Portfolio Review: March 6, 2017


Rank changes

We are adding Celgene ($124; CELG) to the Long-Term Buy List. Cash from operations surged 60% in 2016, while operating profit margin jumped more than 11 percentage points to a record 43%. Unlike many drugmakers, Celgene doesn't rely on price hikes to underpin its growth. Drug sales jumped 22% in 2016, with 18% of that growth coming from higher volumes.

Revlimid, a treatment for multiple myeloma, generated 62% of Celgene's sales last year. The drug's patent protection runs into 2022, creating some long-term risk for the stock. But newer drugs are mostly performing well, and its pipeline also shows promise. Midpoints for management's 2017 outlook call for 21% higher earnings per share on revenue growth of 18%. At 17 times estimated 2017 profits, shares trade 15% below the median S&P 1500 biotechnology stock. Celgene was previously rated A (above average).

J.P. Morgan Chase ($94; JPM) joins the Buy List, bolstered by its improving operating growth, willingness to ramp up capital returns to shareholders, and decent valuation. Last year net interest margin rose for the first time since 2009. Revenue has also perked up recently, as the bank registered growth between 5% and 10% in each of the past three quarters. The consensus calls for 5% higher revenue for the current quarter, and management sees several potential catalysts to fuel more trading activity in the coming years.

At its annual shareholder meeting on Feb. 28, J.P. Morgan said it could pay out upwards of 120% of net income through dividends and stock buybacks in the next couple years, above its long-term payout target of 55% to 75%. It returned 61% to shareholders in 2016. Up 8% in 2017, the shares trade at 15 times trailing earnings, above their five-year median of 10 but below the median of 16 for S&P 1500 diversified banks. J.P. Morgan is also a Long-Term Buy.

We are downgrading LKQ ($32; LKQ) from the Buy and Long-Term Buy lists after the company posted a disappointing December quarter and gave mixed guidance for 2017. LKQ, a supplier of recycled and aftermarket auto parts, said per-share profits rose 15% to $0.39 excluding special items in the December quarter, missing the consensus by a penny. Sales jumped 23% to $2.15 billion, falling short of analysts' target of $2.28 billion.

Management blamed the disappointing results on a lower volume of car repairs due to unusually mild weather. But LKQ has now used this excuse in each of the past three quarters, even as the number of miles driven keeps rising. The stock still earns a solid Quadrix Overall score of 85, and cash flow remains strong, with cash from operations climbing 20% last year. However, profit estimates have eroded in the week since LKQ's quarterly report, which could keep the shares under pressure. The stock is being dropped from coverage and should be sold.

QuintilesIMS ($77; Q) is being dropped from the Buy and Long-Term Buy lists. Its Overall rank has plummeted to 36, hurt by below-average scores in five of six Quadrix categories. The sharp drop in Quadrix largely reflects a charge and Quintiles' October acquisition of IMS Health for $8.75 billion. The decline in Overall score overstates the erosion of fundamentals.

But we see other legitimate concerns. Contract-research organizations have struggled recently, as evidenced by mixed quarterly results. Quintiles has seen its own profit estimates trend lower over the past 90 days. Its shares are up 1% so far in 2017, lagging the 7% advance for the S&P 1500 Index. Yet they look fully valued at 24 times trailing earnings, roughly in line with their five-year average and above the S&P 1500 health-care sector median of 21. Quintiles is being removed from the Monitored List and should be sold.

Retail roundup

Foot Locker ($76; FL) earned $1.37 per share excluding special items in the January quarter, up 18% and $0.05 above the consensus. Total revenue increased 5% to $2.11 billion, while same-store sales rose 5.0%. Results benefited from higher prices. Management also reported a rise in store traffic, something of an anomaly in the current retail landscape.

Foot Locker expects per-share profits to climb at least 10% in fiscal 2018 ending January, while same-store sales are projected to increase at a mid-single-digit rate. That guidance implies minimum per-share profits of $5.42, above the consensus of 5.27.

Despite strong product demand, management conceded that growth will likely be less steady this year. This is largely due to delays in tax refunds, expected to push more sales into the July quarter that would normally occur in the April quarter. Foot Locker shares surged 9% on the report and remain a Buy and a Long-Term Buy.

A weak January-quarter report, disappointing guidance, and a sudden shift in strategy contributed to Target ($58; TGT) shares plunging 12%, their sharpest one-day decline since 2008. The retailer's earnings per share fell 5% to $1.45 excluding special items, missing the consensus by $0.06. Same-store sales slipped 1.5%, worse than analysts had anticipated. Target's outlook for the coming year calls for per-share profits of $3.80 to $4.20, a far cry from the consensus estimate of $5.34 at the time of the report.  Conceding that trendy products alone can't boost store traffic, management pledged to adjust its approach by offering lower prices in order to make itself more competitive with Wal-Mart Stores ($70; WMT) and Amazon.com ($853; AMZN). Target is rated B (average).

In recent quarters, Kroger ($32; KR) has stressed that lower food prices have been driven by weakness in commodity markets — not competitive trends. That may change as Wal-Mart explores slashing grocery prices. In an effort to boost traffic, Wal-Mart is launching a price-comparison test in 1,200 U.S. stores, reported Reuters.

Kroger has steadily taken market share in the deflationary environment. But operating momentum has slowed in recent quarters, causing its Quadrix Overall rank to fall to 68. Kroger was expected to report January-quarter results on March 2, after our deadline. Expectations should be fairly modest, given that Kroger's shares are down 7% in 2017, missing out on the S&P 500 Index's 7% gain. But if Kroger posts a disappointing report, we will consider downgrading the stock on our March 3 hotline.

Kroger is a Long-Term Buy. Wal-Mart Stores is rated B (average).

CommScope wired for bounceback

For the December quarter, CommScope ($39; COMM) grew earnings per share 45% to $0.61 excluding special items, topping the consensus estimate of $0.57. Revenue increased 3% to $1.18 billion, as 13% growth in North America outweighed declines in the other geographic regions. CommScope, which supplies telecom and cable companies with infrastructure gear, announced a $100 million stock-buyback program, equating to roughly 1% of outstanding shares.

CommScope's guidance for the March quarter anticipates 2% to 13% higher per-share profit, well short of the consensus of 23% growth at the time of the announcement. Management's quarterly sales outlook also missed expectations. However, full-year guidance bracketed expectations, with per-share profits expected to climb 10% to 14% on sales growth of 2% to 5%.

Entering the report at an all-time high, the shares slumped on the mixed guidance. The back-loaded outlook adds some risk to the second half of 2017. But the wireless environment appears to be improving, as U.S. spending shows signs of stabilizing, and international spending could ramp throughout the year. CommScope is a Buy and a Long-Term Buy.

Comcast expands in Japan

Comcast ($38; CMCSa) agreed to acquire the remaining 49% stake in Universal Studios Japan for $2.3 billion. Comcast paid $1.5 billion for its initial 51% stake in the park in 2015. The stock is a Buy and a Long-Term Buy.

Rank Changes

Celgene ($124; CELG) is being added to the Long-Term Buy List. J.P. Morgan Chase ($94; JPM), already a Long-Term Buy, is being added to the Buy List. LKQ ($32; LKQ) and QuintilesIMS ($77; Q) are being dropped from the Buy and Long-Term Buy lists, and from coverage.

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