Portfolio Review: February 20, 2017


Three rank changes

Centene ($71; CNC) rejoins the Focus List after a solid December quarter suggested that it should take a larger share of overall health-insurance spending over the next decade. The health insurer is the largest private administrator of Medicaid plans. Centene's business is geographically diversified, with Medicaid operations in 29 states.

The midpoints of Centene's 2017 guidance ranges call for per-share profits of $4.625, up 4%, and revenue of $46.4 billion, up 14%. The consensus had targeted per-share profits of $4.67 on revenue of $46.48 billion at the time of the announcement.

At 15 times estimated 2017 earnings, Centene shares trade at a 12% discount to the median managed-care stock in the S&P 1500 Index. Centene, earning a Quadrix Overall rank of 97, is already a Buy and a Long-Term Buy.

Synchrony Financial ($37; SYF), added as a Long-Term Buy last week, is being upgraded to a Buy.

With an Overall rank of 91, the company supplies private-label and co-branded credit cards for retailers. These credit cards have become an important source of revenue for retailers, as Amazon.com ($843; AMZN) squeezes their traditional business. Moreover, private-label cards allow retailers to avoid interchange fees.

The stock enjoys a robust growth profile and decent valuation. Per-share profits are projected to climb 13% to $3.05 this year. Yet the shares trade at just 12 times estimated earnings, versus the median of 17 for S&P 1500 financial stocks. Amazon.com is rated B (average).

Kroger ($34; KR) is being dropped from the Buy List. The stock's Overall rank has dropped to 64, hurt by slowing operating momentum, falling profit estimates, and poor share-price action. Kroger has proven it can execute well in even the most challenging environments, growing annual sales in each of the past 26 years. It's no different in the current cycle of deflationary food prices, as Kroger posted 5% higher sales for the first nine months of fiscal 2017 ended January.

Kroger is deploying aggressive promotions to keep taking market share. But that strategy has taken a toll on its profit margins, and free cash flow has turned negative in the past two quarters. Some signals point to intensifying deflationary trends. The Producer Price Index for finished consumer foods, a measure of wholesale food inflation for food retailers, fell 2.6% in January from the same time last year and 1.5% from December.

Investors with longer time horizons should keep in mind that food prices will eventually firm up. Kroger has said it expects to begin to see some improvement in the second half of fiscal 2018. Shares trade at 16 times trailing earnings, in line with their five-year average and 24% below the median for S&P 1500 food retailers. Kroger, earning a Value rank of 84, remains a Long-Term Buy.

Earnings reviews

For the January quarter, Applied Materials ($35; AMAT) earned $0.67 per share excluding special items, compared to $0.26 earned in the year-ago quarter and the consensus of $0.66. Sales surged 45% to $3.28 billion, also narrowly ahead of analyst estimates. Cash from operations more than tripled to $646 million. The midpoints of management's April-quarter guidance ranges call for per-share profits to jump 124%, on 44% higher revenue. Analysts were anticipating profit growth of 85% and sales growth of 33% for the quarter at the time of the announcement. Applied Materials is a Buy and a Long-Term Buy.

CBS ($65; CBS) reported December-quarter earnings per of $1.11 excluding special items, up 21%, to ease past the consensus estimate by a penny. Sales dipped 2% to $3.52 billion, missing the consensus of $3.96 billion. Buoyed by higher retransmission fees, affiliate and subscription revenue jumped 13% but could not offset declines of 3% for advertising revenue and 12% for licensing and distribution. Operating cash flow slumped 51% for the quarter but remained up 21% for the year. CBS is a Focus List Buy and a Long-Term Buy.

CVS Health ($79; CVS) grew December-quarter earnings per share 12% to $1.71 excluding special items, surpassing the consensus by $0.04. Revenue increased 12% to $45.97 billion on 18% growth from the pharmacy-benefits management (PBM) unit and 5% growth from the retail business. Same-store sales slipped 0.7% due to front-of-store weakness. PBMs have not been immune to the scrutiny looming over rising drug prices. But CEO Larry Merlo defended its business by saying, "'Any suggestion that PBMs are causing drug prices to rise is simply erroneous. We are the solution and not the problem."' CVS is a Long-Term Buy.

QuintilesIMS ($78; Q) earned $1.09 per share in the December quarter, up 21% and $0.04 above the consensus. Revenue surged 73%, largely because of the all-stock acquisition of IMS Health in October, a deal valued at roughly $9 billion. Organic sales rose 4% at constant currency. March-quarter guidance fell well short of analysts' expectations, though the full-year profit guidance narrowly topped the current consensus. 

Quintiles said its business typically picks up as the year progresses, adding that its $9.5 billion backlog provides good visibility for the remainder of the year. The company also announced a $1.5 billion stock-repurchase plan that it expects to complete by the end of the year. Quintiles is a Buy and a Long-Term Buy.

Investors crush on Apple

Investors have rediscovered their love for Apple ($136; AAPL), pushing the shares up 15% in 2017 to reach an all-time high. The recent rally may point to anticipation of the forthcoming iPhone. And the latest chatter centers on expectations that three models of different sizes will be released. At least one model will abandon the traditional aluminum-alloy chassis for a reinforced glass chassis in a metal frame, according to DigiTimes. The next iPhone may also feature a wireless-charging system.

Apple plans to begin making iPhones in India by the end of April, while continuing to explore opening retail stores and selling used iPhones in the country. At 16 times trailing earnings, the stock trades near its highest level since fiscal 2015 ended September but remains 24% below the median S&P 1500 technology stock. Apple is a Buy and a Long-Term Buy.

Corporate roundup

Lear ($144; LEA) raised its quarterly dividend 67% to $0.50 per share, payable March 23. Each of Lear's last five dividend hikes has exceeded 15%. The company also increased its stock-buyback plan to $1 billion, the equivalent of roughly 10% of shares outstanding at current prices. Stock repurchases have slashed Lear's share count by 34% since the end of 2010. Lear entered 2017 with $341 million remained on its previous buyback plan. Lear is a Focus List Buy and a Long-Term Buy.

Disney ($110; DIS) aims to take complete control of struggling Euro Disney, after raising its stake in the company to 86% from 77%. Separately, the company raised prices up to 5% on some single-day tickets to its U.S. theme parks. Last year, Disney moved to a tiered-pricing structure that increases ticket prices on peak dates. Disney is a Long-Term Buy.

Ingersoll-Rand ($82; IR) agreed to acquire Thermocold Costruzioni, which sells heating, ventilation, and air-conditioning systems in Europe. Terms of the deal were not announced. Ingersoll also announced a $1.5 billion stock-repurchase plan, translating to 7% of its share count at current prices. The company has shrunk its share base by 17% over the past five years. Ingersoll is a Long-Term Buy.

In separate rulings, U.S. courts blocked Anthem's ($163; ANTM) pending $48 billion acquisition of Cigna ($147; CI) and Aetna's ($128; AET) plan to purchase Humana ($205; HUM) for $34 billion. Aetna and Humana decided to terminate their deal, leaving Humana with a $1 billion breakup fee. Meanwhile, Anthem has vowed to fight the ruling, a battle Cigna wants to avoid. Cigna said it will seek $1.85 billion from its former suitor and an additional $13 billion in damages. Anthem has filed a countersuit against Cigna. Both Aetna and Anthem are rated A (above average). Cigna is rated B (average).

Rank Changes

Centene ($71; CNC), already a Buy and a Long-Term Buy, is joining the Focus List. Long-Term Buy Synchrony Financial ($37; SYF) is being added to the Buy List. Kroger ($34; KR) is being dropped from the Buy List but remains a Long-Term Buy.

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