Portfolio Review: November 28, 2016


Tweaking the Long-Term Buy List

As Quadrix scores change and our analysts continue to sift through the latest quarterly results, we are making four changes to our Long-Term Buy List, which focuses on high-quality stocks expected to outperform the market over the next 24 to 48 months.

Ingersoll-Rand ($76; IR) earns an Overall score of 96, reflected by ranks exceeding 50 for all six Quadrix categories. Its climate unit (79% of sales for the nine months ended September) supplies heating, ventilation, and cooling systems for commercial and residential markets. Its industrial business (21%) makes products ranging from air-compressor systems to power tools to golf carts.

In the September quarter, Ingersoll grew adjusted earnings per share 17% on 2% higher revenue; both metrics topped analyst estimates. Operating cash flow more than doubled in the 12 months ended September, while free cash flow totaled $1.18 billion, up from $180 million a year earlier. In October, management hiked its quarterly dividend 25% to $0.40 per share, payable Dec. 30, reflecting confidence in its ability to sustain strong cash flow.

The stock has rallied 17% since the latest quarterly report, though its trailing P/E ratio of 18 remains 24% below the median for S&P 1500 industrial-machinery stocks. Ingersoll is now a Long-Term Buy.

Carnival ($52; CCL) operates 10 different cruise-ship brands, attracting nearly 11 million passengers a year, or roughly 50% of the global market. The aging U.S. population should help stoke demand in coming years. Only half of Carnival's addressable market has taken a cruise, signaling that it has plenty of opportunity to grow. For the 12 months ended August, sales rose just 3% but rising profit margins pushed per-share profits 80% higher. Operating cash flow has increased in each of the past 11 quarters, most recently climbing 12%.

Based on the latest wave of quarterly reports for retailers, consumer spending remains healthy, which could translate into a strong November quarter for Carnival. Analysts expect the company to report per-share profits of $0.58, up 16%, on revenue of $3.92 billion, up 6%. Shares trade at just 16 times trailing earnings, 26% below their five-year median. Carnival, yielding 2.7%, is now rated Long-Term Buy.

We are removing AbbVie ($59; ABBV) from the Long-Term Buy List. The stock looks cheap, with a Quadrix Value score of 78 and a fat dividend yield of 4.3%. Although AbbVie still generates solid operating momentum, growth for its blockbuster drug Humira has slowed. The recent election results suggest mandates on price controls are less likely to materialize, though Humira could still face biosimilar competition in the next couple years. Poor trends for share-price action and earnings estimates could also drag down its Overall rank, currently 89. The stock is now rated B (average) and should be sold.

Shire ($173; SHPG) is being dropped from the Long-Term Buy List. Its Overall score has slipped to 62, lowest among our recommended stocks. Although Shire posted robust sales growth in the September quarter, its per-share profits and cash from operations declined. The sluggish results partly reflect increased price competition. Equally problematic, profit estimates for both the December quarter and 2017 have slid over the past 30 days. The prospect of further erosion of analyst estimates is worrisome. Shire is being dropped from coverage and should be sold.

Foot Locker races to record high on strong results

In the six weeks leading up to its October-quarter report, Foot Locker's ($73; FL) stock had dipped on mixed results and guidance from Nike ($52; NKE), Adidas, and Under Armour ($31; UA). But the retailer eased investor concerns by delivering yet another solid quarter and reaffirming its outlook. Foot Locker grew earnings per share 13% to $1.13 excluding special items, topping the consensus by $0.03. Revenue increased 5% to $1.89 billion, while same-store sales advanced 4.7%. Strong U.S. results offset some weakness in Southern Europe and Germany. Operating profit margin has expanded in 28 straight quarters.

Looking ahead to the January quarter, management said the favorable schedule of product launches should cause same-store sales to rise by mid-single-digits and per-share profits to grow by double-digits, as gross profit margin continues to widen. Shares rallied on the results and currently hover near an all-time high. Foot Locker is a Buy and a Long-Term Buy.

Health-care update

Amgen ($144; AMGN) and Novartis ($68; NVS) said their experimental injectable drug reduced the number of migraines in patients in a late-stage trial. Amgen has the rights to sell the drug in the U.S., Canada, and Japan. Novartis is licensed to sell the drug in the rest of the world and expects to file for regulatory approval next year. Analysts estimate the drug's annual sales could eventually top $1 billion.

In other news, Amgen reported that cholesterol drug Repatha reversed plaque buildup in the arteries of 64% of patients during a study. Insurers have hesitated to cover high-priced cholesterol drugs like Repatha, which carries an annual list price of $14,000. But they may be more willing to embrace Repatha as new benefits emerge. Amgen is a Buy and a Long-Term Buy. Novartis is rated C (below average).

Novartis postponed plans to begin testing an autofocus contact lens being developed with Alphabet ($785; GOOGL). Alphabet is a Focus List Buy and a Long-Term Buy.

QuintilesIMS ($80; Q) agreed to acquire a clinical-trials business from TKL Research, a rival contract-research group. Terms of the deal, expected to close in the December quarter, were not released. QuintilesIMS is a Buy and a Long-Term Buy.

Corporate roundup

Apple ($112; AAPL) expects to reduce the fee it charges content providers to sell movies and TV shows through its App Store. In other news, Apple has reportedly asked iPhone assemblers Foxconn and Pegatron to explore the possibility of making the smartphone in the U.S. Manufacturing the device in the U.S. would likely cause costs to surge. Apple is a Buy and a Long-Term Buy.

Expanding its commitment to online media, Comcast's ($69; CMCSa) NBCUniversal has increased its investment in BuzzFeed by $200 million. In August, Comcast agreed to take an initial $200 million stake in BuzzFeed, valuing the company at $1.5 billion at the time. Comcast is a Focus List Buy and a Long-Term Buy.

Disney ($98; DIS) announced plans to invest $1.4 billion in its Hong Kong Disneyland. The Hong Kong resort, the smallest of Disney's six resorts, lost $19 million in fiscal 2016 ended September, possibly due to the June opening of Shanghai Disneyland. The six-year project is slated to begin in 2018. Separately, Disney expects to open an Avatar-themed land at its Orlando resort next summer. Disney is a Long-Term Buy.

Rank Changes

Carnival ($52; CCL) and Ingersoll-Rand ($76; IR) are being added to the Long-Term Buy List. AbbVie ($59; ABBV) and Shire ($173; SHPG) are being dropped from the Long-Term Buy List, with AbbVie now rated B (average) and Shire removed from coverage.

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