Portfolio Review: December 14, 2015


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Kroger rattles off another great quarter

Kroger ($41; KR) earned $0.43 per share in the October quarter, up 19% to top the consensus by $0.04. Total revenue held flat and missed analyst expectations, largely due to lower gasoline prices. Same-store sales excluding fuel climbed 5.4%, Kroger's 48th straight quarter of growth. Management said improving consumer confidence helped boost traffic.

The company expects same-store sales to rise 4.0% to 4.5% in the January quarter. Kroger also raised its full-year guidance for per-share profits to a range of $2.02 to $2.04 from its prior target of $1.92 to $1.98. The consensus projects earnings per share of $0.54 in the current quarter, up 4%. Shares surged to a record high on the news and are now up 28% on the year. Kroger is a Buy and a Long-Term Buy.

Lower fares add baggage to Southwest

Southwest Airlines ($45; LUV) reported 14% higher traffic and 10% higher capacity in November. However, the stock fell after management lowered its December-quarter guidance for a key metric. Operating revenue per available seat mile is now projected to be flat to down 1%; Southwest had previously projected a 1% increase.

The lower outlook suggests weakness in airfares, a noteworthy concern for investors who recall how overcapacity and pricing wars have decimated the airline industry in past years. Pricing had already shown some softness as Southwest entered the December quarter, which some analysts say is consistent with an environment of falling fuel prices. Its average passenger fare dipped 2.4% in the first nine months of 2015 after rising in each of the past five years.

The news prompted some analysts to lower their profit estimates for Southwest, and more may follow suit. The consensus currently calls for December-quarter earnings per share of $0.91, implying 54% growth on 9% higher revenue. Looking ahead to 2016, the consensus anticipates 14% higher profits on 7% revenue growth. Estimates had been trending higher before the announcement.

Yet U.S. airlines should have a firmer grip on pricing than in years past, given that industry consolidation has led the four biggest carriers to control 80% of the domestic air market. Moreover, Southwest stands to reap the full benefit of slumping oil prices.

As of Sept. 30, Southwest did not have any fuel hedges for the December quarter, a shrewd move considering Brent crude oil, the international oil benchmark, dipped below $40 a barrel in early December for the first time since February 2009. Fuel accounted for roughly one-fourth of Southwest's operating expenses in the first nine months of 2015. Southwest Airlines is a Buy and a Long-Term Buy.

Corporate roundup

C.H. Robinson Worldwide ($61; CHRW) raised its quarterly dividend 13% to $0.43 per share, payable Dec. 31. The dividend hike coincides with surging free cash flow, up in eight consecutive quarters, including 85% growth in the 12 months ended September. Management seeks to return 90% of net income to investors through dividends and stock buybacks. C.H. Robinson is a Focus List Buy and a Long-Term Buy.

The cable industry's shrinking subscriber base leaves Comcast ($59; CMCSa) and Disney ($112; DIS) considering other avenues for growth. Comcast CEO Brian Roberts says the company may begin selling smartphones to go along with its wireless service. In October, Comcast invoked an option to sell wireless service on Verizon Communications' ($45; VZ) network and may seek a similar arrangement with Sprint ($4; S). Separately, Disney doubled its stake in Vice, a youth-oriented digital-media company, to $400 million. Comcast is a Focus List Buy and a Long-Term Buy. Disney is a Long-Term Buy. Verizon is rated A (above average). Sprint is rated C (below average).

New heights of merger mania

In the first few days of December, the volume of announced global mergers and acquisitions reached $4.3 trillion, topping the record set in 2007 with nearly a month to spare. Nine deals have been valued at $50 billion or more, while 58 were worth at least $10 billion. U.S. mergers accounted for 49% of total volume, the highest percentage since 1998. Adjusted for inflation, global deals totaled $4.9 trillion in 2007.

The health-care and technology sectors lead the takeover activity, their most notable deals being Pfizer's ($32; PFE) pending $160 billion acquisition of Allergan ($306; AGN) and Dell's proposed $67 billion acquisition of EMC ($26; EMC). Talks of big deals have also spread to other corners of the market. Dow Chemical ($57; DOW) and DuPont ($74; DD) are reportedly in advanced discussions about merging. The two chemical giants have a combined stock-market value of $137 billion. DuPont has also expressed interest in acquiring Syngenta ($78; SYT). Dow, EMC, and Pfizer are rated B (average). DuPont is rated C (below average).

Attention from potential acquirers is not always wanted. Norfolk Southern ($88; NSC) has twice rejected takeover offers from Canadian Pacific Railway ($129; CP). The second cash-and-stock bid was worth roughly $30 billion; Norfolk called it "grossly inadequate." Norfolk is rated B (average).

Jones Lang LaSalle ($161; JLL) agreed to acquire Corrigo, a company that makes cloud-based facility-management products. Jones Lang completed 12 acquisitions in the first nine months of 2015 and has announced or completed at least six more deals since then. Jones Lang LaSalle is a Focus List Buy and a Long-Term Buy.

CBRE Group ($35; CBG) acquired Tax Credit Group, which offers loans and other services to owners of affordable multifamily properties. CBRE is a Focus List Buy and a Long-Term Buy.

Technology update

Apple ($116; AAPL) shares have slipped in recent days, partly due to soft quarterly reports from iPhone-component suppliers, though timing issues may have come into play. Initial production of the new iPhone went more smoothly this year, pushing revenue earlier in the quarter, and Apple also moved up the launch of the device in China. Separately, CBS ($48; CBS) CEO Leslie Moonves confirmed that Apple has temporarily shelved plans to introduce a television service. In August, Apple postponed the service's launch date until 2016. In other product-related news, Apple Watch shipments totaled 3.9 million units in the September quarter to take a 19% slice of the smartwatch market, estimates industry researcher IDC. Apple has not disclosed the device's sales.

Chatter also swirls about Apple preparing to sell a four-inch iPhone early next year, similar in size to its older iPhone 5S model. In other news, Samsung Electronics agreed to pay Apple $548 million in court-ordered damages in connection with a prolonged patent dispute between the two companies. Samsung, with appeals pending, says the issue is far from over. Apple is a Focus List Buy and a Long-Term Buy.

Alphabet ($763; GOOGL) is trying to secure licensing rights to stream movies and television shows on YouTube. YouTube has launched a subscription service, offering ad-free videos and streaming music for $9.99 a month. A licensing deal would put it in closer competition with services offered by Netflix ($124; NFLX) and Amazon.com ($665; AMZN). Alphabet is a Focus List Buy and a Long-Term Buy. Amazon.com is rated B (average).

Rank Changes

No changes were made this week in Dow Theory Forecasts.

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