Portfolio Review: July 11, 2016


Rank changes

We continue to tweak our buy lists ahead of the June-quarter earnings season. This week we are making the following rank changes:

Four upgrades

D.R. Horton ($33; DHI) is being added to the Focus List. The company is a key player in the fast-growing — and highly volatile — home-construction market. Operating in 27 states, D.R. Horton has a presence in most major U.S. geographic regions outside of New England, with its greatest exposure to southern states. D.R. Horton says its backlog reached $4.1 billion at the end of March, up 14% from a year earlier and equating to about 36% of 12-month sales. In May, management gave upbeat comments about its spring selling season. The stock, earning an Overall rank of 97, is also a Long-Term Buy.

Laboratory Corp. of America ($132; LH), reviewed as the Analysts' Choice in the July 4 issue (accessible at www.DowTheory.com/Go/July4), joins the Focus List. Looking ahead, the improving U.S. economy and favorable demographic trends should bolster demand for the company's laboratory services. The consensus forecasts 10% higher profits in the June quarter and 11% growth this year and next year. LabCorp trades at 16 times trailing earnings, 24% below the median P/E ratio for S&P 1500 Index health-services stocks. LabCorp is also a Long-Term Buy.

EQT Midstream Partners ($78; EQM) is being added to the Buy List. EQT Midstream transports and stores natural gas drilled in the Marcellus and Utica shale formations. The stock has rallied 4% since we added it to the Long-Term Buy list in May. Analyst estimates are also rising, with the consensus projecting 3% profit growth in the June quarter on 19% higher revenue. With a Quadrix® Overall score of 95, EQT Midstream is also a member of our Top 15 Utilities Portfolio.

We are upgrading McKesson ($192; MCK) to a Long-Term Buy. As the largest U.S. pharmaceuticals distributor, McKesson parlays its massive scale into deep price discounts for customers. Nationwide, spending on drugs continues to rise, due to the aging of the U.S. population and the expansion of health coverage by the Affordable Care Act.The stock earns a Value rank of 77 and an Overall rank of 94. In late June, McKesson increased its earnings-per-share guidance for the fiscal year ending March 2017. The midpoint of the new range is $13.68, up from $13.55 and implying 13% year-over-year growth. McKesson was previously rated A (above average).

Four downgrades

Alphabet ($709; GOOGL) is being dropped from the Focus List. The stock earns an Overall score of 63, far below what we like to see in a Focus List stock. Troubles brewing overseas have added some risk in recent weeks. Alphabet's advertising business may soon face antitrust charges brought by the European Union. European countries have also increased their scrutiny of Alphabet's tax practices; Spanish authorities raided Alphabet'soffices in Madrid just a month after the company's headquarters in France was searched. We still view the stock as capable of generating solid returns over the next 12 to 48 months. Alphabet grew earnings per share, revenue, and cash from operations at least 10% in the 12 months ended March. Alphabet remains a Buy and a Long-Term Buy.

Biogen ($247; BIIB) is being removed from the Focus List but remains a Buy and a Long-Term Buy. Although we still like the stock, it no longer ranks among our top picks for 12-month returns. The stock plunged in June on news that an experimental treatment for multiple sclerosis failed a midstage trial. Shares have continued to drift lower in the past month. Yet analyst-estimate trends remain encouraging. The stock trades at less than 14 times trailing earnings, its lowest level since 2010.

As discussed in the May 23 issue (www.DowTheory.com/Go/May23), when we dropped CBRE Group ($25; CBG) from the Focus List, we were looking for the stock to stabilize. That hasn't happened. The shares plunged in the days immediately following the U.K.'s vote to leave the European Union. Unlike most stocks, CBRE has failed to rebound.

The company has fairly high exposure to the U.K., generating nearly 18% of its 2015 revenue there. Uncertainty over the ramifications of Britain's exit could delay commercial real estate deals, adding risk that CBRE could miss the 2016 guidance it reaffirmed in late April. Analysts have begun to ratchet estimates lower. CBRE is being dropped from the Buy List, the Long-Term Buy List, and the Monitored List. The stock should be sold.

We are removing Skyworks Solutions ($59; SWKS) from the Buy and Long-Term Buy lists.  As noted in last week's issue, Skyworks' fate is closely intertwined with its largest customer, Apple ($96; AAPL). In the first few days of July, multiple Apple suppliers reported disappointing sales for June, signaling weak orders for the iPhone 6S. Suppliers have also indicated that Apple is being unexpectedly cautious in ramping production for its forthcoming iPhone 7. 

These developments could further impede Skyworks' operating momentum, which already shows signs of slowing. Cash from operations rose 29% in fiscal 2015 ended September but fell 7% in the first half of fiscal 2016. The stock is down 47% from its June 2015 record high, but up 127% since we first recommended it in November 2013. We are dropping Skyworks from coverage. The stock should be sold.

Auto sales get off track

U.S. automobile sales slipped to a seasonally adjusted annual pace of 16.67 million vehicles in June, the lowest level in at least 13 months. Analysts had expected an annualized sales rate of at least 17 million vehicles. Sales fell 2% for General Motors ($28; GM) and 6% for Toyota Motor ($100; TM), while Ford Motor ($13; F) reported 6% growth. Weakness was concentrated in smaller cars, while trucks and SUVs experienced stronger demand. Ford and GM are rated A (above average). Toyota is rated B (average).

The disappointing U.S. sales and the U.K. referendum have weighed on Lear's ($101; LEA) stock, down 15% since May. Lear relied on Europe and Africa for 37% of revenue last year, and its sales are evenly split between parts for cars and light trucks. The stock trades at just eight times the lowest 2016 estimate of $12.11, which implies 12% growth. The median stock in the S&P 1500 auto-parts industry trades at 12 times consensus 2016 earnings. Lear remains a Focus List Buy and a Long-Term Buy.

Corporate roundup

Apple ($96; AAPL) has entered negotiations to acquire the music-streaming service Tidal, which claims to have more than 3 million paying subscribers. Apple Music has about 15 million paying subscribers, second to Spotify's 30 million. Sales of digital music grew 10% to $6.7 billion last year, with subscription services accounting for 32% of revenue, up from 23% in 2014. Apple is a Buy and a Long-Term Buy.

Alaska Air Group ($59; ALK) reported 10.9% higher traffic in June on capacity growth of 11.7%. Alaska Air is a Buy and a Long-Term Buy.

Hoping to offset ESPN's shrinking subscriber base, Disney ($98; DIS) agreed to purchase a 33% stake in MLB Advanced Media's video-streaming unit. The deal values the business at roughly $3.5 billion. Disney has an option to buy an additional 33% stake in the business, which encompasses Major League Baseball's digital operations, over the next four years. Disney is a Long-Term Buy.

Rank Changes

D.R. Horton ($33; DHI) and Laboratory Corp. of America ($132; LH) are being added to the Focus List. Alphabet ($709; GOOGL) and Biogen ($247; BIIB) are being dropped from the Focus List, though they remain Buys and Long-Term Buys. EQT Midstream Partners ($78; EQM) is being added to the Buy List, and McKesson ($192; MCK) is joining the Long-Term Buy List. CBRE Group ($25; CBG) and Skyworks Solutions ($59; SWKS) are being dropped from the Buy List, Long-Term Buy List, and from coverage. The Vanguard Short-Term Corporate Bond ($81; VCSH) exchange-traded fund now accounts for 19.6% of the buy List and 19.8% of the Long-Term Buy List.

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