Portfolio Review: October 23, 2017


Bank stocks slip on solid results

Bank stocks have helped drive the S&P 500 Index higher since August. But a series of decent September-quarter reports were not enough to keep bank shares from giving away some of their recent gains.

J.P. Morgan Chase ($98; JPM) grew September-quarter earnings per share 11% to $1.76, topping the consensus by $0.11. Revenue advanced about 3%, also ahead of analysts' forecasts. The bank overcame a 21% slump in trading revenue by posting 7% higher average core loans and 9% higher average deposits. Net interest margin crept up to 2.4% from 2.2% in the year-ago quarter. Loan defaults rose, forcing J.P. Morgan to set aside $1.46 billion in provisions for future loan losses, up 24%. Management expects trading revenue to remain weak in the December quarter. Separately, J.P. Morgan agreed to acquire WePay, a company that processes online payments. The deal was valued at more than $220 million, reported The Wall Street Journal. J.P. Morgan is a Buy and a Long-Term Buy.

Comerica's ($77; CMA) per-share profits jumped 40% to $1.26 excluding special items in the September quarter, exceeding the consensus of $1.19. Revenue grew 6%, and net interest margin rose to 3.3% from 2.7%. Although total loans slipped 1% from the year-ago quarter, the yield Comerica earned on its loans rose, helped by higher interest rates. Unlike other banks, Comerica said its credit quality remains strong, with its allowance for credit losses declining 2%. For the December quarter, management expects loans to increase 1% from the September quarter. Comerica is a Buy and a Long-Term Buy.

A couple themes are emerging now that many of the largest U.S. banks have posted their quarterly results. Despite a favorable labor market, consumer credit quality appears to be deteriorating. Additionally, the U.S. Federal Reserve has increased short-term interest rates, but long-term yields remain stubbornly low, limiting banks' ability to expand their net interest margins (the spread between what banks earn on deposits and what they charge for loans). Banks continue to rely on cost cuts and modestly higher loan demand to drive profit growth.

Health stocks zigzag on executive orders

Shares of health insurers and hospitals slumped after President Trump signed a pair of executive orders to let insurers sell less-comprehensive health plans and discontinue monthly insurance subsidies. The federal payments, expected to cost $7 billion this year and $10 billion in 2018, help lower-income Americans afford health plans offered under the Affordable Care Act.

More than 80% of people with ACA insurance receive subsidies. So far, 18 states have filed lawsuits to block Trump's move. In the days since Trump's executive order, two U.S. senators proposed a bipartisan bill that would continue the insurance subsidies for two more years, while allowing states to offer a broader menu of health plans.

Many of the stocks, including Centene ($94; CNC), have recovered most of the ground initially lost on Trump's announcement. An analyst at Morgan Stanley ($50; MS) estimates that ACA exchanges represent 8% of Centene's business, and of that amount just 60% of customers receive the subsidies. Centene CEO Michael Neidorff said the company had raised premiums for 2018 in anticipation that the subsidies would end. "We see it having a minimal impact, if any," Neidorff told The Wall Street Journal. His comments were echoed by several other insurers. Centene is a Focus List Buy and a Long-Term Buy. Morgan Stanley is rated A (above average).

UnitedHealth Group ($205; UNH) grew September-quarter earnings 23% to $2.66 excluding special items, topping the consensus by a dime. Revenue advanced 9%. Although UnitedHealth has pulled out of most ACA markets, it now sees opportunities to boost growth by offering the skimpy health plans promoted by Trump. Management raised its 2017 outlook and projects profit growth of 13% to 16% in 2018. UnitedHealth is rated A (above average).

Celgene ($137; CELG) reported encouraging results from studies involving an experimental treatment for Crohn's disease and ulcerative colitis, both forms of inflammatory bowel disease. Celgene is a Focus List Buy and a Long-Term Buy.

Airlines update

Alaska Air Group ($80; ALK) reported 8.4% higher traffic in September on 10.1% capacity growth. Its load factor, a key efficiency metric, slipped to 82.9% from 84.2%.

Despite the decent operating results, shares of Alaska Air dropped after rival Southwest Airlines ($59; LUV) announced plans to launch service to Hawaii in 2018. Hawaii and Costa Rica combined for 17% of Alaska Air's flight capacity last year. The entry of discount carrier Southwest into the Hawaii market may pressure airfares.

In other news, Southwest raised prices $2 to $5 on many of its one-way flights. Rival airlines tend to match Southwest's price adjustments. Both Alaska Air and Southwest are rated Buy and Long-Term Buy.

Technology review

Qualcomm ($52; QCOM) filed a patent lawsuit against Apple ($160; AAPL) to block the production and sale of iPhones in in China. The lawsuit is just the latest skirmish between two companies that have battled over royalties in the past year.

In other news, the iPhone 7 has reportedly outsold the iPhone 8 since the newest model was launched last month. Prices for the iPhone 7 start at $549, or $150 below the iPhone 8. This emerging sales pattern suggests a bifurcation in Apple's smartphone market, as many shoppers gravitate toward the cheaper iPhone 7 or wait for the company's priciest smartphone yet, the iPhone X, due out on Nov. 3. Apple manufacturer Foxconn has reportedly begun shipping the iPhone X, priced at $999. Due to a series of production delays, initial shipments are significantly lower than prior models but are expected to ramp after October. Apple is a Buy and a Long-Term Buy. Qualcomm is rated B (average).

Seeking to reach more online users, Target ($60; TGT) expanded its home-delivery service with Alphabet ($1,013; GOOGL) to the entire U.S. Wal-Mart Stores ($86; WMT) partnered with Alphabet last month. Alphabet is a Focus List Buy and a Long-Term Buy. Wal-Mart is rated A (above average). Target is rated B (average).   

Facebook ($176; FB) announced plans to launch Oculus Go, a mobile version of its virtual-reality headset Oculus Rift. The device, due out early next year, will cost $199. Facebook is a Focus List Buy and a Long-Term Buy.

Corporate roundup

U.S. retail sales rose 1.6% in September from August levels, partly reflecting higher gasoline prices and consumers replacing vehicles damaged by hurricanes Harvey and Irma. Retail sales climbed 0.5% excluding fuel and automobiles. Consumer sentiment, as measured by the University of Michigan, has reached its highest level since 2004.

T-Mobile US ($61; TMUS) and Sprint ($7; S) are planning to announce their merger by early November, reported Reuters. The deal would combine the third- and fourth-largest wireless carriers in the U.S. Sprint and T-Mobile are rated B (average).

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