Portfolio Review: November 9, 2015


Earnings Reviews

For the September quarter, CDW ($46; CDW) reported earnings per share of $0.84 excluding special items, up 31% and $0.04 above the consensus. Sales rose 7% to $3.50 billion, slightly below analyst expectations, as weakness in education and health care detracted from otherwise strong demand from corporate clients. Sales to the health sector were hurt by the recent wave of consolidation within the industry. In August, CDW paid $431 million for its remaining 65% stake in Kelway, a U.K. provider of technology services. CDW says the deal has helped it gain new clients and win more business from existing U.S. customers with international operations. CDW says 2016 profit growth should exceed low double-digits due to the Kelway deal, its recent Dell partnership, and continued strength from corporate clients. The current consensus calls for 13% growth. CDW also hiked its quarterly dividend 59% to $0.1075, as it moves toward a payout rate of 30% of free cash flow over the next five years. CDW is a Focus List Buy and a Long-Term Buy.

Community Health Systems ($29; CYH) reported full results for the September quarter in line with the warning it issued last week. Revenue crept 1% higher, while per-share profits slumped 45% due to lower admissions volumes, rising operating costs, and an unfavorable payer mix. The hospital operator also slashed its 2015 guidance, implying that December-quarter earnings per share will fall anywhere from 2% to 31% on revenue growth of 1% to 5%. The shares remain well off their record high of $64, reached in late June, though they have bounced in the days since the initial drubbing after the warning. Community Health, earning a maximum Quadrix Value rank of 100, remains a Buy and a Long-Term Buy.

CVS Health ($100; CVS) grew September-quarter earnings per share 12% to $1.29 excluding acquisition-related items and other special items, matching the consensus. Revenue advanced 10% to $38.64 billion on 13% growth from pharmacy services and 7% growth from the retail business. Same-store sales rose 1.7%, driven by pharmacy growth. The midpoint of management's December-quarter guidance calls for per-share profits of $1.53, implying 26% growth and ahead of the consensus at the time of the announcement. But investors were disappointed by the initial 2016 profit guidance, which calls for 10% to 14% growth, versus the consensus of 17%. CVS, yielding 1.4%, is a Buy and a Long-Term Buy.

Goodyear Tire & Rubber's ($33; GT) per-share profits rose 14% to $0.99 excluding special items in the September quarter, topping the consensus estimate by $0.02. Despite 1% higher tire volumes, revenue declined 10% to $4.18 billion, primarily due to foreign-currency headwinds. In other news, Goodyear sold $1 billion of debt in order to redeem bonds issued at a higher interest rate. Goodyear, a Long-Term Buy, yields 0.9%.

Merger mania

Skyworks Solutions ($80; SWKS) and Microsemi ($37; MSCC) continue a fiercely contested bidding war for PMC Sierra ($12; PMCS), a company that designs products used in cloud data centers and mobile networks. Skyworks raised its all-cash offer to $2.27 billion, trumping its prior bid of $2 billion and Microsemi's cash-and-stock bid of $2.25 billion. Just hours later, Microsemi bumped its bid to $2.33 billion, which still includes a combination of cash and stock. After evaluating both bids, PMC said it prefers Skyworks' proposal, citing potential volatility with Microsemi shares. Skyworks is a Buy and a Long-Term Buy. Our sister publication Upside rates Microsemi a Buy.

Shire ($218; SHPG) agreed to pay at least $5.9 billion to acquire Dyax ($35; DYAX), a U.S. drugmaker specializing in rare diseases. That purchase price could reach $6.5 billion if an experimental drug being developed by Dyax is approved to treat hereditary angioedema, a potentially lethal inflammatory disease that can impair patients' ability to breathe. Shire says the experimental drug, which has yet to enter late-stage trials, could be launched in 2018 and eventually generate $2 billion in annual sales. Dyax produced $82 million in sales last year but was unprofitable. Shire will fund the deal with debt. Management claims to remain committed to acquiring Baxalta ($35; BXLT), which spurned Shire's previous $30.6 billion offer. The Irish drugmaker may also pursue additional smaller deals. Shire is a Long-Term Buy.

Seeking to expand its presence in the U.S. drugstore market and improve its power to negotiate drug prices, Walgreens Boots Alliance ($87; WBA) announced plans to acquire Rite Aid ($8; RAD) for $17.2 billion including the assumption of debt. That price tag represents a 48% premium to where Rite Aid traded before news of the takeover surfaced. Walgreens expects to complete the transaction in the second half of 2016, though the deal will likely face close regulatory scrutiny.

Together, Walgreens and Rite Aid have more than 17,000 stores, including about 12,700 in the U.S. Walgreens is reportedly willing to divest up to 1,000 stores to win approval from regulators. Top rival CVS operates about 7,900 stores in the U.S., Puerto Rico, and Brazil. A June deal to operate Target's ($77; TGT) in-store pharmacies and medical clinic will give CVS an additional 1,600-plus locations at the cost of $1.9 billion. Due to its large mail-order business, CVS took a 24% share of the U.S. prescription drug-market last year, versus a combined 22% slice for Walgreens and Rite Aid, reported The Wall Street Journal. Walgreens and Target are rated A (above average).

Pfizer ($34; PFE) said it has entered talks to acquire Allergan ($308; AGN), perhaps best known for its wrinkle treatment Botox. Domiciled in tax-friendly Ireland, Allergan generated $13.06 billion in sales last year and currently has a market value exceeding $120 billion. This marks the second time in the past 18 months that Pfizer has explored a transformative takeover that would lower its corporate tax rate by moving overseas. In 2014, Pfizer failed to convince U.K.-based AstraZeneca ($32; AZN) to merge; AstraZeneca rejected a $120 billion bid. Pfizer is rated B (average).AstraZeneca is rated C (below average).

Visa ($78; V) has agreed to acquire Visa Europe for up to $23.4 billion in cash and stock. The two companies split in 2007, ahead of Visa's initial public offering. Visa is rated B (average).

Corporate roundup

Alaska Air Group ($77; ALK) said traffic rose 12.0% in October on capacity growth of 12.9%. Alaska Air is a Focus List Buy and a Long-Term Buy.

Hewlett-Packard completed a spin-off that separated its legacy personal-computer and printer business, now called HP ($14; HPQ), from its corporate-technology business, named Hewlett Packard Enterprises ($14; HPE). Both companies are components of the S&P 500 Index. We will cover both HP and Hewlett Packard Enterprises with ratings of B (average).

J.P. Morgan Chase ($66; JPM) unveiled Chase Pay, a mobile-payment service it plans to launch next year. The service, available to J.P. Morgan's 94 million bank customers, poses the latest threat to Apple's ($122; AAPL) Apple Pay after Alphabet ($755; GOOGL) and Samsung Electronics separately launched digital wallets in September. Both Apple and Alphabet are rated Focus List Buy and Long-Term Buy. J.P. Morgan is a Buy and a Long-Term Buy.

New rules proposed by the Federal Reserve could force Wells Fargo ($55; WFC) to raise about $26 billion in long-term debt, according to The Wall Street Journal. The so-called total loss-absorbing capital measure would require the largest eight U.S. banks to maintain a similar amount of long-term debt as they do capital. This debt would be used to recapitalize big banks in times of crisis, rather than relying on a federal bailout. Wells Fargo is a Long-Term Buy.

Rank Changes

We're making no rank changes today, but we're raising the target weights for every stock on the Buy List and Long-Term Buy List, except for Focus Buys, which already carry extra weight. After the changes, Vanguard Short-Term Corporate Bond ETF ($79; VCSH) accounts for 18.6% of the Buy List and 16.5% of the Long-Term Buy List.

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