Portfolio Review: September 19, 2016


Two downgrades

Amerco's ($326; UHAL) stock has fallen 4% since we initiated it as a Buy and Long-Term Buy in February, sitting out the S&P 1500 Index's 11% advance. The shares sold off on disappointing June-quarter results, hurt by softer pricing, rental-truck shortages, and rising truck costs at a time when Amerco is building its fleet. We had anticipated the stock and its Quadrix scores would rebound, but both have continued to fall since last month's profit report.

Amerco earns an Overall score of just 60, lowest among our recommended stocks. Both cash from operations and free cash flow have declined in two straight quarters, while gross profit margin has also showed signs of weakening. The stock trades at just 14 times trailing earnings but looks more expensive based on other valuation metrics, indicating potential downside if profit margins fail to recover. Amerco is being dropped from the Buy and Long-Term Buy lists and from coverage. Amerco should be sold.  

Enthusiasm about Nvidia's ($60; NVDA) enviable position in the booming autonomous-vehicle market has helped drive recent share-price action. The stock has surged 83% in 2016 (versus the S&P 1500 Index's 4% gain) and 208% since we first recommended Nvidia in January 2015 (vs. 7% for the index). But its valuation looks stretched, reflected by a Quadrix Value score of 12. At 25 times estimated year-ahead earnings, Nvidia shares fetch a hefty 29% premium to the median S&P 1500 semiconductor stock.

Sales growth has accelerated in five straight quarters, including a 24% increase for the three months ended July. But growth is slowing for free cash flow and operating cash flow. Given Nvidia's rich valuation and exposure to the cyclical graphics-semiconductors business, the stock's risk-reward payoff no longer seems favorable. Nvidia is being removed from the Long-Term Buy list. The stock is now rated B (average) and should be sold.

Keep Kroger in your cart

Kroger ($31; KR) grew July-quarter earnings per share 7% to $0.47 excluding special items, easing past the consensus by $0.02. Total revenue advanced 4% to $26.57 billion and same-store sales crept 1.7% higher excluding fuel; both metrics missed analyst estimates. Falling food prices continue to constrain the grocer's growth. But Kroger is taking market share, as reflected by its estimated 3% volume growth.

Kroger said weak food prices could keep pressuring results through the end of the year and into the April 2017 quarter. Management now expects profits to climb 2% to 7% in fiscal 2017 ending January, versus the consensus projection of 8% at the time of the announcement. Kroger's prior profit-growth target stood at 6% to 11%, though management had said in June that growth would likely be in the bottom half of that range. Same-store sales are now expected to increase 1.4% to 1.8% for the year; Kroger had previously anticipated 2.5% to 3.5% growth.

Investors already appeared to be braced for the worse; the shares were down 25% for the year at the time of the earnings release. Those shares have since fallen 1.9%, ahead of the S&P 500 Index's 2.5% decline. Kroger is a Buy and a Long-Term Buy.

Technology update

Wireless carriers have rolled out aggressive promotions in the hope of poaching current iPhone users from rivals. AT&T ($40; T), Verizon Communications ($51; VZ), Sprint ($7; S), and T-Mobile US ($46; TMUS) are offering a free Apple ($112; AAPL) iPhone 7 to anyone who turns in an iPhone 6 or 6S. Wireless companies view product launches as an opportunity to gain market share. For Apple, the promotions could shorten the upgrade cycle for users.

The strategy appears to be paying off in the first weekend since Apple unveiled its new iPhone on Sept. 7. Both Sprint and T-Mobile said initial preorders for Apple's new iPhone were nearly four times higher than last year. Departing from its previous policy, Apple declined to release initial sales. Apple is a Buy and a Long-Term Buy. Sprint and Verizon are rated B (average).

Separately, Apple has reportedly switched gears on an initiative it never publicly confirmed: self-driving cars. Apple now appears to be focusing on designing the computer system to power the vehicles rather than building the entire car itself. Alphabet ($790; GOOGL) has adopted a similar strategy, developing technology that could be used by traditional automakers.

In other news, Alphabetagreed to pay $625 million to acquire Apigee ($17; APIC), which designs software that connects mobile applications to retailers' computers when shoppers make online purchases. The deal values Apigee at a 7% premium to where its shares traded before the announcement. In a separate move aimed at further expanding its cloud-computing business, Alphabet agreed to let corporate customers of Box ($15; BOX), an online storage company, use its suite of spreadsheets and word-processing applications, known as Google Docs.

Alphabet's life-sciences unit Verily and French drugmaker Sanofi ($39; SNY) pledged to invest $500 million in a joint venture to improve diabetes care. Verily has also partnered with GlaxoSmithKline ($43; GSK) and Novartis ($79; NVS) in an attempt to bridge the technology and health-care sectors. Finally, the European Union gave Alphabet a second extension to reply to antitrust charges concerning its Android mobile operating system. The company must now submit its response by Sept. 20. Alphabet is a Focus List Buy and a Long-Term Buy. Novartis is rated C (below average).

Corporate roundup

Federal Communications Commission Chairman Tom Wheeler proposed a plan aimed at breaking the lock cable companies have on the market for television set-top boxes. Under Wheeler's plan, cable companies would share their subscription feeds with third-party device makers. Most cable subscribers currently rent set-top boxes from cable companies. Predictably, AT&T ($40; T), Comcast ($65; CMCSa), and Twenty-First Century Fox ($24; FOXa) oppose the proposal. The FCC will vote on the plan on Sept. 29. Comcast is a Focus List Buy and a Long-Term Buy. AT&T is rated A (above average). Twenty-First Century Fox is rated C (below average).

Alaska Air Group ($67; ALK) continues to expect to complete its $2.6 billion deal acquisition of Virgin America ($56; VA) between Sept. 30 and Jan. 1. Virgin's stock trades at a modest discount to the takeover price of $57 per share, reflecting little investor concern that the deal could run afoul of regulators. The two companies share just a handful of overlapping routes and would combine to form the fifth-largest U.S. airline by traffic. The U.S. has approved five airline mergers since 2010. That tally includes a $17 billion deal between American Airlines ($36; AAL) and US Airways that was blocked by regulators until the airlines agreed to asset divestitures. Alaska Air is a Buy and a Long-Term Buy.

Southwest Airlines ($37; LUV) reached a tentative agreement with its flight-attendants union. The airline has also struck tentative deals with its pilots and facilities-maintenance technicians in the past month. Southwest's 12,000 flight attendants rejected a tentative contract in July 2015. Southwest is a Focus List Buy and a Long-Term Buy.

Shire ($193; SHPG) won U.S. approval to sell a new drug that treats primary immunodeficiency, a genetic disorder affecting patients' immune systems. Shire is a Long-Term Buy.

Rank Changes

Amerco ($326; UHAL) is being removed from the Buy and Long-Term Buy lists, and from coverage. Nvidia ($60; NVDA) is being removed from the Long-Term Buy List. The Vanguard Short-Term Corporate Bond ($81; VCSH) exchange-traded fund now accounts for 19.1% of the Buy List and 22.0% of the Long-Term Buy List.

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