Portfolio Review


Forecasts lists outperform
So far, 2009 has been a good year for the Forecasts. All three of our recommended lists are beating the S&P 500 Index by a wide margin. Technology stocks have performed particularly well this year, and our lists have been overweight in technology. Our oilfield-services favorites have also rallied strongly in recent days.

As of May 19, our Focus List was up 8.8%, with the Buy List up 8.7% and the Long-Term Buy List up 6.5%. In contrast, the S&P 500 Index was up just 0.5%. All three lists have also outperformed the S&P 500 Index by at least 10 percentage points since the start of 2003, as shown in the chart on page 6. The returns cited in this paragraph exclude dividends and transaction costs and assume fully invested portfolios.

This week, we are making a change on the Buy List, dropping Chevron ($66; CVX) and replacing it with Precision Castparts ($82; PCP).

Chevron has seen its Quadrix® scores drop in recent months, with the Overall rank down to 74 from the mid-90s in March. The stock has recovered 17% from March lows, making Chevron reasonably valued but not necessarily cheap. The shares trade at 13 times estimated profits of $5.13 per share over the year ahead, compared to the average of 11 for integrated oil companies.

A well-publicized pollution-related lawsuit pending in Ecuador seems unlikely to result in a cash payout because Chevron has no assets in the country. Still, a negative verdict could cast a pall on the shares. Chevron is being dropped from the Buy List, but a solid production portfolio suggests the stock still warrants a Long-Term Buy rating.

Precision Castparts faces two quarters of difficult profit comparisons but is expected to grow per-share earnings 2% in fiscal 2010 ending March, a target the company may be able to exceed. The shares look cheap at less than 11 times expected fiscal 2010 earnings of $7.65 per share.

The stock represents an attractive way to play the rebound in commercial aerospace that seems likely over the next 12 to 18 months. Precision Castparts is a supplier of the 787 Dreamliner, a next-generation passenger jet Boeing ($45; BA) expects to begin delivering in the March quarter of 2010. Precision Castparts provides roughly $5 million of material for each plane, making components for the engine, fasteners, and airframe. Precision Castparts, already a Long-Term Buy, is being added to the Buy List.

News roundup
The Defense Department canceled Lockheed Martin’s ($81; LMT) $13 billion contract to develop presidential helicopters. Although the government had already spent $3 billion on the ambitious project, the decision was widely anticipated as a measure to pare down the defense budget. Lockheed Martin is a Long-Term Buy . . . Biogen Idec ($51; BIIB) dismissed the reasoning behind billionaire investor Carl Icahn’s proposal to split the company and sell off underperforming divisions. However, management said it would consider any “credible acquisition proposals.” Biogen is a Focus List Buy and a Long-Term Buy . . . Johnson & Johnson ($56; JNJ) received U.S. approval to widen its marketing of Risperdal Consta, an antipsychotic drug, to treat bipolar I disorder. In other news, J&J said a clinical study showed its new drug-releasing heart stent outperformed a device offered by rival Boston Scientific ($9; BSX). J&J is a Focus List Buy and a Long-Term Buy. Boston Scientific is rated Neutral . . . Harris ($31; HRS) plans to spin off its Harris Stratex Networks ($6; HSTX) unit as a taxable dividend May 27. Shareholders will receive 0.2484 shares of Harris Stratex Class A common stock for each share of Harris they own. Harris is rated Neutral . . . Allegheny Energy ($25; AYE) shares have slid 16% in the last five trading days, in part because of disappointing results from an energy auction for June 2012 through May 2013. Allegheny Energy is not on the Buy List or Long-Term Buy List but is included in our Top 15 Utilities portfolio . . . Airgas ($43; ARG) raised its quarterly dividend 13% to $0.18 per share, payable June 30. Airgas is a Buy.

April-quarter results
Hewlett-Packard ($35; HPQ) earned $0.86 per share excluding special items, down 1% and in line with the consensus. Revenue fell 3%, but rose 3% excluding currency losses. H-P lowered its revenue guidance for the July quarter and the year ending October, and the shares dipped on the news. The news is not encouraging, but at just nine times expected year-ahead earnings, H-P’s share price already reflects some uncertainty. The stock remains a Buy and Long-Term Buy.

Wal-Mart Stores ($49; WMT) earned $0.77 per share, up 1% and in line with the consensus. Revenue slipped 1% to $93.47 billion, but rose nearly 5% excluding losses on currency exchange. U.S. same-store sales increased 3.7% excluding gasoline. Wal-Mart Stores is a Long-Term Buy.

Financial review
Aflac ($34; AFL) sold $850 million of 10-year bonds with a coupon rate of 8.50%, which represents a risk premium of 5.30% above the Treasury rate. Investment-grade corporate bonds average a premium of about 6% over Treasurys, suggesting Aflac got a relatively good deal relative to its peers. The company’s investment losses appear manageable and its balance sheet looks well-capitalized. Aflac is a Long-Term Buy.

Bank of America ($11; BAC) raised $13.5 billion through a stock offering, and the U.S. Treasury Department said the nation’s largest banks raised $48 billion of the $75 billion needed to cover potential shortfalls. Bank of America is rated Neutral.

Goldman Sachs ($141; GS) and Morgan Stanley ($29; MS) have applied to repay $20 billion borrowed under the Treasury Department’s Troubled Asset Relief Program (TARP). J.P. Morgan Chase ($36; JPM) and American Express ($25; AXP) also said they want to repay TARP money. Banks may not repay the money unless they can pass another stress test, issue debt not guaranteed by the government, and convince their regulator that the repayment will not jeopardize their financial soundness. Goldman Sachs, Morgan Stanley, J.P. Morgan, and Amex are rated Neutral.

The government may need to issue additional TARP funds to regional and local banks. Many of these banks face a crush of potential losses on commercial real estate, and total losses could exceed $200 billion by 2010 if conditions worsen, according to a Wall Street Journal study.

Several major insurers gained preliminary approval to tap TARP loans, but some are cautious about approaching the government for money after seeing the banks encumbered with unwelcome restrictions. Ameriprise ($29; AMP) said no thanks, as did Allstate ($27; ALL). Hartford Financial ($16; HIG) and Lincoln National ($18; LNC) appear more likely to accept federal aid. Hartford, Lincoln, Allstate, and Ameriprise are rated Neutral.

Credit-card companies are facing their own troubles, as defaults rose to record highs in April. Citigroup ($4; C), Wells Fargo ($25; WFC), and J.P. Morgan Chase ($36; JPM) saw loss rates rise sharply. In related news, a bill halting sudden interest-rate hikes and hidden fees has moved to the House of Representatives, and President Obama could sign it into law by the end of May. Citigroup, Wells Fargo, and J.P. Morgan are rated Neutral.

Chevron ($66; CVX) is being dropped from the Buy List but remains a Long-Term Buy. Precision Castparts ($82; PCP) is being added to the Buy List.

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