Portfolio Review


Upgrades and a downgrade

As the last of the September-quarter results filter through Quadrix, we are making several tweaks to our buy lists. Shire ($208; SHPG), profiled as our Analysts' Choice, and Travelers ($103; TRV), featured in Quadrix Spotlight, are being added to the Buy List. Both stocks were already rated Long-Term Buy. Two additional rank changes are discussed below.

Mylan ($56; MYL) is being added to the Long-Term Buy List. One of the largest generic drug companies in the world, Mylan appears nicely positioned for earnings growth over the both the year ahead and the next few years. The company delivered better-than-expected results for the September quarter and guided profit expectations higher for full-year 2014. Analyst estimates have moved broadly higher since the report, with the consensus now projecting per-share earnings will climb 23% to $3.56 for 2014 and 16% to $4.14 for 2015.

In the March quarter, Mylan expects to complete the acquisition of Abbott Laboratories' generic drug business in non-U.S. developed markets — a deal which should allow it to change its headquarters for tax purposes to the Netherlands. Strong cash flow and a solid balance sheet should allow for more deals once the Abbott transaction is completed.

At 14 times the 2015 consensus, Mylan trades at a discount to the pharmaceutical group. In Quadrix, the stock earns a Value score of 55 and scores above 80 for Momentum, Quality, Earnings Estimates, and Performance. Mylan, with an Overall score of 93, is a Long-Term Buy.

UGI's ($37; UGI) stock has risen 28% since we added it as a Long-Term Buy in February (outperforming its sector's median gain of 13%) and 26% since it joined the Buy list in March (12%). In the seasonally light September quarter, UGI lost $0.08 per share excluding special items, in line with results from the same quarter last year. The two-analyst consensus had anticipated a per-share loss of $0.05. Revenue increased 4% to $1.31 billion on 9% growth from the international business and a 5% gain at AmeriGas Propane.

The soft results were mildly disappointing and dragged UGI's Overall score down to 46. The bigger problem is the stock's valuation, especially considering its per-share profits are projected to slip 4% in fiscal 2015 ending September. At 19 times trailing earnings, UGI shares carry a 27% premium to their five-year average and a 4% premium to the median for S&P 1500 utilities. For those reasons, we are dropping the stock from the Buy and Long-Term Buy lists. However, UGI still ranks among our favorite utilities and will remain in the Top 15 Utilities portfolio. The stock should be sold by investors tracking our Buy or Long-Term Buy lists.

Keep flying Alaska

Amid rising competition, Alaska Air Group ($55; ALK) nudged higher its expected capacity growth for the December quarter and now expects 10.5% expansion. However, the company also raised projections for both fuel and non-fuel expenses on Nov. 17. The higher anticipated fuel costs alone equate to at least a $0.03-per-share hit to December-quarter earnings. The new guidance caused at least one prominent analyst to lower his profit estimate for the quarter; in the first two days after the announcement, the per-share-profit consensus fell $0.01 to $0.85, still representing more than 50% growth.

The company's air fares have held up pretty well, even as Delta Air Lines ($44; DAL) encroaches on its turf. Delta said its long-term plans involve operating 30 gates at Seattle-Tacoma International Airport, up from its current 11 gates. The airport is an important hub for Alaska Air, which controls 40% of its traffic. A lot of pessimism already appears reflected in Alaska Air's stock, which trades at 12 times estimated year-ahead earnings, a 17% discount to the average S&P 1500 airline. Alaska Air is a Focus List Buy and a Long-Term Buy.

Halliburton's pricey deal shakes up energy-services market

Halliburton ($48; HAL) agreed to acquire smaller rival Baker Hughes ($64; BHI) for $34.6 billion in cash and stock. That price tag represents a lofty 47% premium to where Baker Hughes shares traded before news of a potential deal first surfaced. In the three days since Halliburton announced the acquisition, its shares have slumped 12%.

Together, Halliburton and Baker Hughes reported sales of $55.52 billion for the 12 months ended September, compared to $47.85 billion generated by Schlumberger ($95; SLB). In the hope of allaying antitrust concerns, Halliburton offered to divest businesses that produce $7.5 billion in annual sales. Regardless, the deal will likely face close regulatory scrutiny.

Analysts estimate that after the acquisition, Halliburton and Schlumberger would control a combined 70% to 90% of the U.S. market for some energy services. Halliburton and Baker Hughes also operate overlapping businesses in several overseas markets, which could trigger additional antitrust reviews. The deal carries a $3.5 billion breakup fee.

We think Halliburton is overpaying for Baker Hughes; the stock's big hit reflects those concerns. Halliburton shares now trade at just 12 times the lowest profit estimate for 2015. The rich breakup fee also carries some risk for Halliburton, though we are inclined to think the deal with Baker Hughes will get done and provide Halliburton with significant cost savings in coming years. Halliburton remains a Buy and a Long-Term Buy. Schlumberger is a Focus List Buy and a Long-Term Buy.

Corporate roundup

Comcast ($54; CMCSa) reiterated plans to acquire Time Warner Cable ($144; TWC). "We are full steam ahead," said Comcast CEO Brian Roberts. His comments helped lift Time Warner shares, battered by President Obama's comments that the Federal Communications Commission should take an aggressive stance in blocking internet providers from allowing web publishers to pay extra for faster internet speeds.

Several big companies — including Ford Motor ($15; F), UPS ($106; UPS), and Visa ($250; V) — are also reportedly lobbying for strict enforcement of the internet. Internet providers risk being reclassified as public utilities, limiting their profit potential at a time when they are making massive investments into upgrading infrastructure.

On Nov. 12, AT&T ($35; T) said it will stop expanding its high-speed internet business until the FCC has established its new rules. Regulators responded by asking that AT&T, which is currently seeking approval to acquire DirecTV ($87; DTV), submit all information regarding its plans to suspend deployment, in particular its estimates for expected profitability of fiber investments. Comcast is a Buy and a Long-Term Buy. AT&T, DirecTV, Ford, Visa, and UPS are rated B (average).

Financial regulators in the U.S., U.K, and Switzerland handed out fines totaling $4.3 billion to six banks after completing an investigation into accusations that traders manipulated foreign-exchange markets. Citigroup ($54; C) agreed to pay $1.02 billion, J.P. Morgan Chase ($61; JPM) $1.01 billion, and Bank of America ($17; BAC) $250 million. J.P. Morgan is a Long-Term Buy. Bank of America and Citigroup are rated B (average).

Rank Changes

Mylan ($56; MYL) is being initiated as a Long-Term Buy. Travelers ($103; TRV) and Shire ($208; SHPG) are being added to the Buy List. UGI ($37; UGI) is being dropped from the Buy and Long-Term Buy List.

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