Portfolio Review: April 25, 2016


An upgrade and a downgrade

LKQ ($34; LKQ) is being initiated as a Buy and a Long-Term Buy. The company supplies repair shops with recycled and aftermarket auto parts, which tend to cost 20% to 50% less than new parts from the manufacturer. The company operates in a highly fragmented market that tends to exhibit low profit margins. LKQ has leveraged its vast distribution system to establish itself as a reliable source for parts, reducing its need to compete on price. The stock's trailing P/E of 24 and forward P/E of 19 appear high relative to our research universe but slightly below the norm for distributors in the S&P 1500 Index. Moreover, LKQ's outstanding growth profile makes us look past its middling valuation.

LKQ enjoys strong operating momentum, growing per-share profits 12%, sales 7%, and cash from operations 43% in 2015. Looking ahead, the consensus calls for 18% higher per-share profits on 15% revenue growth this year, with estimates trending higher. Scheduled to disclose March-quarter results on April 28, LKQ is expected to report earnings per share of $0.42, up 17%, on revenue of $1.91 billion, up 8%. Admittedly, it's nerve-wracking to buy a stock ahead of earnings, but this risk seems mitigated by rising profit estimates and LKQ's history of exceeding consensus estimates.

We are removing Jones Lang LaSalle ($121; JLL) from the Focus, Buy, and Long-Term Buy lists.The stock has failed to recover as we anticipated after missing the consensus profit estimate for the December quarter. Cash from operations fell 14% in the December quarter, Jones Lang's second double-digit decline in the past four quarters. More troubling, net income exceeded cash from operations in 2015, a signal of poor earnings quality.

The stock's Quadrix Overall score has fallen to 73 and could face more pressure, as per-share-profit comparisons are likely to turn negative. The erosion of analyst estimates over the past 90 days does not inspire much confidence that Jones Lang will begin to grow profits any time soon. Jones Lang LaSalle is being dropped from the Monitored List and should be sold.

Earnings reviews

In the March quarter, F5 Networks ($97; FFIV) grew per-share profits 6% to $1.68 excluding special items, topping the consensus estimate by a nickel. Sales crept 2% higher to $484 million, slightly below the consensus. Looking ahead to the June quarter, F5 targets per-share earnings of $1.77 to $1.80, implying 6% to 8% growth and exceeding the consensus of $1.73 at the time of the announcement. Sales are projected to rise 1% to 3%; analysts anticipated 4% growth.

F5 also increased its stock-repurchase program by $1 billion, equaling about 15% of outstanding shares. The report caused F5 shares to rally in after-market trading. The stock remains a Buy and a Long-Term Buy.

Lam Research ($83; LRCX) reported March-quarter earnings per share of $1.18 excluding special items, down 16% but $0.08 above the consensus. Revenue fell 6% to $1.31 billion, while cash from operations slipped 4%. Lam continues to expect to complete its $10.6 billion acquisition of KLA-Tencor ($73; KLAC) by the middle of the year.

June-quarter guidance, which excludes the KLA deal, topped analysts' expectations for both sales and profits. Management expects profits to climb 9% to $1.63 per share on revenue of $1.53 billion, up 3%. Lam is a Focus List Buy and a Long-Term Buy.

Wells Fargo ($50; WFC) said March-quarter earnings per share slipped 5% to $0.99, surpassing the consensus by $0.02. Total revenue rose 4% to $22.20 billion, also ahead of analyst expectations. Noninterest income increased 2%, driven by 3% growth for mortgage banking. But noninterest expense rose faster, up 4%.

Wells Fargo's provision for credit losses also jumped to $1.09 billion, up 31% from the end of December and 79% from a year ago, reflecting the bank's exposure to energy loans in danger of souring. Net interest margin continued to slide lower. During the conference call, Wells Fargo CEO John Stumpf shot down speculation that the bank may try to acquire a big credit-card company like American Express ($65; AXP). Wells Fargo is a Long-Term Buy. Amex is rated A (above average).

Health-care update

Health reform remains a somewhat rocky experience for managed-care companies. UnitedHealth Group ($134; UNH) said it plans to stop offering health insurance to individuals through the Affordable Care Act in most markets next year. The announcement coincided with management increasing its forecast for losses on the exchanges to $650 million for 2016. UnitedHealth currently sells health coverage on public exchanges in 34 states. Reduced competition could translate into higher premiums for individuals, while boosting profitability for insurers that remain in the markets.

Anthem ($146; ANTM) seeks to raise rates by 16% in Virginia next year, as Humana ($173; HUM) pulls out of the state. Anthem has said its exchange business should become profitable this year, though Aetna ($113; AET) has expressed concern about the sustainability of the exchanges. Centene ($60; CNC) insisted earlier this year that its business from the health exchanges continues to be profitable. Centene is a Focus List Buy and a Long-Term Buy. Aetna, Anthem, and UnitedHealth are rated A (above average).

Shire ($182; SHPG) filed for U.S. approval of a new formulation of Vyvanse, a treatment for attention-deficit hyperactivity disorder, that will come in the form of a chewable tablet. Vyvanse, Shire's biggest drug, accounted for 28% of the company's revenue last year. Shire is a Long-Term Buy.

Corporate roundup

The European Union charged Alphabet ($775; GOOGL) with allegedly abusing Android's dominant market position as a mobile operating system for smartphones. The EU's antitrust case focuses on exclusive contracts that require manufacturers to preload Android applications on smartphones. Alphabet also offered financial incentives to make Google the default search engine on the devices. The EU has also already charged Alphabet with allegedly favoring its own shopping service in online searchers. Alphabet could face fines of up to 10% of its annual global revenue for each charge. Alphabet's sales totaled $74.99 billion last year, with $74.54 billion coming from the Google unit. 

Separately, News Corp. ($13; NWSa) filed a formal EU complaint that accuses Alphabet of copying the content of news articles that are then displayed in its search results, while if publishers don't want their material copied, the links do not show up in search results. In other news, Alphabet prevailed against a group of writers after the U.S. Supreme Court declined to hear a case claiming the company violated copyright laws when it scanned millions of books to make a searchable online database. A lower court had already ruled in favor of Alphabet. The stock is a Focus List Buy and a Long-Term Buy.

Apple ($107; AAPL) launched its new line of 12-inch MacBook laptops, featuring faster processors, longer battery life, and a new color option: rose gold. Amid the slumping market for personal computers, Apple's Mac are holding up fairly well, with shipments creeping 1% higher in the March quarter, according to industry researcher Gartner ($89; IT). Industrywide PC shipments slid 10% last quarter, marking the sixth straight quarterly decline and falling to levels last seen in 2007. Apple is a Focus List Buy and a Long-Term Buy.

CVS Health ($103; CVS) partnered with startup company Curbside to launch CVS Express, a service that lets shoppers buy products through a mobile application, then pick up their purchases about an hour later without leaving their car. Other retailers, such as Target ($83; TGT) and Wal-Mart Stores ($69; WMT) have developed similar curbside-pickup programs to compete with Amazon.com's ($633; AMZN) online-delivery service. CVS is a Buy and a Long-Term Buy. Target and Wal-Mart are rated A (above average). Amazon.com is rated B (average).

Rank Change

LKQ ($34; LKQ) is being initiated as a Buy and a Long-Term Buy. Jones Lang LaSalle ($121; JLL) is being dropped from the Focus, Buy, and Long-Term Buy lists, and from coverage.

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