billion for Harris Teeter Supermarkets ($49; HTSI), a high-end supermarket chain that operates 212 stores, mostly in the southeastern U.S. That bid translates to $49.38 per share, just a 2% premium to Harris Teeter's price prior to the announcement, though the chain's shares have risen about 30% since reports surfaced in January that the company had put itself up for sale.

Harris Teeter generated $4.54 billion in sales last year, versus Kroger's $96.75 billion. Kroger expects the deal, its largest since 1999, to boost earnings per share by $0.06 to $0.09 in the first full year following completion. Kroger plans to finance the deal — which includes the assumption of about $100 million of Harris Teeter's debt — by issuing its own debt. Kroger plans to reduce but not eliminate its share-buyback program. Kroger, reviewed at greater length in our Sector Spotlight, is a Focus List Buy and a Long-Term Buy.

Seeking to enhance its internet presence, DirecTV ($62; DTV) ranked among the three highest bidders for Hulu, an online video service owned by Comcast ($43; CMCSa), Disney ($65; DIS), and News Corp. ($16; NWSa). A group led by AT&T ($36; T) was also among the top bidders. Details of the bids weren't released, though Hulu is reportedly valued at more than $1 billion.

Hulu generated about $700 million in sales last year, drawn from both advertising revenue and monthly fees for its premium streaming services. DirecTV could leverage existing retransmission contracts by bundling Hulu with its pay-TV services. Hulu has not announced a winner yet, as it must negotiate deals involving not just the purchase price, but also licensing terms. An agreement could be struck in the next couple of weeks. DirecTV, reviewed in more detail in our Sector Spotlight, is a Focus List Buy and a Long-Term Buy. Comcast is a Long-Term Buy. Disney is rated A (above average). News Corp. is rated B (average). AT&T is rated C (below average).

B/E Aerospace ($66; BEAV) shares have risen 8% over the last two weeks, posting an all-time closing high July 9, lifted in part by positive developments in the aerospace industry. Boeing ($105; BA), a key customer of B/E Aerospace, said airplane deliveries rose to a 15-year high in the June quarter. To keep pace with strong demand, Boeing has boosted production of its 737 jet, with plans to step up production again in 2014.

Separately, the National Transportation Safety Board's investigation into the Boeing 777 that crashed in San Francisco appears to indicate pilot error rather than an equipment malfunction. However, the NTSB says it has released facts rather than conclusions, and that the probe is ongoing. B/E Aerospace is a Focus List Buy and a Long-Term Buy. Boeing is rated A (above average).

A U.S. judge ruled that Apple ($422; AAPL) illegally fixed prices on electronic books with five U.S. publishers. The company faces a separate trial to determine damages in a lawsuit filed by attorneys generals in 33 states. Apple plans to appeal the federal ruling. Apple is a Buy and a Long-Term Buy.

Financial review

The Federal Reserve plans to adopt several measures designed to insulate U.S. taxpayers from a bailout of large U.S. banks in the event of another financial crisis. One such proposal would require the eight largest U.S. banks to hold capital equaling at least 5% of assets, while their banking units would have to hold 6% of assets.

Global regulators currently require a leverage ratio of 3%. The eight banks currently fall a combined $63 billion short of the 5% leverage ratio; only Bank of America ($14; BAC) and Wells Fargo ($43; WFC) appear to satisfy the proposed threshold. J.P. Morgan Chase ($55; JPM) may face the largest shortfall among these banks, but it should be able to manage higher capital requirements, given its massive scale.

While the new rules would help banks absorb losses from another financial crisis, they could also limit profitability, dividend growth, and stock buybacks.

In other news, a U.S. judge approved J.P. Morgan Chase's plan to pay $546 million in a settlement stemming from the bank's connection with MF Global's failed broker-dealer unit. In other news, J.P. Morgan expanded in Iraq, signing a one-year contract to help the Trade Bank of Iraq fund imported goods and services. Both J.P. Morgan Chase Wells Fargo are Focus List Buys and Long-Term Buys. Bank of America is rated B (average).

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