Portfolio Review: April 18, 2016


Jabil downgraded

Jabil Circuit ($18; JBL) is being removed from the Buy and Long-Term Buy lists. The shares tumbled 11% when management warned last month that May-quarter results would fall well short of expectations. We wrongly thought the stock was due to bounce, given its unusually cheap valuation. But it shows no signs of getting off the mat, falling an additional 6% since the warning, while the S&P 1500 Index has risen 2%.

The Quadrix Overall score has slumped to 62 from 92 at the end of February, a level too low for a Buy-rated stock unless we see specific reasons why Quadrix may be wrong. However, cash from operations has fallen in each of the past two quarters, while analyst estimates continue to deteriorate. We are dropping Jabil from coverage. The stock should be sold.

J.P. Morgan clears low hurdle

J.P. Morgan Chase ($62; JPM) said March-quarter earnings per share declined 7% to $1.35 but topped the consensus of $1.26. Revenue slipped 3% to $24.08 billion, also comfortably ahead of analyst expectations. Trading revenue fell 11% and investment-banking fees 25%, partly offset by a 7% rise in mortgage banking. Although the bank paid no material legal costs in the quarter, it set aside $1.82 billion for loans that may sour, up from $1.25 billion in the December quarter. CEO Jamie Dimon trumpeted the strength of the U.S. consumer and dismissed concerns of a recession this year. J.P. Morgan shares rallied on the report and remain a Long-Term Buy.

Slowing M&A activity puts banks in a bind

U.S. banks continue to weather persistently low interest rates and the prospect of rising loan defaults in the oil patch. The forecast may call for more pain, given the slowdown in corporate deals. The volume of announced mergers and acquisitions in the March quarter that targeted U.S. companies plunged 38% to $245.7 billion, says Thomson Reuters.

Global deal activity totaled $699.4 billion, down 18% from the March 2015 quarter and down 56% from the December quarter, marking the sharpest sequential decline since at least 1980. Thomson Reuters says both full-year 2015 and the December 2015 quarter set all-time highs. March-quarter deal activity was especially strong in the industrials and materials sectors and particularly weak in health care.

The June quarter has gotten off to a rough start on the M&A front. True, Alaska Air Group ($82; ALK) agreed to acquire Virgin America ($55; VA) for $2.6 billion. But Pfizer ($33; PFE) abandoned its $160 billion merger with Allergan ($220; AGN), Canadian Pacific Railway ($150; CP) ended its hostile bid to buy Norfolk Southern ($81; NSC) for $28 billion, and Halliburton's ($38; HAL) pending $26 billion acquisition of Baker Hughes ($41; BHI) may be on the verge of collapse. Pfizer's failed deal alone wiped out roughly $200 million in fees for a group of advisers that included J.P. Morgan Chase ($62; JPM), Goldman Sachs ($160; GS), and Morgan Stanley ($26; MS).

Still, several more deals may be in progress, including:

• Alphabet ($772; GOOGL) is reportedly considering a bid for Yahoo's ($37; YHOO) core online business. Seeking to expand its mobile-video offerings, Verizon Communications ($51; VZ) is also reportedly preparing a bid for Yahoo, due April 18. AT&T ($38; T), Comcast ($62; CMCSa), and Microsoft ($55; MSFT) are unlikely to pursue Yahoo.

• Biogen ($272; BIIB) is reportedly exploring the sale of its hemophilia business, which generated sales of $544 million last year, or roughly 5% of total revenue. Biogen launched hemophilia drugs Alprolix and Eloctate in the U.S. in 2014.

Alaska Air, Alphabet, and Comcast are rated Focus List Buy and Long-Term Buy. Biogen is a Buy and a Long-Term Buy. J.P. Morgan is a Long-Term Buy. Verizon is rated A (above average). AT&T, Goldman, Microsoft, Morgan Stanley, Norfolk, and Pfizer are rated B (average). Halliburton is rated C (below average).

Corporate roundup

Shares of Alaska Air Group ($82; ALK) slipped after the airline updated its guidance for the March quarter. Cost per available seat mile fell about 1% excluding fuel last quarter, missing its prior target of a 1.5% decline. Alaska Air said fuel cost roughly $1.29 per gallon last quarter, down 35% and roughly in line with its guidance of $1.28 per gallon. Fuel usage rose 8.5%, below its original guidance of 11% growth. Passenger revenue per available seat mile fell about 8%. Alaska Air will report its full results on April 21; the consensus expects earnings per share to be up 26% to $1.41 on revenue of $1.34 billion, up more than 5%. In other news, the company's Horizon Air unit agreed to buy 30 jetliners for about $2.8 billion. Alaska is a Focus List Buy and a Long-Term Buy.

Just 11% of U.S. iPhone buyers purchased their devices directly from Apple ($112; AAPL) last year, down from 16% in 2013, according to Consumer Intelligence Research Partners. Wireless carriers took a 76% share of iPhone sales, up from 65%. The report indicates that Apple is expanding the distribution of its iPhone, though profit margins might face some pressure because of the shift. Apple is a Focus List Buy and a Long-Term Buy.

Nvidia ($37; NVDA) sued Qualcomm ($52; QCOM) in London for allegedly using its market dominance to squash Nvidia's mobile broadband-chipset business. In 2011, Nvidia paid $352 million for Icera, a key component of the unit it has been forced to unwind. Nvidia is a Long-Term Buy. Qualcomm is rated B (average).

F5 earnings preview

F5 Networks ($97; FFIV) shares have been roughly flat in 2016, reflecting a muddied outlook for its networking software and hardware products. Management said U.S. enterprise spending softened near the end of the December quarter, as several deals were delayed due to macroeconomic volatility. The networking industry is moving toward cheaper cloud-based applications and away from expensive hardware. Some customers remain uncertain about adopting the newer cloud-based products, contributing to the pause in spending. F5 insists the shift toward the cloud will not hurt gross profit margins, though these applications sell at lower prices, depressing sales.

F5's days sales outstanding has risen in two straight quarters and five of the past six. A key revenue-recognition metric, DSO measures how long it takes a company to get paid. Rising DSO can signal channel stuffing, which essentially steals sales from future quarters. At the same time, F5 enjoys strong momentum for operating cash flow, growing 22% in the 12 months ended December, and free cash flow, up in 11 straight quarters. Operating cash flow consistently exceeds net income, a positive check on earnings quality.

F5 will report March-quarter results on April 20. The consensus expects F5 to deliver per-share earnings of $1.63, up 3% on revenue growth of 3%. Those estimates fall within the range forecasted by management, which conceded at the time its guidance may prove conservative. Encouragingly, foreign-currency trends appeared to have stabilized in the March quarter, benefiting F5's overseas operations (48% of total revenue). Management also claims to be committed to boosting capital returns through opportunistic stock buybacks and possibly launching a dividend. F5 is a Buy and a Long-Term Buy.

Rank Change

Jabil Circuit ($18; JBL) is being dropped from the Buy and Long-Term Buy lists and from coverage. Vanguard Short-Term Corporate Bond ($80; VCSH) exchange-traded fund now accounts for 21.7% of the Buy List and 21.6% of the Long-Term Buy List.

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