Portfolio Review: August 28, 2017


Tech giants take diverging paths

Applied Materials ($44; AMAT) grew July-quarter earnings per share 72% to $0.86 excluding special items, easing past the consensus estimate by $0.02. Revenue, up 33% to $3.74 billion, also topped analysts' expectations. Operating cash flow climbed 39% and free cash flow 43% to $1.18 billion.

Management now expects industrywide spending on wafer-fabrication equipment to increase at least 20% in 2017, up from its prior forecast of 15% growth. The company also expects spending to rise further in 2018. The midpoint of management's October-quarter outlook calls for growth of 36% for earnings per share and 19% for revenue. At the time of the announcement, the consensus had anticipated 24% higher profits and 12% higher sales. Shares rallied on the report. Applied Materials is a Buy and a Long-Term Buy.

Cisco Systems ($31; CSCO) said per-share profits slipped 3% to $0.61 excluding special items in the July quarter, matching the consensus. Sales declined 4% to $12.13 billion, dragged down by weakness in Cisco's switching and routing segments, both down 9%. Management blamed the lower switching revenue on customers waiting for Cisco to refresh its product line.

However, Cisco's transition toward software and services from its traditional hardware business could remain bumpy. Looking ahead to the October quarter, Cisco expects earnings per share to be flat to down 3%, while revenue is projected to fall 1% to 3%. Shares slumped on the news. Cisco is rated B (average).

Retailers ring up mixed quarter

One of the weakest pockets in the S&P 1500 Index, the average retail stock has generated a total loss of 6% in the past month and 12% in 2017. The group's recent weakness underscores mixed results from last quarter.

Lowe's ($73; LOW) reported July-quarter earnings per share of $1.57 excluding special items, up 15% but $0.04 short of the consensus. Total revenue advanced 7% to $19.50 billion, also missing analysts' forecasts. Same-store sales rose 4.5%, with growth accelerating to 7.9% for the month of July. While that sudden momentum surge seems encouraging, management refrained from raising its full-year revenue target, and its updated guidance for adjusted per-share profits of $4.42 to $4.52 is below the consensus of $4.62.

Rival Home Depot ($149; HD) topped analysts' expectations by growing per-share profits 14%, revenue 6%, and same-store sales 6.3% in the July quarter. Management raised its full-year guidance, citing continued strength in U.S. housing as more first-time home buyers stream into the market.

Outside of home-improvement retail, some of the industry's strongest July-quarter growth came from discounters. TJX ($72; TJX) posted 6% higher revenue and 3% higher same-store sales. Wal-Mart Stores ($80; WMT) said U.S. same-store sales rose 1.8% excluding fuel, helped by 1% traffic growth. Target's ($56; TGT) same-store sales climbed 1.3% — its first growth in a year — on price cuts and 2% higher traffic. All three retailers topped consensus profit estimates. Both TJX and Target raised their full-year profit guidance. Wal-Mart targets 1.5% to 2.0% growth for same-store sales in the October quarter.

But full-priced retailers struggled. July-quarter same-store sales fell 0.4% at Kohl's ($36; KSS), 2.8% at Macy's ($21; M), and 6.0% at Foot Locker ($35; FL). Dick's Sporting Goods ($27; DKS) squeezed out 0.1% higher same-store sales, noting that it was forced to slash prices due to aggressive discounts by competitors.

Lowe's shares slumped on the report but remain a Buy and a Long-Term Buy. Home Depot and Wal-Mart Stores are rated A (above average). Target and TJX are rated B (average).

Technology update

Apple ($160; AAPL) has budgeted $1 billion for acquiring or developing up to 10 TV shows next year, reported The Wall Street Journal. That investment aims to boost Apple's iTunes and music-streaming businesses, a move more likely to pressure Spotify than put Apple in closer competition with Netflix ($169; NFLX) and Amazon.com ($958; AMZN). Facebook ($169; FB) is also pushing into video, as it tries to create compelling online material for its younger audience. Industry researcher EMarketer estimates that usage on Facebook's social networking website will slip 3% this year for U.S. teenagers, who are migrating toward photo-sharing applications such as Snapchat and Instagram, the latter owned by Facebook. Both Apple and Facebook are rated Buy and Long-Term Buy. Netflix and Amazon.com are rated B (average).

Alphabet ($943; GOOGL) has begun to test tools aimed at helping news publishers increase online subscriptions. Alphabet has not said how it would share revenue with media companies, including The New York Times and the Financial Times. In other news, Alphabet may be designing smart headphones that could compete with Apple's AirPods, according to an online report. The device could be ready to launch as soon as this fall, potentially coinciding with the release of a new Chromebook and updated Android operating system. Alphabet is a Focus List Buy and a Long-Term Buy.

VMware ($100; VMW) shares rallied to a three-year high following an analyst upgrade at Deutsche Bank, upbeat results from a survey conducted by J.P. Morgan Chase ($92; JPM), and news of an expanded partnership with Alphabet. J.P. Morgan noted "very positive" survey results from 35 VMware partners, who are increasing their adoption of VMware's management offerings and virtualization servers. Separately, Alphabet will be using VMware to power the digital-workspace platform for Chrome devices. VMware also impressed investors with strong preannounced results on Aug. 14; the company released its full July-quarter report on Aug. 24, after our deadline. VMware is a Focus List Buy and a Long-Term Buy. J.P. Morgan is a Buy and a Long-Term Buy.

Vectren jumps

Vectren ($67; VVC) has reportedly hired an adviser to gauge takeover interest after being approached by a potential acquirer. Vectren operates three utilities that supply electricity or natural-gas service to 1.2 million customers in Indiana and Ohio. With a market value of $5.53 million, Vectren is one of the smaller utilities in the S&P 1500 Index. But it's generating outsized growth, with per-share profits up 21% and sales up 13% for the 12 months ended June. Merger deals in the utility sector have surged 40% to $88 billion this year, according to Bloomberg. The shares surged on the news and are up 28% for the year. For now, Vectren remains a member of our Top 15 Utilities portfolio.

Rank Changes

No changes were made this week in Dow Theory Forecasts.

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