Portfolio Review


ADT adds security to the Focus List

ADT ($42; ADT), initiated in the March 30 issue of the Dow Theory Forecasts and presented as our Analysts' Choice in the April 6 issue, is being upgraded to the Focus List. As the nation's leading provider of security systems for homes and small businesses, ADT enjoys steady growth and a large base of recurring of revenue. Penetration is fairly low in this highly fragmented industry, leaving plenty of opportunity as the economy keeps improving.

In recent years, telephone-service providers have expanded into the security business. With a market value of about $7 billion, ADT could become a takeover target for Comcast ($59; CMCSa) or AT&T ($33; T), especially if their pending acquisitions collapse. However, ADT shares look attractive in their own right.

Drawing on the U.S. for 94% of its revenue, ADT has little exposure to the foreign-currency headwinds that have slowed growth for many of the larger U.S. companies. Customer-attrition rates are improving, and the expiration of a noncompete agreement with former parent company Tyco International ($43; TYC) could juice 2015 results as ADT starts competing for the business of larger companies. Analyst estimates for fiscal 2015 ending September have ticked higher in the past month, with the consensus projecting 4% growth for per-share profits on 5% revenue growth. The consensus appears overly conservative. The stock earns a Value score of 80 despite delivering a three-month return of 20%. Earning an Overall score of 96, ADT is also a Long-Term Buy.

Health-care deals, lawsuits come fast and furious

Although we review our recommended health-care stocks in Sector Spotlight, recent news warrants additional coverage here.

Mylan ($68; MYL) said it was interested in acquiring generic-drug firm Perrigo ($195; PRGO) for $205 per share in a cash-and-stock deal valued at roughly $28.9 billion. That price tag represents a 25% premium to Perrigo's price prior to the announcement. Mylan shares jumped 15% on the news and ended Wednesday with a market value of $27.4 billion. Perrigo said its board will meet to discuss the proposal. The public bid suggests Perrigo has been resisting Mylan's advances, and the U.S. firm may have to sweeten its offer.

Mylan has spent more than $16 billion on acquisitions in the past nine years, contributing to its somewhat stretched balance sheet that includes net debt of $8.08 billion. It also made unsuccessful bids to acquire Actavis ($295; ACT) for $15 billion in May 2013 and Sweden's Meda for $5 billion in April 2014. There have been rumblings that rival Teva Pharmaceutical Industries ($67; TEVA) could be interested in acquiring Mylan. A Perrigo deal may make Mylan too big to eat, but one analyst suggested that Mylan's acquisition efforts could force Teva to make an even more compelling case for a merger. Mylan is a Buy and a Long-Term Buy.

A spurt of patent lawsuits have popped up as generic firms try to grow their business under the banner of the Hatch-Waxman Act, a federal law intended to accelerate the arrival of less-expensive generic drugs.

The hedge fund Hayman Capital Management is challenging the validity of patents for two of Shire's ($247; SHPG) drugs: Lialda and Gattex. Lialda, a treatment for a rare form of inflammatory bowel disease, is Shire's second-biggest seller, accounting for $634 million, or 11%, of the company's revenue last year. Shire acquired Gattex when it paid $5.2 billion for NPS Pharmaceuticals in February. Gattex, a treatment for short bowel syndrome, generated more than $70 million in sales in 2014.

The hedge fund is not the only entity to wrangle with Shire. Mylan will challenge Lialda patents in a trial set for Sept. 1. Shire successfully defended its rights to Lialda in a 2013 lawsuit, and at least two other companies have tried and failed to secure regulatory approval to make a generic version of the drug.

In other news, Shire's stock rallied after the drugmaker announced it will launch a U.S. study for an experimental drug intended to treat attention-deficit/ hyperactivity disorder in adults. Shire hopes to launch the drug in the second half of 2017. Shire is a Focus List Buy and a Long-Term Buy.

Actavis filed an abbreviated new-drug application with U.S. regulators to sell a generic version of Letairis, made by Gilead Sciences ($100; GILD) to treat pulmonary-arterial hypertension. Gilead responded by filing a lawsuit to block Actavis. This is the second challenge Letairis has faced this year, even though its U.S. patent does not expire until 2018. Letairis generated sales of $595 million last year, roughly 2% of Gilead's total revenue. Separately, Gilead filed for U.S. approval to market a new HIV drug. Gilead, which earns a Quadrix Overall score of 98, is a Long-Term Buy.

Corporate roundup

Alaska Air Group ($65; ALK) said traffic rose 11% in March, while capacity grew 12%. The company's load factor, which reflects the proportion of airline capacity actually used, slipped to 86% from 87%. For the March quarter, Alaska Air's capacity grew 11%, in line with management's expectations. Capacity is projected to grow 9.5% for the entire year. Alaska Air, scheduled to report full March-quarter results on April 23, is a Focus List Buy and a Long-Term Buy.

We have seen a plethora of reports on Apple's ($126; AAPL) new products, both announced and rumored. The company began taking preorders for the Apple Watch on April 10 and encouraged perspective buyers to schedule appointments to try on the device at its retail stores rather than waiting in long lines on the launch date. In related news, a trademark filed 30 years ago could block imports of the Apple Watch into Switzerland. Set to expire in December, the trademark prohibits companies from using "apple" to describe any watches or jewelry in the country.

Separately, the European Union is reportedly probing whether Apple's arrangements with record companies for a forthcoming streaming-music service could improperly obstruct rival services. Finally, Apple reportedly wants its TV partners to handle — and fund — the infrastructure required to stream its proposed TV service. Apple is a Focus List Buy and a Long-Term Buy.

The Centers for Medicare and Medicaid Services said 2016 payments for Medicare Advantage will rise about 1.25%. The agency had proposed a rate cut of 0.95% in February. Roughly 17 million people are enrolled in Medicare Advantage plans, says consulting firm Avalere Health, up 7% from a year ago.

Aetna ($107; AET) ended 2014 with 1.1 million Medicare Advantage members, up 18% from 2013 to represent 5% of its total medical membership. UnitedHealth Group ($118; UNH) has 3.0 million Medicare Advantage members, accounting for 7% of its total medical members. However, Medicare Advantage accounts for close to one quarter of revenue for both insurers. Aetna is a Focus List Buy and a Long-Term Buy. UnitedHealth is rated A (above average).

Keeping an eye on Google

We do not love all our picks the same. As we enter earnings season, Google ($549; GOOGL) is among a handful of stocks on an especially short leash. The stock has a Quadrix Overall score of 62, reflecting slowing operating momentum, a middling valuation, and unfavorable estimate-revision trends. Management must also rebuild investor trust, considering Google has missed the consensus profit estimate in five consecutive quarters.

Complicating matters, the European Union's antitrust arm is reportedly preparing to charge Google in coming weeks. Over the last five years, the European Commission has been investigating Google's practices for its online-search business. This would mark the EU's highest-profile antitrust lawsuit since charges were brought against Microsoft ($41; MSFT), which ultimately paid about $1.8 billion in fines. Google is a Buy and a Long-Term Buy. Microsoft is rated B (average).

Rank Changes

ADT ($42; ADT) is being added to the Focus List.

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