Portfolio Review: August 17, 2015


2 upgrades and 4 downgrades

Google ($691; GOOGL) is being added to the Focus List. With an Overall score of 86, the stock ranks in the top one-fifth of our research universe for five of six Quadrix categories. The exception is Value, though the stock's trailing P/E of 26 lags the median of 30 for S&P 1500 internet software and services stocks. Google shares got a boost after the company unveiled plans to install a new corporate structure. A new holding company called Alphabet will house its core business, along with long-term projects dubbed "moon shots." Borrowing a page from Berkshire Hathaway's ($142; BRKb) playbook, each subsidiary will have its own CEO who reports to co-founder Larry Page. Splitting out the core business from other projects could improve financial-reporting transparency. Google is also Buy and a Long-Term Buy.

CDW ($39; CDW), already a Buy and a Long-Term Buy, joins the Focus List. CDW, a supplier of hardware and software products, overcame a soft market for personal computers to deliver 20% higher per-share profits in the June quarter on 7% revenue growth. Rising analyst estimates anticipate 25% higher per-share profits in the September quarter and 24% growth in the December quarter; management expects the double-digit growth to continue through 2018. The stock surged on the strong June-quarter report yet trades at a reasonable 15 times trailing earnings, a 20% discount to the median S&P 1500 technology stock.

We are removing Affiliated Managers Group ($203; AMG) from the Buy and a Long-Term Buy lists. The stock's Overall rank has fallen to 71, largely due to eroding operating momentum in the June quarter. Sales rose just 2% and operating profit margins contracted in a challenging quarter for many asset managers. Analysts have trimmed their profit estimates to reflect Affiliated Managers' lower 2015 outlook that came with its June-quarter report. The current consensus estimate for 2015 per share profits is $13.47, implying 18% growth; the midpoint of management's guidance range is $13.40. Given the market's recent downturn, analyst estimates could fall further. The stock is being dropped from the Monitored List and should be sold.

Lam Research ($73; LRCX) is being dropped from the Focus List but remains a Buy and a Long-Term Buy. The Focus List is limited to our very favorite ideas for 12-month returns, and we simply prefer CDW and Google over Lam. The stock's share-price action in the past couple months has proved somewhat disappointing — even as the company delivered strong June-quarter results and bullish guidance for the September quarter. Investors may be concerned by management's comments that shipment growth could slow in the December quarter, but Lam continues to gain share in an industry it expects to expand in 2016. The stock trades at just 14 times trailing earnings, a 29% discount to its five-year average.

Corning ($18; GLW) is being removed from the Long-Term Buy List and is now rated B (average). We had expected the stock to bounce in the days following its June-quarter report, but the share price has broken down further, nearing its 52-week low. Although the stock now trades at just 11 times trailing earnings, profit estimates for the remainder of 2015 are trending lower, hurt by soft glass demand. The stock's Quadrix scores are also eroding, with its Momentum rank now 24 (versus 78 at the end of March) and Overall rank just 61 (89). The stock should be sold.

We are dropping Macy's ($64; M) from the Long-Term Buy List after the retailer posted a disappointing July quarter and cut its outlook for fiscal 2016 ending January. Earnings per share slid 20% to $0.64 in the quarter, missing the consensus by $0.12. Revenue, down nearly 3% to $6.10 billion, also fell short of expectations. Same-store sales slipped 2.1% at company-owned stores, hurt by lower tourist spending and shipment delays at West Coast ports. The retailer maintained its full-year guidance for per-share profits but lowered its guidance for total revenue and same-store sales. The stock has risen 82% since we first recommended it in February 2012, while the S&P 1500 Index advanced 57%. Macy's is now rated B (average) and should be sold.

Top 15 Utilities changes

Today we're adding NextEra Energy ($108; NEE) and Unitil ($36; UTL) to the Top 15 Utilities portfolio, replacing New Jersey Resources ($29; NJR) and Westar Energy ($39; WR).

NextEra, which serves nearly 5 million customer accounts in Florida, has managed impressive growth (sales up 13%, per-share profits 47%) over the last year. That torrid pace won't continue, but analyst profit-growth targets of 7% this year and 9% next year seem somewhat conservative. At 19 times the 2015 estimate, NextEra isn't cheap. However, the growth warrants a premium price.

Unitil has grown operating profits in nine of the last 10 years and sales in eight of the last 10. The consensus calls for sales growth of 5% and per-share-profit growth of 6% this year, followed by gains of 4% and 4% respectively in 2016, hurdles the New England electricity and natural-gas provider may be able to top.

New Jersey's Resources' sales have fallen in five of the last six quarters, and its Quadrix Momentum score has receded to 24. Analysts expect sales to fall this year and next year, with profits down this year and flat next year. Despite its lack of operating strength, New Jersey Resources isn't cheap, trading at 16 times expected year-ahead earnings.

Westar's Overall score of 40 is among the lowest in the Top 15, and its sector-specific scores have also eroded in recent months. Given the company's lack of growth in recent quarters (sales up 2% in the year ended June, per-share profits down 1%), analysts' expectations for 9% growth next year seem too optimistic. Westar's shares have risen 9% over the last three weeks, and we're happy to sell on the strength.

Earnings reviews

A familiar story played out for Magna International ($52; MGA) in the June quarter, as a strong U.S. dollar masked modest production growth. The auto-parts supplier said earnings per share slipped 1% to $1.19 excluding special items to ease past the consensus by a penny. Revenue fell 9% but rose 1% at constant currency. In Europe, Magna's production sales slumped 23% despite a slight increase in the continent's vehicle production. Management raised its full-year sales guidance, with the new midpoint implying a 13% decline, and boosted its 2015 target for operating margin for the third time this year. Magna is a Focus List Buy and a Long-Term Buy.

Nvidia ($24; NVDA) grew per-share profits 13% to $0.34 in the July quarter on sales of $1.15 billion, up 5%. Both results exceeded analysts' expectations. Despite weakness in the personal-computer market, Nvidia is benefiting from solid demand for high-end computers that use its graphics semiconductors for video games. Management expects October-quarter sales of $1.18 billion, down 4% but above the consensus at the time of the announcement. Shares surged to their highest level since February 2011 on the results and guidance. Nvidia is a Long-Term Buy.

Corporate roundup

Alaska Air Group ($79; ALK) announced a new $1 billion share-repurchase plan, equating to about 10% of outstanding shares at current prices. Stock buybacks reduced the airline's share count 6% in the 12 months ended June. Alaska Air is a Focus List Buy and a Long-Term Buy.

Apple ($115; AAPL) says its new streaming music service has gained more than 11 million members.  Apple Music, launched on June 30, remains in its three-month free trial period. Analysts described the initial results as a solid start but far from overwhelming. Apple has reportedly targeted 100 million subscribers. Apple is a Focus List Buy and a Long-Term Buy.

Rank Changes

CDW ($39; CDW) and Google ($691; GOOGL) are being added to the Focus List. Lam Research ($73; LRCX) is coming off the Focus List but remains a Buy and a Long-Term Buy. Affiliated Managers Group ($203; AMG) is being dropped from the Buy List, Long-Term Buy List, and from coverage. Corning ($18; GLW) and Macy's ($64; M) are being dropped from the Long-Term Buy List.

On the Top 15 Utilities portfolio, New Jersey Resources ($29; NJR) and Westar Energy ($39; WR) are coming off while NextEra Energy ($108; NEE) and Unitil ($36; UTL) are going on.

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