Portfolio Review


Railroad steams onto Long-Term Buy List

Norfolk Southern ($94; NSC), with Quadrix® scores of 96 for Overall and 76 for Value, is being added to the Long-Term Buy List. Norfolk has rallied 6% since posting solid December-quarter results on Jan. 22, but the stock still trades at a discount to the railroad group. Unlike some of its peers, Norfolk has not seen its shipments of coal turn higher yet. But the harsh winter has depleted coal inventories and lifted natural-gas prices, suggesting coal demand from electricity producers in Norfolk's service region should rebound over the next year. More important, Norfolk is streamlining operations as it expands the capacity of its rail network. Helped by increased shipments of crude oil, December-quarter revenue jumped 7%, the best increase since 2011. Operating expenses dropped to 69.4% of sales, down from 73.4% in the year-earlier period. Norfolk, yielding 2.3%, is a Long-Term Buy.

Mutual fund closes

T. Rowe Price New Horizons ($50; PRNHX) is being dropped from our recommended Growth and Conservative Portfolios because it closed to new investors. Current shareholders can still invest in this top pick among small-cap growth funds and should not sell. Taking its place in our recommended portfolios is T. Rowe Price Diversified Small-Cap Growth ($26; PRDSX), which boasts an impressive 97 fund score. The fund, which holds nearly 300 stocks, favors technology (23% of assets) and health care (21%). T. Rowe Price Diversified Small-Cap Growth ranks among the top 20% of its peers for three- , five- , and 10-year returns. An annual expense ratio of 0.91% is below the category average of 1.44%. The fund, which requires a $2,500 minimum initial investment, is up 4.2% so far in 2014.

Earnings reviews

Magna International ($96; MGA) earned $2.03 per share in the December quarter, up 36% and $0.49 above the consensus. Revenue also exceeded expectations, rising 14% to $9.17 billion, Magna's fifth straight quarter of at least 9% growth. Sales from production rose 21% in Asia, 17% in Europe, and 12% in North America. Shares rallied on the results.

Magna said it plans to become more aggressive with its balance sheet, which holds $1.55 billion of cash and just $102 million of long-term debt. Management says the balance sheet can spare about $800 million of excess cash to fund dividends, stock buybacks, and possibly acquisitions over the next two years. Magna also raised its quarterly dividend 19% to $0.38 per share, payable March 28. Stock buybacks shaved 4% from the share count in 2013. Magna is a Focus List Buy and a Long-Term Buy.

Continental Resources ($124; CLR) earned $1.23 per share in the December quarter excluding special items, up 19% though $0.07 below the consensus. Total revenue advanced 19% to $820 million. Continental, the largest lease holder in the Bakken shale formation, said production surged 35% as natural gas rose 44% and crude oil 31%. During the quarter, oil accounted for 70% of production, versus 30% for natural gas.

Management continues to expect organic production to climb 26% to 32% in 2014. Although analyst profit estimates have dipped since the report, Continental still seems capable of generating big growth in 2014, with the consensus projecting 29% higher per-share profits on 25% higher revenue. Continental Resources is a Long-Term Buy.

Technology update

Apple ($531; AAPL) debuted CarPlay, a mobile operating system that integrates the iPhone with the dashboard and speaker systems in Volvo, Mercedes-Benz, and Ferrari vehicles on display at the Geneva International Motor Show. It has also announced CarPlay partnerships with many other automakers, including Ford Motor ($15; F), General Motors ($37; GM), Honda Motor ($37; HMC), and Toyota Motor ($115; TM). In other news, Apple said Luca Maestri, vice president of finance, will become chief financial officer when Peter Oppenheimer retires in September. Apple is a Buy and a Long-Term Buy. Ford, GM, and Toyota are rated B (average).

Skyworks Solutions ($37; SWKS) initiated a quarterly dividend of $0.11 per share, payable in the June quarter. Skyworks' free cash flow has risen in 10 of the past 12 quarters and totaled $397 million, up 64%, in the 12 months ended December. Skyworks Solutions, now yielding 1.2%, is a Focus List Buy and a Long-Term Buy.

Qualcomm ($76; QCOM) raised its quarterly dividend 20% — its fifth double-digit hike in as many years — to $0.42 per share. The dividend payable March 26 will be $0.35, with the new rate taking effect for the following payment, most likely in June. The company also boosted its share-repurchase plan by $5 billion to $7.8 billion, enough to buy back about 6% of outstanding stock at current prices. Qualcomm is a Focus List Buy and a Long-Term Buy.

Corporate roundup

Dover ($79; DOV) spun off its Knowles ($31; KN) unit, distributing one share of Knowles for every two shares of Dover. Knowles makes audio equipment, such as microphones, speakers, receivers, and hearing aids. Knowles generated sales of roughly $1.2 billion last year, or 14% of Dover's total revenue and three-fourths of its communication revenue. Knowles does not yet receive a score in Quadrix, and we do not intend to follow the stock. Investors should sell Knowles.

The spin-off should boost Dover's profit margins and reduce overseas exposure. Engineered systems now account for about 51% of Dover's revenue, followed by energy (31%), printing and identification (14%), and communication technology (5%). Without Knowles, Dover expects earnings per share to rise 7% to 11% this year on revenue growth of 5% to 6%. The stock's trailing P/E ratio is 18 excluding Knowles, a 19% premium to its five-year average though 16% below the median for S&P 1500 industrial-machinery stocks. Dover remains a Long-Term Buy.

Kroger ($42; KR) shares rallied on a report that the grocer may submit a takeover bid for Safeway ($40; SWY), which has already attracted a $9 billion offer from private-equity firm Cerberus Capital Management. Kroger, a Focus List Buy and Long-Term Buy, was expected to report January-quarter results March 6, after our deadline.

Comcast ($51; CMCSa) is reportedly weighing its options to divest about 3 million subscribers should it win approval to complete a proposed $45 billion acquisition of Time Warner Cable ($140; TWC). It could spin off the subscribers into a separate company or sell them to one of several interested rivals. Together, Comcast and Time Warner have about 33 million subscribers. Comcast is willing to divest the subscribers to keep the combined company's assets from exceeding 30% of the U.S. pay-TV market.

The 30% cap set by the Federal Communications Commission no longer has legal meaning, as a federal appeals court has twice invalidated it, most recently in 2009. However, the sale of subscribers is presumably designed to appease the FCC. Comcast is a Buy and a Long-Term Buy.

Rank Change

Norfolk Southern ($94; NSC) is being added to the Long-Term Buy List.

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