Portfolio Review


Utility portfolio swaps two stocks

Today we're replacing two companies in the Top 15 Utilities portfolio.

National Fuel Gas ($73; NFG) boasts strong operating momentum, with sales up 17% and per-share profits 15% in the 12 months ended December. Among S&P 1500 Index utilities, the stock's Quadrix Momentum score of 89 ranks only behind Great Plains Energy ($26; GXP) — another component of the Top 15 Utilities.

National Fuel Gas operates a traditional gas utility but generates about two-thirds of its profits from energy businesses, including an exploration-and-production unit and a midstream business that operates pipelines and storage tanks. The consensus projects profit growth of 7% in fiscal 2014 ending September, and estimates are rising. While the company's P/E ratio is well above the industry average, noncash expenses have depressed profits, and the stock looks reasonably priced based on other valuation ratios.

Otter Tail ($31; OTTR) operates an electric utility in Minnesota and North and South Dakota but collects nearly half of its profits from businesses not commonly connected with utilities. Its manufacturing unit makes metal components for such end markets as vehicles and industrial equipment; a construction segment builds water and power plants; and a plastics business makes PVC pipe.

The broad business base should allow Otter Tail to participate in the economic recovery, and profit estimates are trending higher in the wake of a 30% surprise in the December quarter. However, the company still pays a utility-style dividend, yielding 4.0% after a January hike, the first in six years. The stock trades at 18 times projected 2014 earnings, higher than the typical utility but reasonable considering its appealing combination of profit-growth potential (8% estimated for the year ahead) and dividend yield.

New Jersey Resources ($44; NJR) raised its profit guidance on March 12, causing the shares to jump. However, we are no longer confident in the stock's prospects and advise readers to take advantage of the strength and sell. It earns a Quadrix Overall score of 27, by far the lowest among the Top 15, and sector-specific scores below 5. Massive noncash losses connected with the company's derivatives drag on profits, and while we give such losses less weight than operating losses, the company seems plagued by troubles most of its peers have avoided.

While New Jersey Resources had lagged until March 12, Sunoco Logistics Partners ($84; SXL) has raced too far out in front. The master limited partnership has delivered a three-month return of 23% — nearly twice the return of our portfolio's next-best performer. However, Sunoco wasn't cheap before its run-up, and now its trailing P/E ratio of 26 is nearly twice the five-year average. The consensus projects a profit decline this year, and estimates for both 2014 and 2015 are falling — not the recipe for continued outperformance. The stock should be sold.

Earnings reviews

Kroger ($43; KR) earned $0.78 per share in the January quarter excluding merger-related items, down 11% but $0.06 above the consensus. Excluding an extra week in the year-ago quarter, profits rose 10%. Revenue slid 4% to $23.22 billion, though it rose 5% after adjusting for last year's extra week. Same-store sales increased 4.3% excluding fuel. For fiscal 2015 ending January, management expects profit growth of 10% to 14%, ahead of the consensus at the time of the announcement. On Jan. 28, Kroger completed its $2.5 billion acquisition of Harris Teeter Supermarkets, which should account for about one-fifth of the year-ahead earnings growth.

Kroger did not directly address speculation that it would bid for Safeway ($39; SWY), which agreed to a takeover deal worth more than $9 billion from Cerberus Capital Management. But Kroger implied it is unlikely to make a competing bid because it does not want to risk its investment-grade status and avoids purchasing companies with weak operating results. Safeway's annual sales and cash from operations fell more than 15% in 2013. Alternatively, Kroger could buy some Safeway stores if Cerberus must divest them to satisfy antitrust regulators. Kroger is a Focus List Buy and a Long-Term Buy.

Foot Locker ($46; FL) said January-quarter earnings per share jumped 28% to $0.82 excluding special items, topping the consensus by $0.06. Revenue increased 5% to $1.79 billion, or 10% after adjusting for the year-ago quarter's extra week. Same-store sales grew 5.3%. Analyst estimates for fiscal 2015 ending January surged after management projected double-digit growth in per-share profits on same-store sales growth in the mid-single-digits. Foot Locker said same-store sales rose at a low-double-digit rate through the first five weeks of the April quarter. Following the earnings report, shares rallied nearly 9% to an all-time high but still trade at just 14 times estimated year-ahead earnings, a 17% discount to the median for S&P 1500 apparel retailers. Foot Locker is a Buy and a Long-Term Buy.

United Rentals buys to rent

United Rentals ($90; URI) agreed to acquire privately held National Pump in a deal that includes $765 million of cash and $15 million of stock. The price tag could rise by an additional $125 million should National Pump meet certain milestones. National Pump controls a 15% share of North America's market for specialty pump rentals, which has seen demand rise in response to the shale-gas boom. In the 12 months ended February, National Pump generated $103 million in operating profit.

United Rentals shares surged on the news, continuing a trend for many acquirers in recent months as investors reward companies for putting their balance sheets to work. U.S. companies, undeterred by the run-up in stock prices, announced $336 billion in deals during the first two months of 2014, according to Dealogic, the most since 2000 and up 31% from the same period in 2013. Global deals are off to their fastest start since the financial crisis. United Rentals is a Focus List Buy and a Long-Term Buy.

Corporate roundup

Express Scripts ($79; ESRX) raised its stock-buyback plan by 65 million shares, equaling 8% of its share count. Buybacks reduced Express Scripts' share count by 4% in 2013, with management paying an average price of $65 per share. The stock is a Buy and a Long-Term Buy.

Disney ($81; DIS) signed DISH Network ($62; DISH) to a digital-licensing deal and has reportedly entered talks with DirecTV ($97; DTV) about forging a similar agreement. In the first pact of its kind, DISH agreed to pay Disney for the rights to stream online content through personal computers, tablets, and smartphones, all outside of a pay-TV contract. DirecTV is a Focus List Buy and a Long-Term Buy. Disney is rated A (above average).

Cognizant Technology Solutions ($52; CTSH) completed a two-for-one stock split on March 10. Cognizant is a Focus List Buy and a Long-Term Buy.

Rank Change

We're making no changes to our buy lists. In the Top 15 Utilities portfolio, National Fuel Gas ($73; NFG) and Otter Tail ($31; OTTR) are replacing New Jersey Resources ($44; NJR) and Sunoco Logistics Partners ($84; SXL).

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