Portfolio Review: November 30, 2015


Foot Locker keeps its edge

In the days leading up to the October-quarter report, Foot Locker's ($65; FL) investors braced for the worst. The stock had slumped 23% from its record high, set in late September, as a barrage of bad results from apparel retailers revealed uneven growth within the U.S. retail industry.

Foot Locker put those concerns to rest after it said per-share earnings surged 20% to $1.00 excluding special items, topping the consensus by a nickel. Despite stiff foreign-currency headwinds, total revenue advanced 4% to $1.79 billion, narrowly ahead of the consensus estimate. Same-store sales, which exclude effects of the U.S. dollar, rose 8.7% on broad strength across all geographies and product categories. Accelerating demand for running and casual shoes helped offset slowing growth in basketball footwear. Store traffic continued to decline in the U.S. but rose overseas. Foot Locker also noted higher prices for both apparel and footwear.

The company said same-store sales growth through the first few weeks of the January quarter is trending toward the high end of mid-single-digits. Shares rallied on the results, yet still trade at 16 times trailing earnings, a 7% discount to the median S&P 1500 Index retailer. Foot Locker is a Focus List Buy and a Long-Term Buy.

Health reform enters winter of discontent

Facing mounting losses from its participation in President Obama's health reform, UnitedHealth Group ($113; UNH) cut its 2015 outlook, slashed marketing efforts for individual health plans this year, and threatened to pull out of the public health exchanges altogether in 2017. UnitedHealth expects to lose about $700 million in 2015 and up to $500 million next year on health plans that are part of the Affordable Care Act (ACA) and sold through state or federal exchanges. It says those who have signed up for the plans tend to use more medical care, while others abruptly drop coverage after receiving expensive medical procedures.

UnitedHealth's current tone stands in sharp contrast to comments made in October, when management said it planned to offer ACA plans in 11 more states in 2016, expanding its total to 34. But it echoes comments made by HCA Holdings ($69; HCA), which unexpectedly reported a surge in uninsured patients in the September quarter — though that problem was far less pronounced at rival Community Health Systems ($29; CYH).

The problems may be specific to UnitedHealth. Rivals Aetna ($106; AET), Anthem ($132; ANTM), and Centene ($57; CNC) reaffirmed their 2015 guidance and commitment to health reform. The health exchanges have yet to be profitable for Aetna and Anthem, though Aetna has expressed optimism that things will improve next year. In October, Centene said its exchange business has exceeded expectations for both 2014 and 2015. Centene generates more than 80% of revenue from Medicaid, which may be an advantage considering it gets higher federal subsidies from serving low-income customers.

Demand for ACA plans appears solid, with initial enrollment for 2016 plans running at a faster pace than last year. Moreover, financial penalties for individuals who forgo coverage will keep escalating in 2016. Finally, Anthem, Aetna, and Centene — unlike UnitedHealth — are making large acquisitions that could help improve efficiency in the brave new world of health reform.

Shares of health insurers and hospital operators have rebounded in the days since UnitedHealth's warning. We will be paying close attention to Centene's 2016 outlook, scheduled for Dec. 18. Centene and Community Health are rated Buy and Long-Term Buy. Aetna, Anthem, and UnitedHealth are rated A (above average). HCA is rated B (average).

Technology update

Alphabet ($770; GOOGL) tapped VMware ($60; VMW) co-founder Diane Greene to head up its cloud-computing business. Despite building one of the most powerful networks of data centers, Alphabet has just a 6% share of the cloud-computing market, lagging Amazon.com ($671; AMZN) and Microsoft ($54; MSFT). In other news, Alphabet plans to launch its application store in China next year, which would mark its first major presence in the country since 2010. Alphabet is a Focus List Buy and a Long-Term Buy. Amazon.com, Microsoft, and VMware are rated B (average).

Apple ($119; AAPL) reportedly plans to bring mobile-payment service Apple Pay to China by early February after forging deals with country's four biggest state-run banks. Apple is a Focus List Buy and a Long-Term Buy.

CDW ($44; CDW) announced plans for a secondary offering of up to 9.2 million shares at $44.05 a share. Two large shareholders have gradually sold off their stakes in CDW since taking the company public in July 2013. CDW, which will not receive any of the proceeds of the offering, is a Focus List Buy and a Long-Term Buy.

Takeover rumblings

Pfizer ($32; PFE) and Allergan agreed to merge in a deal that values the combined company at $160 billion. The deal will be structured so that Pfizer is acquired by its smaller rival, in order to move its headquarters to tax-friendly Ireland. Pfizer will exchange 11.3 shares for each Allergan share, valuing Allergan at $364 a share, or a 23% premium to Allergan's level before news of the potential deal first surfaced on Oct. 28. Pfizer investors can opt to receive cash in lieu of stock in the combined company. Allergan is perhaps best known for its anti-wrinkling treatment Botox. The resulting company will retain Pfizer's name and ticker PFE. Pfizer is rated B (average).

Canadian Pacific Railway ($146; CP) offered to acquire Norfolk Southern ($95; NSC) for more than $28 billion. Norfolk appeared cool to the proposal, prompting Canadian Pacific's CEO Hunter Harrison to say he's willing to sweeten the deal. A merger between the two railroads would draw close scrutiny from regulators and could spur further consolidation within the industry. Norfolk is rated C (below average).

Cisco Systems ($27; CSCO) agreed to pay $700 million to acquire Acano, a company based in the U.K. that makes video-conferencing products. The deal continues Cisco's push into the conferencing industry; it has spent a combined $6.5 billion on two other deals in the space since 2007. Cisco expects 25% of corporate conference rooms around the world to be connected for video 10 years from now, up from 10% today. Cisco Systems is a Long-Term Buy.

Skyworks Solutions ($80; SWKS) ended its pursuit of PMC-Sierra ($12; PMCS) after smaller rival Microsemi ($34; MSCC) raised its takeover offer to $2.5 billion in cash and stock. Skyworks' last bid totaled $2.24 billion in cash. Skyworks stands to collect a termination fee of $88.5 million from PMC. Skyworks is a Buy and a Long-Term Buy. Microsemi is rated Buy at our sister publication Upside.

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No changes were made this week in Dow Theory Forecasts.

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