Portfolio Review: October 10, 2016


Three upgrades

FedEx ($174; FDX) is being upgraded to Buy and Long-Term Buy. Benefiting from the growing online-retail market, FedEx enjoys strong operating momentum. Both earnings per share and revenue jumped 20% in the August quarter to surpass consensus estimates. Results benefited from solid organic growth and FedEx's $4.8 billion acquisition of TNT Express, a Dutch package-delivery company.
FedEx raised its guidance for fiscal 2017 ending May, with per-share profits now projected to climb 10% to 14% excluding one-time items.

Free cash flow fell 45% to $302 million for the 12 months ended August. But FedEx is investing heavily to upgrade its infrastructure and remains committed to growing its quarterly dividend, hiked 60% to $0.40 per share in June. The stock has rallied 17% this year, yet its trailing P/E ratio remains below 16, a 24% discount to its five-year average and 19% below the median for the S&P 1500 industrials sector. The stock earns above-average scores for all six Quadrix categories, contributing to an Overall rank of 92. FedEx was previously rated A (above average).

We are adding Zions Bancorp ($32; ZION), a regional bank that operates close to 450 branches in the West and Southwest, to the Focus List. The stock has delivered a 5% total return in the past month, while the average S&P 1500 regional bank has returned 1%. We are encouraged by Zion's recent share-price action, which partly reflects the positioning of its loan portfolio. Given that loans to oil and gas companies represent 6% of its portfolio, Zions could get a boost from stabilizing oil prices if the Organization of the Petroleum Exporting Countries follows through with plans to trim production. Zions earns an Overall rank of 98, and both sector-specific scores exceed 90. The stock is also a Long-Term Buy. 

QuintilesIMS ($81; Q) joins the Buy and Long-Term Buy lists. A contract researcher, Quintiles performs clinical trials for experimental drugs being developed by pharmaceutical companies. Although cash from operations and free cash flow slipped in the June quarter, both are up more than 65% over the past 12 months. Rising analyst estimates call for Quintiles to report 5% higher earnings per share in the September and 15% growth for 2016. At 21 times estimated 2016 profits, the stock trades 13% below the median for the S&P 1500 life-sciences industry.

Top 15 Utilities changes

We're making some changes to our Top 15 Utilities portfolio. CONE Midstream Partners ($19; CNNX) is replacing Spectra Energy Partners ($42; SEP), you can read about those MLPs in Income Spotlight. WGL Holdings ($60; WGL) is also joining the portfolio, while Scana ($69; SCG) is out.

WGL provides natural gas to more than 1.1 million customers in the Washington, D.C., region. WGL stands out from the utility crowd in at least two ways:

1) Per-share profits rose 8% over the last 12 months and 11% annualized over the last three years, stronger than the typical utility.

2) The Overall score of 74 is nearly 30 points higher than the average for gas utilities in our Utility Update (www.DowTheory.com/Go/Util).  

Profit-growth estimates for the year ahead seem overly conservative, given WGL's solid long-term prospects. The utility yields 3.3%.

While Scana has a solid long-term growth history, that growth has eroded recently. Per-share profits declined in the last two quarters. The stock looks riskier than it did a few months ago, with regulators expected to rule on a proposed rate increase and cost recovery for a nuclear-construction project, both of which face some resistance. Despite Scana's issues, the stock remains expensive, earning a Value score of 44.

Airlines update

Alaska Air Group ($68; ALK) reported 7.4% higher traffic on 4.2% capacity growth for September. The load factor improved to 84.1% from 81.6%, signaling efficiency gains. Given that capacity rose 8% in July and 10% in August, the airline's September-quarter capacity may have come in below management's target of 8% growth. Shares rallied, as the report likely eased investor concerns about Alaska Air expanding too aggressively. Alaska Air is a Buy and a Long-Term Buy.

Southwest Airlines' ($39; LUV) pilots' union wants to renegotiate some sections of its tentative labor agreement after pilots at Delta Air Lines struck a more lucrative deal. The current contract calls for Southwest to increase pay for its pilots 29% over the four-year deal. Southwest Airlines is a Focus List Buy and a Long-Term Buy.

Corporate roundup

Alphabet ($801; GOOGL) unveiled several new gadgets, including a smartphone, smart-speaker system, and virtual-reality headset. Alphabet is a Focus List Buy and a Long-Term Buy.

Just a week after reports surfaced that Disney ($92; DIS) could try to acquire Twitter ($25; TWTR), the media giant has been linked to another takeover candidate, Netflix ($106; NFLX). Disney has stepped up its efforts to push into online video, announcing in August it would invest $1 billion in BAMTech, the streaming media unit created by Major League Baseball. Disney is a Long-Term Buy.

LKQ ($34; LKQ) acquired Andrew Page Ltd., an auto-parts distributor with 102 branches in the United Kingdom. Terms of the deal were not disclosed. LKQ generates about 19% of its sales in the U.K. LKQ is a Focus List Buy and a Long-Term Buy.

Health-care review

Amgen ($167; AMGN) agreed to pay up to $673.5 million for a stake in Arrowhead Pharmaceuticals ($8; ARWR). Arrowhead is trying to develop a drug that will prevent certain genes from producing proteins that can cause heart disease. Amgen also reported encouraging study results for an experimental treatment to prevent migraines, a drug some analysts say could eventually reach $1 billion in annual sales. Amgen is a Buy and a Long-Term Buy.

According to Johnson & Johnson ($119; JNJ), a clinical trial found one of its experimental drugs outperformed AbbVie's ($63; ABBV) Humira for treating patients with psoriasis, an autoimmune inflammatory disorder. Separately, the U.S. Food and Drug Administration granted breakthrough designation to an experimental AbbVie drug for hepatitis C. The designation accelerates the development and review of promising treatments for serious diseases. AbbVie is a Long-Term Buy. J&J is rated B (average).

Shire's ($194; SHPG) dry-eye drug Xiidra has gotten off to a strong start since its July launch, taking a 21% share of new prescriptions. The drug could potentially generate $1 billion in annual sales by 2018, according to Goldman Sachs ($166; GS). Shire is a Long-Term Buy. Goldman is rated A (above average).

On Dec. 1, Walgreens Boots Alliance ($81; WBA) will replace CVS Health ($86; CVS) in Express Scripts' ($70; ESRX) pharmacy network used by TRICARE, the U.S. Department of Defense military health program. TRICARE reportedly accounts for no more than 2% of CVS' annual per-share profits and revenue. CVS is a Buy and a Long-Term Buy. Express Scripts is rated A (above average). Walgreens is rated B (average).

Rank Changes

FedEx ($174; FDX) and QuintilesIMS ($81; Q) are being upgraded to Buy and Long-Term Buy. Zions Bancorp ($32; ZION) is joining the Focus List. In the wake of these changes, our Buy List now holds 12.4% in the Vanguard Short-Term Corporate Bond ($80; VCSH) ETF, and the Long-Term Buy List 16.4%. On our Top 15 Utilities portfolio, CONE Midstream Partners ($19; CNNX) and WGL Holdings ($60; WGL) are in, replacing Spectra Energy Partners ($42; SEP) and Scana ($69; SCG).

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