Portfolio Review: December 12, 2016


Two new stocks

Citizens Financial Group ($35; CFG) is a regional bank with about 1,200 branches in 11 states across the New England, Mid-Atlantic, and Midwest regions. The stock earns a Quadrix Overall score of 97, supported by ranks of 60 or higher for all six categories. Solid loan growth, an expanding deposit base, and higher interest rates boosted the bank's per-share profits 20% and revenue 9% in the first nine months of 2016.

Earlier this month, management said loan growth should strengthen in the December quarter and expressed confidence it could grow its mortgage business in an environment of rising rates. Citizens raised its quarterly dividend 20% in the June quarter and has already received approval for a 17% hike in 2017. Although shares have surged 33% since the end of October, they still look cheap relative to industry norms from virtually every angle. Citizens is being added as a Long-Term Buy.

CommScope ($37; COMM), a supplier of network-infrastructure products to telecom and cable companies, is being added to the Buy and Long-Term Buy lists. The stock has surged 42% this year, yet its valuation remains attractive due to outstanding operating momentum. In the 12 months ended September, CommScope delivered growth of 11% for per-share profits, 40% for sales, and 105% for operating cash flow.

A $3 billion acquisition, completed in August 2015, contributed to recent operating gains, though management anticipates organic growth in the mid-single-digits in 2017. At 15 times trailing earnings, the stock trades well off its three-year median of 26; the median communications-equipment stock in the S&P 1500 Index has a trailing P/E ratio of 18. Shares trade at just 14 times estimated 2016 earnings, a 23% discount to their industry median.

Technology update

Apple ($111; AAPL) CEO Tim Cook said Apple Watch sales surged in the first week of holiday shopping and are on pace to set a record in the December quarter. Cook's comments counter concerns that demand for the device is waning. Industry researcher IDC estimated Apple Watch sales plunged 71% to 1.1 million units in the September quarter. Separately, Apple has cut iPhone 7 orders due to slowing sales, reported DigiTimes. In other news, Apple publicly disclosed for the first time its plan to design software to run autonomous vehicles. Apple, yielding 2.1%, is a Buy and a Long-Term Buy.

Alphabet ($791; GOOGL) expects all of its offices and data centers to run on wind and solar power in 2017. The company is the world's largest corporate buyer of clean energy. Alphabet is a Focus List Buy and a Long-Term Buy.

Kroger executes well in a time of deflation

For the October quarter, Kroger's ($34; KR) earnings per share slipped 5% to $0.41 excluding special items, matching the consensus. Total revenue rose 6% to $26.56 billion, while same-store sales excluding fuel crept 0.1% higher. Kroger trimmed the upper end of its full-year per-share-profit guidance, resulting in a new midpoint of $2.125, versus the consensus of $2.13 at the time of the announcement. For the January quarter, Kroger expects "slightly positive" growth in same-store sales.

Lower food prices weighed on results and guidance, as deflation has intensified since the July quarter. Kroger says it's currently in the third deflationary period in the past 30 years. Prices began to creep down in the April quarter, and management expects deflation to continue into the first half of 2017. Prior deflationary cycles lasted three to five quarters.

Somewhat troubling, Kroger's cash from operations slumped 58% in the three months ended October, and free cash flow turned negative for the second straight quarter. But the grocer continues to report favorable trends for volume and traffic, contributing to higher market share. At 16 times trailing earnings, the stock trades 28% below the sector median.

Kroger shares rose on the report and remain a Buy and a Long-Term Buy.

Regulatory clouds clear for Alaska Air's Virgin deal

The U.S. approved Alaska Air Group ($88; ALK) to proceed with plans to acquire Virgin America ($57; VA) in an all-cash deal worth $2.6 billion. To win the endorsement of antitrust officials, Alaska Air agreed to cut back on its code-sharing partnership with American Airlines Group ($40; AAL). Under code-sharing agreements, airlines sell tickets for certain routes on behalf of their partners. Alaska Air and Virgin still face a consumer lawsuit that seeks to block the merger. But if the deal is ultimately completed, Alaska Air would become the fifth-largest U.S. airline, with about 6% of the U.S. market. 

In other news, Alaska Air said traffic climbed 7.0% in November on 2.8% higher capacity, in line with management's 3% target for capacity growth in the December quarter. Alaska Air's load factor, an efficiency metric, improved to 85.1% from 81.7% in November 2015. Southwest Airlines ($50; LUV) reported 7.2% higher traffic and 4.9% capacity growth for November. The load factor rose to 85.1% from 83.3%. Alaska Air is a Buy and a Long-Term Buy. Southwest Airlines is a Focus List Buy and a Long-Term Buy.

Corporate roundup

Carnival ($53; CCL) agreed to plead guilty to seven felony charges linked to its involvement in illegally dumping oil-contaminated waste and then attempting to cover up its actions. It will also pay a $40 million penalty. That fine represents less than 1% of Carnival's cash from operations for the 12 months ended August (up 21% to $5.09 billion) and 3.5% of free cash flow (up 38% to $1.13 billion). The company has weathered its share of negative headlines, with one cruise ship sinking in 2012 and another experiencing a sewage backup after a fire in 2013. The stock is a Buy and a Long-Term Buy.

Owens Corning ($55; OC) hiked its quarterly dividend 11% to $0.20 per share, payable Jan. 18. Management had already raised the dividend once this year, a 6% boost in February. Owens is a Focus List Buy and a Long-Term Buy.

Opening arguments have begun in a lawsuit between Biogen ($285; BIIB) and Forward Pharma ($17; FWP). The dispute centers on patents involving multiple sclerosis drug Tefidera, Biogen's top-selling product. Forward seeks to win a 10% royalty on Tecfidera sales, which totaled $2.97 billion in the first nine months of 2016, or 35% of Biogen's revenue. An outcome may not be known until the middle of next year. Biogen is a Buy and a Long-Term Buy.

At an industry conference, J.P. Morgan Chase's ($84; JPM) CEO said he will consider offering a special cash dividend and curtail stock buybacks if the bank's share price climbs to a certain level. J.P. Morgan shares have rallied 27% this year, outpacing the S&P 500 Financial Sector Index, up 22%, and the broad index, up 10%. J.P. Morgan is a Long-Term Buy.

Rank Changes

Citizens Financial Group ($35; CFG) and CommScope ($37; COMM) are being added to the Long-Term Buy List; CommScope is also joining the Buy List. Vanguard Short-Term Corporate Bond ($79; VCSH) exchange-traded fund now accounts for 5.7% of the Buy List and 5.6% of the Long-Term Buy List.

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