Portfolio Review: June 26, 2017


FedEx delivers solid quarter

FedEx ($212; FDX) said May-quarter earnings per share surged 29% to $4.25 excluding special items, topping the consensus estimate of $3.88. Revenue, up 21% to $15.7 billion, also surpassed expectations. For fiscal 2018 ending May, FedEx expects per-share profits of $13.30 to $14.00, implying 8% to 14% growth, versus the consensus of $13.59 at the time of the announcement. Management also said it may follow the lead of rival UPS ($109; UPS) by introducing surcharges on shipments during the peak holiday season. In other news, FedEx hiked its quarterly dividend 25% to $0.50 per share, payable July 6. FedEx shares rallied on the report and remain a Long-Term Buy. UPS is rated C (below average).

Shifting media landscape thrusts Alphabet and Facebook to the top

A decline in the number of pay-TV subscribers and sluggish TV ratings have forced advertisers to rethink their marketing campaigns. The primary beneficiaries are Alphabet ($979; GOOGL) and Facebook ($154; FB), both seizing big leads over traditional media companies for ad revenue.

Alphabet and Facebook took a combined 20% share of global ad spending in 2016, says media agency Zenith, up from 11% five years ago. Alphabet generated a leading $79.4 billion in ad revenue last year, followed by Facebook at $26.9 billion and Comcast ($40; CMCSa) at $12.9 billion. 

Hoping to build on that momentum, Facebook has begun to court automakers and drug companies, two industries it has yet to penetrate. Advertising has never been more important to Facebook, representing 98% of its revenue, up from 84% in 2012. Facebook's nonadvertising revenue has declined in recent years as popularity wanes for video games played on its network.

Unlike Facebook, Alphabet has used its cloud services and Pixel smartphone to help diversify operations. Ad revenue accounted for 87% of Alphabet's sales in the March quarter, versus 90% a year earlier. By analyzing records of credit-card transactions, users' online-browsing history, and geographic locations, Alphabet has begun to track sales resulting from digital ads — a service advertisers could find valuable.

Alphabet's Overall score of 65 may be deceptively low, for two reasons. First, the stock earns a Value rank of just 36 but looks more reasonably valued when accounting for its massive cash hoard. Its trailing P/E ratio of 26 drops to 23 after excluding net cash of $126 per share. Second, its per-share profits rose just 3% in the March quarter and are projected to slip 1% for the year. But the sluggish profits are largely due to management's decision to no longer exclude stock-based compensation from adjusted earnings per-share. Given the difficulty with year-over year profit comparisons, investors may want to put greater emphasis on Alphabet's revenue, projected to grow 20% for the year.

Separately, antitrust officials from the European Union reportedly plan to hit Alphabet with a record fine due to complaints it skewed Google search results to favor its own shopping service. Intel ($35; INTC) currently holds the dubious distinction of the largest EU penalty, a $1.2 billion fine in 2009.

In other news, Alphabet agreed to sell robotics business Boston Dynamics to SoftBank Group for an undisclosed sum.

Alphabet and Comcast are rated Focus List Buy and Long-Term Buy. Facebook is a Buy and a Long-Term Buy. Intel is rated A (above average).

Technology rally stalls

After racing out to a big lead over the first five months of 2017, technology stocks have stumbled in recent weeks. The S&P 500 Index technology sector has slipped 2% since June 8, while the broad index has held flat. But technology remains up 17% for the year, better than any other sector; the S&P 500 is up 9% in 2017. The pullback probably stems from profit-taking and valuation concerns, rather than weakening fundamentals. As noted in the last issue, technology companies are generating strong operating growth. And analysts remain upbeat on the sector, with the consensus now projecting 12% profit growth in 2017, versus 10% on
April 1, says Thomson Reuters.

Apple ($146; AAPL), one of the year's top performers in the technology space, is down 6% since June 8 but remains up 27% for 2017. The stock has shown signs of stabilizing in the past week, as CEO Tim Cook publicly confirmed for the first time that Apple is designing an autonomous-car system. Apple is a Buy and a Long-Term Buy.

Amazon envelops retailers

Jeff Bezos took his first steps to disrupt the retail industry when Amazon.com ($1,002; AMZN) was little more than a bookstore run out of his garage. Now, as the fourth-largest U.S. company by market value, Amazon still finds new ways to upend the industry.

Most recently, Amazon agreed to acquire Whole Foods Market ($43; WFM) for $13.7 billion. The deal would expand the internet retailer's presence in both physical stores and the grocery market. It also illustrates the crisscrossing strategies of Amazon and Wal-Mart Stores ($76; WMT). Wal-Mart announced that same day that it will spend $310 million to acquire Bonobos, an online retailer of men's clothing. Kroger ($22; KR) shares plunged on the news, just one day after the grocer cut its full-year guidance due to stiff competition from Wal-Mart and the emerging presence of low-price German supermarkets. 

Amazon.com is also exploring ways to spread its tentacles into online grocery in India, online car sales in the U.K., and retail pharmacy in the U.S. Additionally, Nike ($53; NKE) is reportedly close to forging a pact to sell its products directly on Amazon's website, a development that would likely hurt Foot Locker ($48; FL).

Lowe's ($79; LOW), our sole recommended retailer, appears shielded from Amazon's reach for now. Wal-Mart Stores is A (above average). Amazon.com is rated B (average). Nike is rated B (average). Kroger is B (average). Lowe's is a Focus List Buy and a Long-Term Buy.

Corporate roundup

Alaska Air Group ($91; ALK) said traffic increased 7.6% in May on 5.9% higher capacity. The company also increased its June-quarter and full-year guidance for cost per available seat mile, due to higher pilots' wages. Alaska Air is a Buy and a Long-Term Buy.

D.R. Horton ($34; DHI) formally entered talks to acquire a 75% stake in real estate developer Forestar Group ($16; FOR) for about $520 million. D.R.
Horton is a Buy and a Long-Term Buy.

EQT Midstream Partners' ($72; EQM) shares rallied after parent EQT Corp. ($51; EQT) agreed to acquire Rice Energy ($24; RICE). EQT Corp. says it may merge Rice's midstream assets with EQT Midstream next year. EQT Midstream is a Long-Term Buy.

Rank Changes

No changes were made this week in Dow Theory Forecasts.

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