Portfolio Review: March 28, 2016


Focus List switch

We always review quarterly profit reports closely to determine whether we must tweak our rankings of top stocks for year-ahead returns. With that in mind, we are removing Jabil Circuit ($19; JBL) from the Focus List and adding Robert Half International ($44; RHI).

Staffing agency Robert Half enjoys strong pricing power and limited exposure to the sluggish banking industry, as the overall U.S. labor market shows steady job growth. Last year Robert Half increased per-share profits 19%, sales 9%, and cash from operations 29%. Free cash flow surged 42% to $256 million in 2015, paving the way for management to hike its quarterly dividend 10% in February. Robert Half has raised its dividend at least 6% every year since initiating the quarterly distribution in 2004.

Robert Half noted favorable trends for flexible staffing in the first few weeks of the March quarter. The midpoint of management's March-quarter guidance calls for 10% higher per-share profits on 8% revenue growth. Shares trade at 16 times trailing earnings, 36% below their five-year average. Robert Half is also a Long-Term Buy.

Jabil shares plunged 11% the day after issuing disappointing May-quarter guidance. Jabil insists that the downturn is temporary and that its roster of new product platforms should help fuel growth in the August quarter. Equally important, the company claims to be gaining share with its largest customer, Apple ($106; AAPL), while also diversifying into health-care products. The stock has yet to show any signs of bouncing back. But at eight times trailing earnings, Jabil's P/E ratio lingers at its lowest level in more than five years and offers an enticing 49% discount to the median S&P 1500 stock in the electronic-manufacturing services industry. We are dropping Jabil from the Focus List, though the stock remains a Buy and a Long-Term Buy.

Banks bank on more buybacks

J.P. Morgan Chase ($60; JPM) said it received the Fed's blessing to repurchase an extra $1.88 billion in stock through June (about 1% of its share count) — on top of its existing buyback plan of $6.4 billion, approved last year. The Fed also cleared Bank of America ($14; BAC) to increase its stock-repurchase plan by $800 million. Shares of both banks rallied on the announcements. Banks' annual capital plans for dividends and stock buybacks are due to the Fed on April 5. Investors might not know the fate of these plans until late June.

In other news, shareholders at J.P. Morgan and Citigroup ($42; C) will vote on separate proposals calling for the banks to break up. J.P. Morgan CEO Jamie Dimon has said the bank's strength lies in its scale and diverse operations. Shareholder proposals rarely get much traction without management's endorsement. J.P. Morgan is a Long-Term Buy. Bank of America and Citigroup are rated A (above average).

Apple's new iPhone and cloud ambitions

Facing the prospect of lower sales for the first time since the March 2003 quarter, Apple ($106; AAPL) unveiled the iPhone SE, a cheaper, smaller model than its flagship iPhone 6S. Prices for the iPhone SE, available in late March, will start at $399, versus $649 for the 6S. With the new device, Apple addresses the midtier smartphone market, which could boost its share in China and India. Nearly lost in all the iPhone buzz: Apple introduced a new iPad Pro smaller than its predecessor model.

Apple took a 15.9% slice of the global smartphone market last year, up from 15.4% in 2014, according to industry researcher Gartner. Samsung commanded a 22.5% share and may be gaining ground, as its latest Galaxy smartphone garnered upbeat reviews earlier this year. Expectations appear modest for Apple's iPhone SE, with suppliers expecting 2016 shipments to reach 15 million units, according to DigiTimes. Apple sold more than 230 million iPhones in the 12 months ended December. With the iPhone 7 expected to arrive this fall, analysts expect iPhone unit sales to slip 6% in fiscal 2016 ending September. Apple is a Focus List Buy and a Long-Term Buy.

In other news, Alphabet's ($758; GOOGL) cloud-based services have reportedly gained new customers in Apple, Disney ($97; DIS), and Home Depot ($130; HD). Apple also uses cloud services offered by Amazon.com ($570; AMZN) and Microsoft ($54; MSFT), though the company plans to invest at least $3.9 billion in data centers to reduce its reliance on third-party cloud providers. Alphabet ranks fourth in the cloud-services market with a 4% share, while Amazon.com has a leading 31% share, says industry researcher Synergy Research. Separately, Alphabet won a deal to offer wireless and broadband internet access in Cuba, according to Reuters. Alphabet and Apple are rated Focus List Buy and Long-Term Buy. Disney is a Long-Term Buy. Home Depot is rated A (above average). Both Amazon.com and Microsoft are rated B (average).

Corporate roundup

Southwest Airlines' ($44; LUV) pilots union has demanded pay raises that would average 4% annually over seven years, giving them the highest compensation in the airline industry. The pilots rejected a tentative contract agreement in November. Southwest Airlines is a Buy and a Long-Term Buy.

Foot Locker ($64; FL) shares fell after key supplier Nike ($62; NKE) gave guidance that fell short of analyst expectations. Nike's per-share profits rose 22% to $0.55, topping the consensus by $0.06, on 8% higher revenue. Nike said global orders for delivery from March to July rose 12%, and it predicts sales for fiscal 2017 ending May will rise by high-single-digits; both targets fell short of consensus projections. Foot Locker purchases about three-fourths of its merchandise from Nike. Foot Locker is a Buy and a Long-Term Buy. Nike is rated B (average).

Health-care update

A U.S. jury ruled that Gilead Sciences ($90; GILD) violated two patents held by Merck ($53; MRK). Merck claimed it originally developed a key ingredient later used in Gilead's hepatitis C drugs Sovaldi and Harvoni. Merck seeks $2 billion in damages and 10% of future sales generated by Sovaldi and Harvoni. While the ruling is disappointing, it should have little effect in the near term; Gilead is likely to appeal. Gilead remains a Focus List Buy and a Long-Term Buy. Merck is rated B (average).

UnitedHealth Group's ($130; UNH) pharmacy-benefit manager OptumRx formed a pact with Walgreens Boots Alliance ($82; WBA) that will allow its members to fill prescriptions at Walgreens pharmacies at lower prices than they would receive at other pharmacies. Rival PBM Express Scripts ($67; ESRX) filled a leading 1.3 billion scripts in 2015, followed by CVS Health ($101; CVS), with 1.2 billion and OptumRx with 1.0 billion. CVS is a Buy and a Long-Term Buy. Express Scripts, UnitedHealth, and Walgreens are rated A (above average).

Rank Changes

Jabil Circuit ($19; JBL) is being dropped from the Focus List but remains a Buy and a Long-Term Buy. Robert Half International ($44; RHI) will replace Jabil on the Focus List.

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