Portfolio Review: April 11, 2016


Alaska couples with Virgin America

Alaska Air Group ($80; ALK) outlasted JetBlue Airways ($20; JBLU) in a spirited bidding war to acquire smaller rival Virgin America ($55; VA) for $2.6 billion. That price tag translates to $57 a share for Virgin America, a 47% premium to the stock's close before the announcement and 86% above its price before news of the talks hit the street.

The deal, expected to close by Jan. 1, will make Alaska Air the fifth-largest U.S. airline by traffic. The company expects the deal to boost annual sales 27% and add to earnings in its first year. Virgin America will help Alaska Air expand its presence in San Francisco and Los Angeles, though the two airlines use different types of jets, potentially complicating integration efforts. Virgin America may be obligated to pay Alaska Air $78.5 million if it backs out of the deal.

Alaska Air has a balance sheet unrivaled in the airline industry. Free cash flow more than doubled to $651 million last year, pushing the company's cash hoard to $1.33 billion, versus total debt of $686 million — no other S&P 1500 airline carries more cash than debt on its balance sheet. Still, Alaska Air now plans to cut back on stock repurchases over the next two years as it digests the deal.

Separately, Alaska Air said both traffic and capacity rose 9.2% in March. For the March quarter, Alaska Air expanded capacity 12.9%, below its target of 13.5% growth. Alaska Air is a Focus List Buy and Long-Term Buy. JetBlue is rated Best Buy at sister publication Upside.

In other airline news, Southwest Airlines ($44; LUV) said it will begin offering flights from Long Beach Airport to Oakland on June 5. Southwest won four slots at the Long Beach Airport, which expanded earlier this year. Southwest is a Buy and a Long-Term Buy.

Auto sales tap the brakes

Automakers reported U.S. sales for March that fell short of analysts' expectations. U.S. sales rose 8% for Ford Motor ($13; F) and 1% for General Motors ($30; GM) in March, while falling 3% for Toyota Motor ($100; TM) and 10% for Volkswagen's ($28; VLKAY) namesake-branded vehicles. Despite ramping promotions, automakers are struggling to build on 2015's record results. The annualized sales rate fell to 16.6 million vehicles adjusted for seasonal trends, the lowest level in 13 months.

Automaker shares fell on the results, as did those of auto-parts supplier Lear ($106; LEA), which generated 23% of sales from Ford and 20% from GM in 2015. The U.S. drove much of Lear's growth last year and accounted for 23% of its total revenue. In January, Lear said it expects vehicle production to climb 4% in North America and 3% globally this year. Lear is a Focus List Buy and a Long-Term Buy. Both Ford and GM are rated A (above average). Toyota and Volkswagen are rated B (average).

U.S. erects new barriers on overseas deals

The U.S. Treasury Department unveiled new rules aimed at discouraging U.S. companies from using inversion deals with foreign firms to lower their tax bills. The rules came in stricter than some experts anticipated and have already proved effective. Pfizer ($33; PFE) has scrapped its planned $160 billion merger with Allergan ($245; AGN). To gain the full tax benefits from inverting, a U.S. company's shareholders must own 50% to 60% of the merged company; this prevents big companies from snapping up tiny overseas rivals in order to shift their legal address out of the U.S.

The new rules also seek to curb the practice of foreign companies reaping tax savings by rapidly acquiring multiple U.S. companies. That could present a hurdle for Shire's ($181; SHPG) pending $30.7 billion acquisition of Baxalta ($41; BXLT). In response to the U.S. Treasury's announcement, Shire insists the deal is not an inversion, adding that it still expects the transaction to "proceed as previously announced," with completion slated for the middle of 2016.

Shire, based in Ireland, previously projected that the resulting company would have a tax rate of 16% to 17%, versus Baxalta's current rate of 23.5%, resulting in $260 million in tax benefits by 2020. Some experts have suggested that target may now prove unrealistic, though Shire's latest statement implies otherwise. The deal's break-up fee is capped at 1% of Shire's market value. The Baxalta acquisition has been unpopular with Shire's shareholders, so the stock could get a boost if Shire backs out of the deal.

Additionally, the U.S. Treasury's new laws could make Shire a less-attractive takeover target. Recall, AbbVie ($60; ABBV) abandoned plans to acquire Shire for more than $50 billion in October 2014, shortly after reports surfaced that the U.S. Treasury planned to crack down on inversions. Shire currently has a market value of $35.80 billion; it has spent about $15.3 billion on three acquisitions in the past two years, not including the Baxalta deal. In other news, Shire reported positive trial results for a drug to treat children for attention-deficit/hyperactivity disorder. Shire is a Long-Term Buy. AbbVie is rated A (above average). Pfizer is rated B (average).

Corporate roundup

Gilead Sciences ($97; GILD) won approval from the U.S. Food and Drug Administration to sell a combination HIV drug called Descovy. Gilead says Descovy is as effective as Viread, which generated $1.11 billion in sales (3% of company revenue) last year. However, Descovy uses a lower dose of a key ingredient that can cause serious side effects. Gilead is a Focus List Buy and a Long-Term Buy.

Kroger ($39; KR) made an undisclosed but "meaningful" investment in Lucky's Market, a specialty grocery chain. Lucky's focuses on selling natural and locally grown products at prices below rivals at 17 stores in the Midwest and Southeast. Kroger is a Buy and a Long-Term Buy.

Disney ($97; DIS) announced Chief Operating Officer Thomas Staggs will resign next month. Staggs was widely viewed as the most likely candidate to replace CEO Robert Iger, expected to retire in June 2018. Disney is a Long-Term Buy.

The U.S. filed to block Halliburton ($36; HAL) from acquiring Baker Hughes ($43; BHI) in a $26 billion deal that would combine the second- and third-largest oil-services companies. Halliburton vowed to challenge the lawsuit. Halliburton must pay a $3.5 billion breakup fee if the deal is squashed. Halliburton is rated C (below average).

Walgreens Boots Alliance ($84; WBA) said February-quarter earnings per share advanced 11% to $1.31 excluding special items, topping the consensus by $0.03. Revenue increased 14% to $30.18 billion, missing analyst expectations. Same-store sales, up 2.2%, rose at the slowest rate since the three months ended May 2013. Management raised the lower end of its full-year earnings guidance. The new midpoint of $4.45 implies 15% growth but falls short of the consensus of $4.48. Shares fell on the report. Walgreens is rated A (above average).

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