Portfolio Review: November 21, 2016


Four rank changes

We are adding FedEx ($184; FDX) to the Focus List. Management expects another record shipping season during the upcoming holidays due to rising demand for online shopping. Yet its hiring plans for seasonal workers are more modest than last year, signaling improved efficiency. Analysts forecast 12% higher earnings per share for three months ending November, followed by 8% growth in the February quarter. Encouragingly, analyst estimates are drifting higher.

The stock carries some risk, especially if incoming president Donald Trump follows through on threats to disrupt global trade agreements.  But the shares already appear to reflect some of those concerns. The stock's trailing P/E ratio of 16 lags its five-year median of 21 and the S&P 1500 airfreight and logistics industry median of 20. FedEx is also a Long-Term Buy.

F5 Networks ($143; FFIV), a company that makes networking software and hardware, is being added to the Focus List. Reports emerged earlier this year that F5 is exploring strategic options, including the possibility of putting itself up for sale. Even if a deal never materializes, we like F5 on its own merits: a strong track record, improving outlook, and decent valuation.

Sales, operating cash flow, and free cash flow have grown in each of the past 14 fiscal years; annual earnings per share declined just twice in that span. Analyst estimates have jumped since F5's strong September-quarter report, with the consensus now projecting 14% higher earnings per share in fiscal 2017 ending September on 7% higher revenue. Shares trade at 17 times estimated earnings for the current fiscal year, below the technology-sector median of 19. F5 was already a Buy and a Long-Term Buy.

LKQ ($33; LKQ), a supplier of aftermarket auto parts, is being removed from the Focus List but remains a Buy and a Long-Term Buy. The company posted a strong September quarter, with both per-share profits and revenue up at least 25%, lifted by a combination of organic growth and acquisitions. But LKQ trimmed its full-year guidance due to foreign-currency headwinds, lower scrap prices, and regulatory delays for a pending acquisition. Its Quadrix Overall score has fallen to 79 from 91 at the end of September, reflecting lower profit estimates and sluggish share-price action.

But the shares look attractively valued at 19 times trailing earnings, near their lowest level since 2010 and well off their five-year average of 24. Moreover, even the most pessimistic analyst projects 8% higher profits and revenue in 2017. If LKQ merely meets the lowest 2017 profit estimate of $1.96 and its trailing P/E ratio rises to 20, its shares will rally 19% over the next 14 months.

Applied Materials ($30; AMAT) joins the Buy List. The company competes in nearly every key semiconductor-equipment segment and holds a 22% share of the market, up from 18% in 2012. It scores above 50 for all six Quadrix categories, earning an Overall rank of 91. Management expects to keep expanding market share and boosting profit margins for the next couple years.

Shares have surged 61% in 2016 but still look reasonably valued at 22 times trailing earnings, in line with the median for S&P 1500 semiconductor-equipment stocks and 4% below their own five-year average. The company was expected to report October-quarter results on Nov. 17, after our deadline. Applied Materials has met or topped the consensus profit estimate in each of the past 12 quarters. The stock is also a Long-Term Buy.

Disney results depict smaller world after all

Disney ($99; DIS) earned $1.10 per share excluding special items in the September quarter, down 8% and $0.06 below the consensus. Revenue, down 3% to $13.14 billion, also missed expectations. Media networks posted 3% lower sales and consumer products and interactive media reported a 17% contraction, overwhelming modest growth for studio entertainment (up 2%) and parks and resorts (up 1%).

ESPN's advertising revenue fell 13% last quarter, and industry researcher Nielsen says the sports network lost 621,000 subscribers in the past month. Disney disputed the findings but declined to offer numbers of its own. Disney hopes to halt ESPN's slump by attracting viewers through partnerships with Hulu and AT&T ($37; T). The company projected modest growth for per-share earnings in fiscal 2017 ending September, followed by stronger growth in fiscal 2018, and the shares rallied on the news. Disney remains a Long-Term Buy. AT&T is rated A (above average).

Health-care update

AbbVie ($62; ABBV) reported encouraging trial results for an experimental Hepatitis C treatment. AbbVie hopes to file for U.S. approval for the drug by the end of 2016. AbbVie is a Long-Term Buy.

Centene ($56; CNC) said the Government Accountability Office upheld a pair of regional Tricare contracts that had been awarded to Health Net, acquired by the insurer in March. The contracts, offered through the Department of Defense, will begin in the second half of 2017. Shares rallied on the news but remain down 17% since Donald Trump was elected president, which has created uncertainty over the future of the Affordable Care Act. Centene is a Focus List Buy and a Long-Term Buy.

Some analysts have speculated that Shire ($179; SHPG) could pursue a takeover of Merrimack Pharmaceuticals ($6; MACK), a biotechnology firm focused on oncology drugs. The two companies have a licensing partnership for pancreatic-cancer drug Onivyde. Merrimack, with a market value of about $810 million, is not expected to be profitable this year or next year. Shire is a Long-Term Buy.

Technology update

Apple ($110; AAPL) said 13 new banks and credit unions in China and Russia will support its mobile-payment service Apple Pay, now available in 12 countries. Apple Pay transactions surged 500% in the September quarter from the same time last year. Separately, Apple is expected to show off its new line of iPads in March, according to a report published online. In other news, Apple has reportedly decided to cancel plans to update its smaller 4-inch iPhone SE, which could be cannibalizing the sales of more expensive iPhone models. Apple is a Buy and a Long-Term Buy.

In a blog post aimed at rebutting antitrust claims brought by the European Union, a lawyer for Alphabet ($780; GOOGL) insisted the mobile operating system Android improves competition rather than hurting it. Kent Walker said Alphabet does not require smartphone manufacturers to preinstall Google applications on Android devices. Alphabet is a Focus List Buy and a Long-Term Buy.

Corporate roundup

Comcast ($67; CMCSa) has reportedly entered talks to acquire a 15% to 30% stake in broadcaster Euronews, a move aimed at bolstering NBCUniversal's NBC News in Europe. Comcast is a Focus List Buy and a Long-Term Buy.

J.P. Morgan Chase ($77; JPM) reportedly agreed to pay about $200 million to settle a U.S. probe into claims it improperly hired the children of Chinese officials in order to win business. J.P. Morgan is a Long-Term Buy.

Rank Changes

FedEx ($184; FDX) and F5 Networks ($143; FFIV), already Buys and Long-Term Buys, are being added to the Focus List. LKQ ($33; LKQ) is being dropped from the Focus List but remains a Buy and a Long-Term Buy. Applied Materials ($30; AMAT) is being added to the Buy List. After these changes, the Vanguard Short-Term Corporate Bond ($80; VCSH) exchange-traded fund accounts for 11.9% of the Buy List and 13.4% of the Long-Term Buy List.

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