Portfolio Review: May 23, 2016


Rank changes

With earnings season nearly complete, we are tweaking our buy lists with several more rank changes.

On the Focus List

Initiated as a Buy and Long-Term Buy in the May 11 hotline, Citrix Systems ($83; CTXS), an application-software maker, is being upgraded to the Focus List. Earning an Overall rank of 96, the stock offers outstanding operating momentum, rising analyst estimates, and encouraging share-price action. Citrix is expected to grow earnings per-share 14% in the June quarter and 15% for the year. At 17 times trailing earnings, the stock trades 19% below the median S&P 1500 application-software stock.

LKQ ($32; LKQ) is being added to the Focus List. A wholesale distributor of aftermarket auto parts, LKQ uses a steady diet of acquisitions to complement organic growth. Annual sales have climbed more than 5% in 14 straight years, a trend expected to extend at least through 2017. Demand for replacement auto parts remains healthy, as more Americans elect to keep older cars on the roads. Analyst estimates have risen over the past 60 days, with the consensus expecting 23% higher earnings per share on 32% revenue growth for the June quarter. LKQ, scoring at least 95 for both sector-specific ranks, is also a Buy and a Long-Term Buy.

Southwest Airlines ($43; LUV) replaces rival Alaska Air Group ($66; ALK) on the Focus List. Southwest scores slightly higher in Quadrix than Alaska Air, and its shares are holding up better in a challenging market for airline stocks. Southwest is projected to grow per-share profits 20% this year, above the average of 13% for its peers in the S&P 1500 Index, on 6% higher revenue. Better yet, shares trade at just 10 times estimated 2016 earnings, a forward P/E ratio that ranks among the lowest 15% of stocks in our research universe.

Southwest recently reversed course on airfares by raising prices for most U.S. one-way flights $3. Several rivals executed similar price hikes. The U.S. airline industry has succeeded in raising fares on domestic flights five times in 2016, according to J.P. Morgan. Southwest also raised its quarterly dividend 33% to $0.10 per share, payable June 29, and approved $2 billion in share repurchases. Southwest, earning an Overall score of 95, was already a Buy and a Long-Term Buy.

Off the Focus List

We are dropping Alaska Air Group ($66; ALK) from the Focus List. Alaska Air's pending $2.6 billion takeover of Virgin America ($56; VA) has added near-term uncertainty to the stock, down 19% since the deal was announced in early April — nearly twice the average decline for S&P 1500 airline shares. Alaska Air CEO Brad Tilden has acknowledged the challenge of preserving Virgin's premium brand and retaining its loyal customers, while also meeting cost-cutting goals. The U.S. has also asked both airlines for more information on the deal, potentially delaying its completion. We still like the acquisition, especially for investors with longer time horizons. Moreover, Alaska Air continues to earn strong Quadrix scores, with an Overall rank of 93. At less than 10 times trailing earnings, the stock trades near its lowest level since 2012. Alaska Air remains a Buy and a Long-Term Buy.

CBRE Group ($28; CBG) is being removed from the Focus List. Recent volatility in global markets has caused investors to fret that CBRE's clients will become more reluctant to pursue real estate transactions. CBRE shares have slumped 18% in 2016, far worse than the 3% dip for the S&P 500 Index Financial Sector Index and flat returns for the broader index. Even after CBRE posted fairly upbeat March-quarter results, the stock extended its decline. Despite disappointing share-price action, CBRE offers strong operating momentum, rising analyst estimates, and a low valuation. For now, CBRE remains a Buy and a Long-Term Buy, though we may further downgrade the stock if it doesn't stabilize soon.

Lam Research ($74; LRCX) is being dropped from the Focus List. Operating momentum slowed in the March quarter, as Lam posted declines of 16% for earnings per share, 6% for sales, 4% for operating cash flow, and 31% for free cash flow. Additionally, the request by U.S. regulators for more information on Lam's proposed $10.6 billion acquisition of KLA-Tencor ($68; KLAC) may add new hurdles to the deal. Yet Lam issued surprisingly bullish guidance for the June quarter, and the stock remains a standout in Quadrix, including an Overall score of 94. Lam, still a Buy and a Long-Term Buy.

On the Long-Term Buy List

EQT Midstream Partners ($75; EQM) transmits and stores natural gas, primarily in Pennsylvania and West Virginia. As a master limited partnership (MLP), EQT could present tax complications; owners of the MLP will receive a Form K-1 at income-tax time. For more on MLPs, visit www.DowTheory.com/Go/MLP. Regardless of the tax issues, EQT and its 4.0% dividend yield should appeal to investors with long-term horizons or those seeking steady income growth. EQT draws its revenue from long-term contracts and usage fees, limiting its direct exposure to fluctuations in commodity prices. It scores above 60 for all six Quadrix categories, contributing to an Overall rank of 98. Already a member of our Top 15 Utilities Portfolio, EQT now joins our Long-Term Buy List.

Off the Long-Term Buy List

Wells Fargo ($49; WFC) is being downgraded from the Long-Term Buy list. We do not like all of our recommended stocks equally, and Wells Fargo has lurked near the bottom of our list for some time. March-quarter results and unfavorable trends for analyst estimates have worsened the outlook. The bank's Quadrix Overall score is just 61, dragged down by Momentum, Earnings Estimates, and Performance ranks that have slipped below 30. Added to the Long-Term Buy List in May 2012 at $33 per share, Wells Fargo should be sold. The stock is now rated A (above average).

Two stocks in the penalty box

Both Gilead Sciences ($83; GILD) and Goodyear Tire & Rubber ($27; GT) reported disappointing March-quarter results, with sales missing the consensus estimates. Yet they reiterated their 2016 guidance. Rather than reassure investors, these moves may have increased concerns that the companies will struggle to boost operating momentum in the remainder of the year. Both stocks have retreated at least 10% since the end of March, lagging S&P 500 Index, which declined 1%. Although Gilead and Goodyear still earn strong Overall scores in Quadrix, their category ranks for Momentum, Earnings Estimates, and Performance have slipped in the past month.

However, the two stocks do have some factors in their favor:

• Biotech's sell-off makes the market for acquisitions more attractive than last year — good news, given rising pressure on Gilead to make a big deal.

• Healthy labor and auto markets appear to be supporting tire demand and could help Goodyear pass higher commodity prices on to consumers.

• Both stocks also look quite cheap, scoring above 90 for Value.

Gilead and Goodyear remain rated Buy and Long-Term Buy.

Nvidia looks more expensive after acing earnings test

Nvidia ($43; NVDA) earned $0.46 per share excluding special items in the April quarter, up 39%. The consensus estimate was $0.32. Sales advanced 13% to $1.30 billion, also ahead of the consensus. Nvidia set the midpoint of its July-quarter revenue target at $1.35 billion, implying 17% growth and exceeding the consensus.

The stock surged on the report to a record high. Nvidia's shares, up 32% on the year, have outperformed all of our other recommended stocks in 2016. But at 24 times trailing earnings, Nvidia trades 29% above the median for S&P 1500 semiconductor stocks. For now, Nvidia remains a Long-Term Buy.

Corporate roundup

A committee for CalPERS, the largest public pension fund in the U.S., recommended awarding its pharmacy-benefits contract to UnitedHealth Group's ($131; UNH) OptumRx. CVS Health ($102; CVS) manages CalPERS' current five-year contract, due to expire at the end of the year. The lost contract, worth about $5 billion over five years, would reduce CVS' 2017 earnings per share by $0.02 to $0.03, estimates one analyst. CVS is a Buy and a Long-Term Buy. UnitedHealth is rated A (above average).

Apple ($95; AAPL) shares rallied after Berkshire Hathaway ($141; BRKb) disclosed that it has acquired a $1 billion stake in the company. Separately, Apple invested $1 billion in Didi Chuxing, a Chinese car-hailing service similar to Uber. Apple is a Buy and a Long-Term Buy.

J.P. Morgan Chase ($64; JPM) raised its quarterly dividend 9% to $0.48 per share, payable July 31. The dividend hike is part of J.P. Morgan's capital-allocation plan approved by U.S. regulators last year. J.P. Morgan is a Long-Term Buy.

Rank Changes

Citrix Systems ($83; CTXS), LKQ ($32; LKQ), and Southwest Airlines ($43; LUV) are joining the Focus List. Alaska Air Group ($66; ALK), CBRE ($28; CBG), and Lam Research ($74; LRCX) are being dropped from the Focus List but retain their Buy and Long-Term Buy ratings. EQT Midstream Partners ($75; EQM) is being initiated as a Long-Term Buy. Wells Fargo ($49; WFC) is being dropped from the Long-Term Buy List.

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