Portfolio Review: June 13, 2016


Mohawk joins Buy, Long-Term Buy lists

Seeking to gain exposure to the improving housing market, we are initiating coverage of Mohawk Industries ($201; MHK) as a Buy and a Long-Term Buy. Mohawk manufactures carpet, rugs, ceramic tile, stone, and hardwood flooring. Cash from operations surged 61% to $1.10 billion in the 12 months ended March, while free cash flow quadrupled to $561 million. Mohawk's annual operating profit margin has expanded in each of the past four years and rose again in the March quarter. Returns on equity and investment have also marched higher. The U.S. represents two-thirds of the company's sales, limiting its exposure to currency fluctuation.

Shares have risen 34% in 2016 and aren't especially cheap at 24 times trailing earnings, in line with the median for S&P 1500 home-furnishings industry. However, Mohawk impressed investors with its March-quarter results and June-quarter guidance. As a result, analyst estimates have jumped, with the consensus now projecting 25% higher earnings per share in the June quarter on 15% revenue growth. For the full year, Mohawk is expected to grow per share profits 20% on revenue growth of 11%.

Airlines' traffic, fares rise

Alaska Air Group ($66; ALK) said traffic rose 11.6% in May. Capacity grew 11.3%, in line with management's expectations for the June quarter. The load factor, an efficiency metric that measures utilized capacity, crept higher to 84.7% from 84.5%. Southwest Airlines ($44; LUV) reported 6.4% higher traffic on 4.6% capacity growth for May. Its load factor climbed to 85.8% from 84.4%. Management has projected 4% to 5% higher capacity in the June and September quarters.

In other news, most U.S. airlines, including Alaska Air and Southwest, matched a $3 price hike by JetBlue ($18; JBLU) for one-way domestic flights in overlapping markets. This represents the sixth successful domestic fare hike in 2016 out of 12 attempts, according to J.P. Morgan Chase ($65; JPM), compared to an 18% success rate from 2013 through 2015. Southwest Airlines is a Focus List Buy and a Long-Term Buy. Alaska Air is a Buy and a Long-Term Buy. J.P. Morgan is a Long-Term Buy. JetBlue is rated Best Buy at sister publication Upside.

Biotech update

Biogen ($254; BIIB) said an experimental multiple sclerosis treatment missed its main and secondary goals in a midstage trial. Biogen had been optimistic that the potential treatment could help improve patients' physical and cognitive function, while also slowing the disease's progression. Analysts had expected the drug to help Biogen revive its portfolio of multiple sclerosis drugs, which has experienced slowing growth. Goldman Sachs ($155; GS) had projected this particular drug could ultimately generate $6 billion in annual sales, though it only gave the drug a 20% chance of success. Shares dropped 13% on the news.

Although the clinical setback is disappointing, Biogen's pipeline of Alzheimer's disease treatments remains promising. The European Union announced in June that it would help Biogen accelerate development of an experimental drug designed to treat early Alzheimer's. Biogen is expected to announce study results for several highly anticipated Alzheimer's treatments in the second half of 2016. Biogen is a Focus List Buy and a Long-Term Buy.

A U.S. judge rescinded a federal jury's ruling that had ordered Gilead Sciences ($87; GILD) to pay Merck ($58; MRK) $200 million in a patent lawsuit. The judge said Merck exhibited a pattern of misconduct during the trial that included its lawyer lying under oath. Gilead also avoids paying Merck royalties on future sales of its hepatitis C drugs. Gilead is a Buy and a Long-Term Buy. Merck is rated B (average).

Tech roundup

F5 Networks ($120; FFIV) took a step toward putting itself up for sale by hiring Goldman Sachs ($155; GS) to gauge interest from potential suitors, according to news reports. F5, a maker of hardware and software products for computer networks, has a market value of $8.2 billion. F5 could prove an attractive acquisition target at a time when many large technology companies are straining to grow.

F5 is projected to increase earnings per share 7% on 4% higher sales in fiscal 2016 ending September, followed by 11% profit growth on 7% higher sales in fiscal 2017. Over the years, F5 has reportedly attracted takeover interest from the likes of IBM ($154; IBM), Oracle ($39; ORCL), and Juniper Networks ($24; JNPR). F5 is a Buy and a Long-Term Buy. Both IBM and Oracle are rated B (average). Goldman is rated C (below average).

Alphabet ($743; GOOGL) is reportedly in advanced talks to sell two robotics businesses to Toyota Motor ($106; TM), which is trying to strengthen its artificial-intelligence division. Separately Alphabet seeks to raise up to $221 million by selling shares in Lenovo, a maker of personal computers based in China. Alphabet is a Focus List Buy and a Long-Term Buy. Toyota is rated B (average).

The U.S. Patent and Trademark Office invalidated two of three patents held by Smartflash, which won a $533 million verdict against Apple ($99; AAPL) in February 2015. Apple had already won a new trial regarding the size of damages, though this latest ruling may help the company avoid paying the penalties altogether. In other news, Tesla Motors ($236; TSLA) CEO Elon Musk says Apple — not Alphabet — looms as the bigger potential competitor in the nascent market for self-driving cars. Musk added that Apple could begin producing electric cars by 2020. Apple is a Buy and a Long-Term Buy.

Corporate roundup

Zootopia is Disney's ($98; DIS) second movie to take in more than $1 billion in global box office sales this year, after Captain America: Civil War achieved the feat in May. Disney is a Long-Term Buy.

FedEx ($165; FDX) hiked its quarterly dividend 60% to $0.40 per share, payable July 1. FedEx is rated B (average).

Verizon Communications ($52; VZ) reportedly plans to bid about $3 billion in an auction to acquire Yahoo's ($37; YHOO) core internet business. As recently as April, Yahoo's online unit was expected to fetch $4 billion to $8 billion. Verizon is rated A (above average).

Rank Changes

Mohawk ($201; MHK) is being added to the Buy and Long-Term Buy lists, which now hold 16.5% and 17.2%, respectively, in the Vanguard Short-Term Corporate bond ($80; VCSH) exchange-traded fund.

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