Portfolio Review


Don't charge into Visa, MasterCard

MasterCard ($250; MA) and Visa ($86; V), recent additions to our improved Monitored List, are very similar. Both process billions of transactions every year. Neither company issues credit or debit cards, sets cardholder fees, or provides loans to card users. MasterCard earns a Quadrix® Overall score of 88, while Visa scores 89. Both companies have impressive profit momentum and score above 90 for Earnings Estimates. In 2010, MasterCard is expected to grow per-share earnings by 19%, versus 21% for Visa.

While MasterCard and Visa both earn A (above average) ratings, somewhat rich valuations are keeping them off our Buy List. The stocks earn below-average Value scores and seem expensive. Based on trailing earnings, MasterCard has a P/E ratio of 24 and Visa 26. Meanwhile, processing fees collected by both companies on debit-card transactions have come under scrutiny. In addition, controversy is brewing over interchange fees (also called swipe fees), which relate to the price a merchant pays a card issuer when a credit card is used. MasterCard and Visa would be more attractive on price pullbacks of 15% to 25%, or after we gain some confidence that the fee issues will be resolved without a major effect on the companies’ revenue.

Dolby brings 3-D into focus

The movie Avatar — $1.34 billion of tickets sold worldwide in its first four weeks of release — caps a year that embraced 3-D technology. Dolby Laboratories ($50; DLB), producer of one of the three major 3-D formats used in U.S. theaters, has benefited from the enthusiasm. The stock jumped nearly 46% in 2009 and in January rose to heights not seen in two years.

3-D digital equipment generates only a small portion of Dolby’s revenue (it folds into the products division, which produced 13% of sales in fiscal 2009 ended September). But the technology could become a long-term growth driver if 3-D movies become theater staples and 3-D TV finds its place in middle-class homes over the next decade. DirecTV ($33; DTV) and Panasonic ($16; PC) plan to launch three high-definition 3-D channels by June.

Dolby’s sales depend on consumer spending. Consumer-electronics sales dipped about 1% during the holiday season and are expected to be sluggish in 2010. Wall Street sees Dolby’s per-share profits sliding 8% in fiscal 2010 before bouncing back 17% in fiscal 2011. Dolby is a Focus List Buy. DirecTV is a Focus List Buy and a Long-Term Buy.

Retail review

GameStop ($21; GME) reported flat holiday sales of $2.86 billion but an 8.6% decline in same-store sales, slashing guidance for the January quarter. GameStop said winter storms and unexpected shortages of key products contributed to the disappointing performance. An initiative by Wal-Mart Stores ($55; WMT) to reduce prices on video games likely cut into GameStop’s revenue as well. The news disappointed investors, especially as GameStop had issued upbeat sales guidance in mid-December. In other news, GameStop says it expects to repurchase $300 million in shares in fiscal 2011 ending January, which at current prices would reduce the share count by 9%. While the sales news is disappointing, GameStop’s cheap valuation and strong free cash flow suggest the shares have the potential to rebound to $24 or $25 over the next six months. The stock remains a Buy.

TJX ($38; TJX) posted 14% higher same-store sales for December, easily topping the 5.6% consensus. The retailer raised January-quarter profit guidance, now projecting growth of at least 41%. At least two analysts promptly downgraded the stock, but in our view, TJX remains reasonably valued and faces modest sales comparisons for the first three months of 2010. Earning a Quadrix Overall score of 97, TJX is a Long-Term Buy.

Health-care report

Hospira ($52; HSP) plans to slash its work force by 10%, with the savings — between $110 million to $140 million by 2011 — to be plowed into research and development. Hospira will also consider divesting noncore businesses. Hospira is a Focus List Buy and a Long-Term Buy . . . Teva Pharmaceutical Industries ($59; TEVA) settled a longstanding patent dispute over AstraZeneca’s ($47; AZN) acid-reflux medication Nexium. The agreement will protect AstraZeneca’s sales from generic competition until Teva enters the U.S. market on May 27, 2014. AstraZeneca is a Buy and a Long-Term Buy . . . Stryker ($55; SYK) reported sales of $1.83 billion for the December quarter, up 7% and slightly above the consensus. For 2010, the company projects earnings growth of 8% to 12%, in line with Wall Street forecasts. Stryker is a Buy and a Long-Term Buy.

Energy update

Chevron ($80; CVX) warned that December-quarter per-share earnings will be probably lower than the recent consensus estimate of $1.75. The weakness stems in part from down stream operations, as refining margins shrank. Chevron remains a Long-Term Buy . . . Transocean ($90; RIG) and Exxon Mobil ($70; XOM) are discussing a contract to build a drilling rig for use in the Arctic. The rig could potentially cost $1 billion to construct and earn day rates near $650,000, the current record high. Transocean is a Focus List Buy and a Long-Term Buy. Exxon is rated Neutral.

Corporate roundup

Microsoft ($30; MSFT) CEO Steve Ballmer, presenting a new computer that could extend sales momentum, said U.S. sales of personal computers running on Windows rose 50% over the holidays. A touch-screen tablet computer designed by Hewlett-Packard ($52; HPQ) should go on sale later this year. Apple ($208; AAPL) could unveil its version of a tablet computer in the next few weeks. Microsoft is rated a Long-Term Buy. Hewlett-Packard is a Buy and Long-Term Buy.

Alcoa ($16; AA) earned $0.01 per share excluding restructuring charges and other special items, $0.05 below the consensus estimate. Sales dipped 4% to $5.43 billion on weakness in aerospace, industrial gas turbines, and commercial building and construction. Shares plunged 11% on the news. Alcoa is rated C (below average).

Don’t rush into Berkshire

As an insurance holding company, Berkshire Hathaway ($3,300; BRKb) owns a stable of property and casualty insurers, including GEICO. It also operates a diverse collection of businesses including electric utilities, retailers, and makers of candy, ice cream, cleaning supplies, and jewelry. Berkshire reports operations in three segments: insurance and other (83% of sales in the nine months ended September), utilities and energy (10%), and finance and financial (7%).

Berkshire’s $57.41 billion portfolio of equity securities includes positions of at least $3 billion in Coca-Cola ($57; KO), Wells Fargo ($28; WFC), Procter and Gamble ($61; PG), American Express ($42; AXP), and Kraft Foods ($29; KFT).

In a $26 billion cash-and-stock deal, Berkshire agreed to purchase the remaining 77.4% of Burlington Northern International ($99; BNI), the country’s largest rail transporter of coal and grain. In connection with the deal, Berkshire will split its class B shares 50-to-1. Earning a Quadrix Overall score of 52, Berkshire is rated B (average).

No changes were made this week in Dow Theory Forecasts.

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