Portfolio Review: April 3, 2017


Carnival cruises to new highs

Carnival ($59; CCL) earned $0.38 per share in the February quarter, down 3% but $0.03 above the consensus. Revenue increased 4% to $3.79 billion. Stronger demand and higher ticket prices helped offset rising fuel expenses and unfavorable foreign-currency trends. The company also said advance bookings are running well ahead of 2016 levels.

For the May quarter, Carnival expects earnings per share of $0.43 to $0.47, versus the consensus of $0.46 and year-ago profits of $0.49. Management also raised the midpoint of its full-year guidance for per-share profits to $3.60, up from its prior target of $3.45. The consensus stood at $3.61 at the time of the announcement. Shares rallied to a record high on the report. Carnival is a Buy and a Long-Term Buy.

PBMs combat criticism

With drug prices marching incessantly higher, drugmakers have become a popular punching bag for politicians. Drugmakers have tried to pass the blame to pharmacy-benefit managers (PBMs), who play the role of middlemen for setting prices. This scrutiny has caused some investors to question whether the PBM model is sustainable.

PBMs, such as CVS Health ($79; CVS), Express Scripts ($65; ESRX), and UnitedHealth Group's ($163; UNH) OptumRX, are hired by insurers and employers to negotiate lower prices for drugs, often in the form of rebates. These rebates, based on a percentage of a drug's list price, are passed on to clients, with PBMs taking a small cut. Express Scripts, for instance, takes just 10% to 15% of rebates. But their cut has soared along with drug prices in recent years.

One would think that recent consolidation within the PBM industry would help control drug prices. But list prices for branded drugs rose 6% in both January and February from year-earlier levels, after rising an average of 8% in 2016. Some experts say the arrangement with PBMs has forced drugmakers to increase prices even higher to accommodate rebates. Gilead Sciences ($67; GILD) claims PBMs would balk if the company suddenly dropped prices for its drugs, which would also lower rebates.

PBMs say drugmakers are solely responsible for setting list prices. Citing their leverage, PBMs claim they serve as a crucial check on drugmakers and prices would be even higher without the rebate system. PBMs are also incentivized to find cheaper alternatives, such as generic treatments or lower-cost channels. Additionally, rebates are believed to represent a small portion of PBMs' profits. They generate the bulk of their revenue from administration fees, mail and specialty pharmacy dispensing, and clinical programs. Finally, PBMs risk losing business if rivals extract greater savings from drugmakers.

Nevertheless, CVS shares trade at just 13 times trailing earnings, near their lowest level since 2011. That discount reflects a couple of other risks. CVS lost a couple of pharmacy contracts last November. Its front-of-store business also faces online threats, as more shoppers turn to the likes of Amazon.com ($874; AMZN) for replenishing such basic goods as soap and toothpaste. CVS is a Long-Term Buy. UnitedHealth is rated A (above average). Amazon.com, Express Scripts, and Gilead are rated B (average).

iPhone hopes buoy Apple

Apple's ($144; AAPL) stock reached a record high in the final days of March as optimism builds for its all-important iPhone. The iPhone seems due for a major revamp this fall.

The latest speculation suggests the device could go by the name iPhone Pro and feature 3-D facial recognition, a glass front and back, and wireless charging. It could carry a $1,000 price tag, up from a starting price of $649 for the iPhone 7 and $769 for the larger iPhone 7 Plus. Encouragingly, Apple will release the device at a time when the average iPhone age is rising and its user base expanding. Both trends could boost upgrades for the next iPhone.

Apple shares have generated a total return of 25% in 2017 — higher than 96% of stocks in the S&P 500 Index, which has an average return of 5%. The rally has pushed Apple's Quadrix Value score down to 59, its lowest since November 2014. Shares now trade at 17 times trailing earnings, their highest level since February 2015 but below the average of 21 for S&P 500 technology stocks.

The strong share-price action appears warranted. Based on supplier sales data, iPhone shipments for the March quarter were tracking above expectations, say analysts at Goldman Sachs ($228; GS). The consensus expects Apple to report March-quarter earnings per share of $2.01, up 6%, on revenue of $52.88 billion, up 5%.

In the past 10 quarters, Apple has surpassed consensus profit estimates nine times and sales estimates eight times. Apple is a Buy and a Long-Term Buy. Goldman is rated A (above average).

Stick with CFG despite false information

Facing pressure to meet corporate targets, 11 former and current workers at Citizens Financial Group ($34; CFG) say they provided false information about customer meetings that never occurred. The meetings were intended as financial checkups for customers, with the goal being to sell more banking products. The workers' claims do not show any sign that the bank opened fraudulent customer accounts, as happened at Wells Fargo ($56; WFC). But Citizens Financial did report the number of customer appointments to investors, implying that the meetings could boost sales. Citizens Financial shares slipped on the news but remain a Focus List Buy and a Long-Term Buy. Wells Fargo is rated A (above average).

ACA here to stay (for now)

Shares of Centene ($71; CNC) and Laboratory Corp. of America ($143; LH) rose after House Republicans shelved a bill to replace the Affordable Care Act (ACA). Republicans claim they will revisit repealing ACA. But such a plan could get more complicated as a growing number of states explore expanding their Medicaid programs. Kansas voted to expand Medicaid in late March, though the state's Republican governor has yet to sign off on the plan. Virginia, Maine, and North Carolina are also considering taking similar measures. Currently, 31 states have expanded Medicaid. Centene and LabCorp are rated Focus List Buy and Long-Term Buy.

Corporate roundup

Alaska Air Group ($94; ALK) plans to dissolve the Virgin America brand in 2019. Management had previously considered keeping the brand, acquired in a $2.7 billion deal last year. Alaska Air is a Buy and a Long-Term Buy.

Applied Materials ($39; AMAT) announced plans to sell $2.2 billion of debt. At the end of January, Applied Materials held $4.15 billion in cash on its balance sheet, versus $3.13 billion in debt. Applied Materials is a Buy and a Long-Term Buy.

As more consumers shun traditional cable, Comcast ($37; CMCSa) seeks to roll out a rebranded streaming-video service in the September quarter. Comcast hopes the service, reportedly priced at $15 to $40 a month, will eventually lead subscribers to upgrade to more expensive services. Comcast has already acquired rights from programmers to offer cable networks nationally, rather than just within its regional territories. That move could help Comcast bring its streaming-video business to new markets. In other news, Comcast's NBC will broadcast live all events for the 2018 Winter Olympics, to be held in South Korea. In the past, NBC streamed live events online but broadcasted popular events on tape delay for prime-time audiences. Comcast is a Buy and a Long-Term Buy.

Disney ($113; DIS) extended CEO Bob Iger's contract to July 2019. This marks the third time Iger has postponed his retirement, illustrating Disney's struggles in finding a successor. Disney is a Long-Term Buy.

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