Portfolio Review: November 14, 2016


CVS off Buy List

CVS Health ($77; CVS) said it earned $1.64 per share excluding special items, up 28%, to top the consensus estimate of $1.57 per share. Sales climbed 15% to $44.62 billion, missing the consensus of $45.29 billion. The pharmacy-services unit posted 19% higher sales, while the retail business delivered 12% growth. Same-store sales increased 2.3%. CVS approved $15 billion in share repurchases, in addition to $3.7 billion remaining on its existing plan.

For the December quarter, CVS expects per-share profits of $1.64 to $1.70, up 7% to 11% but below the consensus estimate of $1.79 at the time of the announcement. Management's 2017 profit guidance also missed expectations by a wide margin, as the retail unit could lose more than 40 million prescriptions after some pharmacy-benefit managers moved their business to rival Walgreens Boots Alliance ($82; WBA). CVS also lost its contract with Tricare, a Department of Defense health-care program, to Walgreens. CVS filled 1.03 billion scripts in 2015. CVS says per-share profits could be flat to slightly higher next year; analysts projected 12% growth. Shares tumbled on the results. CVS is being dropped from the Buy List, but for now it remains a Long-Term Buy. Walgreens is rated A (above average).

Health care: A sector divided

In the first day of trading after Donald Trump's surprising victory in the U.S. presidential election, no group of stocks took a more divergent path than those in the health-care sector. Shares of companies that have enjoyed higher volumes from the Affordable Care Act — laboratories, such as Laboratory Corp. of America ($122; LH), hospitals, and medical-device makers — slumped on expectations that Trump will follow through with his pledge to reject the law.

The reaction within the managed-care industry was more mixed. Shares rose for many of the big commercial insurers that had been unable to make the health exchanges profitable. However, insurers with businesses concentrated in Medicare and Medicaid sold off on the prospect of lower enrollment. The sharp decline for Centene ($54; CNC) seems overdone, and we will be looking for a rebound for the shares.

The sector's biggest winners appear to be drug stocks, which had slumped in recent months on concerns that a Hillary Clinton presidency would bring heavier regulations on prices. A proposal to cap drug prices paid by public-health programs also failed in California. AbbVie ($63; ABBV), Amgen ($146; AMGN), Biogen ($320; BIIB), and Shire ($187; SHPG) all surged at least 5% on the day after the election, while QuintilesIMS ($78; Q), a company that conducts clinical trials for experimental drugs, also got a lift.

Trump has been vague about his policies, leaving investors to guess at what the future may hold. The dismantling of the massive health-care law would likely reverberate through all pockets of the sector. But lawmakers could feel pressure to replace ACA to prevent 20 million Americans from losing coverage. With that in mind, volatility within the sector may prove to be a knee-jerk reaction that could reverse in coming days. For now, we are maintaining rankings for all of our health-care stocks. Centene and LabCorp are rated Focus List Buy and Long-Term Buy. Amgen, Biogen, and QuintilesIMS are rated Buy and Long-Term Buy. AbbVie and Shire are Long-Term Buys.

The election news overshadowed several key developments for some of our health-care stocks.

AbbVie's top-selling product dodged a potential threat of biosimilar competition. The U.S. Patent and Trademark Office rejected a petition submitted by Coherus BioSciences ($27; CHRS) to challenge the validity of Humira's patent. Coherus must now pursue its patent case through the U.S. federal courts, a far lengthier process that will delay the launch of any biosimilar version of Humira.

Biogen and Ionis Pharmaceuticals ($38; IONS) reported positive results in a late-stage study for an experimental drug aimed at treating children with spinal muscular atrophy. Biogen hopes to launch Spinraza in the U.S. by early 2017. No drugs are currently approved for spinal muscular atrophy, a genetic disease that can lead to paralysis.

Centene won a four-year contract for Nevada's Medicaid program, which has an enrollment of 400,000 members.

Earnings review

For the September quarter, D.R. Horton ($28; DHI) reported earnings per share of $0.79 excluding special items, up 30% and $0.02 above the consensus. Total revenue rose 18% to $3.65 billion, while cash from operations rose 3% to $529 million. D.R. Horton also raised its quarterly dividend 25% to $0.10, payable Dec. 12.

For fiscal 2017 ending September, management expects revenue of $13.4 billion to $13.8 billion, implying 13% to 16% growth; the company had forecasted 10% to 15% growth in July. But the volume of new orders rose just 3% last quarter, adding some risk to the company's ability to meet its growth target. Shares fell on the report. D.R. Horton remains a Focus List Buy and a Long-Term Buy.

Southwest lands labor pacts

Southwest Airlines' ($42; LUV) pilots' union approved a new contract after four years of negotiating. The contract calls for an immediate 15% pay hike, followed by 3% annual raises through 2020. The airline's flight attendants approved their own contract a week earlier. Southwest said the new labor pacts will cause unit costs excluding fuel to climb 3.5% in the December quarter. In other news, U.S. air travel is projected to climb 2.5% during the Thanksgiving period running from Nov. 18 to Nov. 29, says industry group Airlines for America. Southwest Airlines is a Focus List Buy and a Long-Term Buy.

Smartphone growth picks up

Global smartphone shipments rose to 375 million units, up 6% year-over-year, in the September quarter, according to industry researcher Strategy Analytics. Alphabet's ($806; GOOGL) Android operating system powered the growth, with shipments up 10%, while shipments of Apple's ($111; AAPL) iPhone slipped 5%. Android grabbed a record 88% of global shipments, versus Apple's 12% share. However, Apple took 103% of the market's profits, up from 90% in the year-ago quarter, as many smartphone makers sold their devices at a loss.

In October, Alphabet launched Pixel, a high-end smartphone that has generally received glowing reviews. With an estimated manufacturing cost of $286 and retail price of $769, the Pixel could offer iPhone-like profit margins. Alphabet initially planned to produce roughly 3 million Pixel units this year, barely enough to move the needle for the company's operating results or the overall smartphone market. But demand for the device appears to be outstripping supply so far, and it will bear watching in the coming quarters to see if Alphabet can start to chip away at the iPhone's share of the smartphone market's profits. Alphabet is a Focus List Buy and a Long-Term Buy. Apple is a Buy and a Long-Term Buy.

Rank Changes

CVS Health ($77; CVS) is being dropped from the Buy List but remains a Long-Term Buy. The Buy List now holds 15.1% in the Vanguard Short-Term Corporate Bond ($80; VCSH) exchange-traded fund.

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