Portfolio Review: July 18, 2016


Airlines prepare for Cuba departure

The U.S. gave preliminary approval to eight U.S. airlines to add commercial routes to Havana, Cuba. Alaska Air Group ($63; ALK) was tentatively awarded a daily flight between Los Angeles and Havana. Southwest Airlines ($42; LUV) said it received preliminary approval for a daily flight from Tampa Bay and two daily flights from Fort Lauderdale. The U.S. Transportation Department expects to make a final decision on the routes later this summer. U.S. airlines were cleared last month to add routes to other cities in Cuba.

In other news, Southwest said its passenger traffic rose 6.8% in June, while capacity expanded 5.4%. The airline's load factor, a key efficiency metric, improved to 87.4% from 86.2%. Separately, Alaska Air updated its June-quarter guidance, now projecting a 3.5% decline in cost per available seat mile excluding fuel, versus its prior target of a 1.5% decline. Alaska Air also revised its outlook for fuel costs to $1.53 per gallon (28% lower than the year-ago quarter) from $1.54 per gallon (25% lower). The company increased capacity 11.2% for the quarter, in line with its original projection of 11% growth. Traffic also rose 11.2%.

Despite the encouraging developments, S&P 1500 airline stocks have lost 10% on average over the past three months, with Alaska Air down 23% and Southwest down 9%. The S&P 1500 has returned 3% during that same stretch.

The industry's poor performance partly reflects fears that airlines will slide back into the bad habits of the past. For years the airline industry wallowed in a devastating blend of high costs, overcapacity, and aggressive pricing. Coping with the volatility in fuel prices remains a challenge, as evidenced by the failure of many airlines to lock in low oil prices in January. But the industry shows some signs of entering a brave new world.

Airlines have benefited from consolidation, limited new competition, and an emphasis on shareholder returns. They have also taken advantage of cheap financing to buy more fuel-efficient planes. Investors continue to clamor for slower capacity growth, and most airlines are heading that way. In addition, U.S. airlines have successfully pushed through six fare hikes this year.

If industry expansion remains rational, we expect Alaska Air to do especially well. The company has a history of disciplined organic growth, and it should also benefit from its pending $2.6 billion acquisition of Virgin America ($56; VA). Moreover, unlike most of the large airlines, both Alaska Air and Southwest lack direct exposure to Europe, limiting the potential risks from the U.K. leaving the European Union. Southwest Airlines is a Focus List Buy and a Long-Term Buy. Alaska Air is a Buy and a Long-Term Buy.

Technology update

The European Union is preparing additional formal charges against Alphabet's ($729; GOOGL) shopping service, reported The Wall Street Journal. In April 2015, the EU charged Alphabet with improperly using its dominant position in online search to favor its comparison-shopping services. Alphabet's Google unit's advertising practices may also draw formal EU charges later this summer. In other news, Alphabet is reportedly designing two Android smartwatches, according to an online published report. Alphabet is a Buy and a Long-Term Buy.

Apple's ($97; AAPL) slice of the smartphone market in China slipped to 11% in May from 12% one year earlier, said industry researcher Counterpoint Research. Apple now ranks fifth in China, behind four local manufacturers. Apple is a Buy and a Long-Term Buy.

New drugs and potential deals

The European Commission approved Shire's ($192; SHPG) request to expand the usage of Revestive, a treatment for short bowel syndrome. Revestive accounted for about 2% of Shire's $6.10 billion in sales last year. In other news, Shire won U.S. approval for Xiidra, a treatment for dry-eye disease, which affects nearly 16 million people in the U.S. Shire is a Long-Term Buy.

Gilead Sciences ($86; GILD) received approval to sell Epclusa, its newest hepatitis C treatment, in the European Union. The U.S. cleared Gilead to sell Epclusa last month. Gilead is a Buy and a Long-Term Buy.

Centene ($72; CNC) and WellCare Health Plans ($108; WCG) have reportedly submitted competing bids to acquire a portfolio of Medicare Advantage plans owned by Aetna ($119; AET). The deal could be worth around $1 billion. Aetna is trying to divest assets in order to salvage its $34 billion merger with Humana ($161; HUM). Centene is a Focus List Buy and a Long-Term Buy. Aetna is rated A (above average).

Corporate roundup

With the labor market continuing to tighten, J.P. Morgan Chase ($63; JPM) became the latest U.S. company to announce plans to boost wages, following the lead of Target ($73; TGT), Starbucks ($56; SBUX), and Wal-Mart Stores ($74; WMT). J.P. Morgan said it will raise wages for 18,000 bank tellers and customer-service representatives over the next three years. The move is projected to cost roughly $100 million over the next three years. Last year, J.P. Morgan's compensation expense amounted to $29.75 billion. In other news, CEO Jamie Dimon said J.P. Morgan may be forced to move thousands of jobs out of Britain if the country loses its ability to sell financial services to the European Union due to its Brexit referendum. The bank employs 16,000 workers in the U.K. J.P. Morgan is a Long-Term Buy. Wal-Mart Stores is A (above average). Starbucks and Target are rated B (average).

Comcast's ($67; CMCSa) NBCUniversal unit expects advertising sales to rise at least 15% for this summer's Olympics in Brazil, compared to the 2012 games in London. Ad sales should benefit from NBC's ability to air more live events in the evenings. Rio de Janeiro is just one hour ahead of the U.S. East Coast, compared to London's five-hour difference. NBC sold slightly more than $1 billion in national ads during the London Olympics. Comcast is a Focus List Buy and a Long-Term Buy.

Lam shares run higher

Lam Research's ($89; LRCX) stock has rallied 8% in the past month to reach an all-time high. Shares of rival Applied Materials ($26; AMAT) have also broken out, rising 8% in the past month, versus the S&P 1500 Index's 4% gain. Both companies figure to take a larger share of the market for wafer-fabrication equipment, expected to be flat this year. Lam scores at least 60 for all six Quadrix categories, supporting an Overall rank of 94. Analysts expect earnings per share of $1.65, up 10%, on revenue of $1.53 billion, up 3%. The company last missed the consensus profit estimate in the December 2012 quarter. Lam will report results on July 27. Lam is a Buy and a Long-Term Buy. Applied Materials is rated A (above average).

Rank Changes

No changes were made this week in Dow Theory Forecasts.

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