Portfolio Review


Upgrades & downgrades

Based on December-quarter results, company prospects, valuations, and Quadrix® scores, the Forecasts is making several rank changes.

First, the downgrades:

AstraZeneca ($45; AZN) is being dropped from the Buy List and Long-Term Buy List. The drug company reported December-quarter profits of $1.42 per share, up 14% but $0.10 below the consensus estimate. Sales advanced 9% to $8.95 billion, above analyst expectations. AstraZeneca said it would repurchase up to $1 billion of shares this year, raise its dividend, and slash the work force. The shares, however, fell on the company’s disappointing guidance, which projects per-share earnings will fall 3% to 9% in 2010.

The outlook seems unlikely to improve in the near term, given that generic competition threatens to bite into profits as major patents expire in the coming years. Wall Street anticipates per-share earnings will decline 4% annually over the next five years. Also, the company must fend off lawsuits related to Schizophrenia drug Seroquel, with legal costs possibly reaching $1.2 billion. While AstraZeneca is attractively valued, the worse-than-anticipated 2010 outlook suggests the stock will be hard-pressed to make much headway this year. With better year-ahead and long-term plays available, selling AstraZeneca seems prudent. On our Monitored List, AstraZeneca is being downgraded to B (average).

Qualcomm ($39; QCOM) was dropped from the Long-Term Buy List on the Jan. 29 hotline, reflecting its disappointing guidance for the March quarter. Qualcomm makes chipsets and other technologies used in mobile phones and smartphones. Although this is a growing market, two of Qualcomm’s biggest customers are struggling to gain share. Also, tougher competition from new players is putting pressure on prices, a trend likely to continue over the next year. Qualcomm’s inability to grow in a growing market suggests the company could disappoint again. On our Monitored List, Qualcomm is being downgraded to B (average).

Now, the upgrades:

Advance Auto Parts ($41; AAP) is being added to the Long-Term Buy List. The company operates more than 3,400 stores under four different names. The traditional business involves selling auto parts and accessories to do-it yourself customers. Advance Auto is also moving into the market for supplying parts to garages, a potential growth kicker.

The stock boasts strong Quadrix scores, rising cash flow, and an attractive valuation. For 2009, same-store sales climbed 6.1% through Oct. 10, while per-share earnings rose 10%. December-quarter results, expected around Feb. 17, are expected to show a 10% drop in per-share earnings. But the company has a history of exceeding expectations, and 2010 per-share earnings are expected to rise 7%. Advance Auto is being initiated as a Long-Term Buy.

Initiated as a Long-Term Buy on the Jan. 29 Hotline, Ross Stores ($47; ROST) is being added to the Buy List. There is some risk in adding the stock before January sales are released Feb. 4, but early indications point to positive results. Free cash flow has shown year-to-year growth for seven consecutive quarters.

Two chains — Ross Dress for Less and dd’s DISCOUNTS — combine for 1,008 stores that sell off-price apparel and home accessories, an attractive niche considering U.S. consumers’ emphasis on value. Ross also offers a compelling value to investors at 15 times trailing earnings, a 16% discount to the five-year average. Ross is a Buy and a Long-Term Buy.

General Mills ($71; GIS) is being added to the Focus List. The company offers a pantry of strong brands, including Cheerios, Wheaties, Gold Medal, and Green Giant. Sales to retailers have held up well as more people are eating at home. Management says it has gained share in the soup market and notes that cereal and yogurt products are also performing better than expected.

General Mills trades at less than 14 times trailing earnings, compared to the five-year average of 16. The consensus sees per-share profits growing 18% in the February quarter on 3% higher sales. Already a Buy and a Long-Term Buy, General Mills is being added to the Focus List.

December-quarter earnings

Comcast’s ($16; CMCSa) per-share earnings rose 16% to $0.29 excluding special items, $0.02 above Wall Street’s forecast. Sales increased 3% to $9.07 billion, also topping the consensus. Average total revenue per video customer climbed 6% to $118. Comcast grew its total customer count by 5% from a year ago. Comcast is a Focus List Buy and a Long-Term Buy . . . Aflac ($50; AFL) grew earnings 20% to $1.18 per share excluding investment losses, $0.03 above the consensus. Revenue advanced 8% to $4.60 billion, well short of Wall Street projections. Aflac offered 2010 guidance with a midpoint of $5.36, ahead of the consensus estimate at the time of the announcement. Aflac is a Focus List Buy and a Long-Term Buy . . . CA ($22; CA) reported flat earnings of $0.43 per share excluding special items, topping the consensus by a penny. Sales climbed 8% to $1.3 billion, or 4% in constant currency. Bookings rose 10%, while the backlog climbed 13% to $7.92 billion. In other news, CA named William McCracken CEO, replacing John Swainson, who in September announced plans to retire. CA is a Focus List Buy and a Long-Term Buy . . . Dolby Laboratories ($51; DLB) earned $0.60 per share excluding noncash expenses, special charges and gains, and an accounting change, down 2% but $0.11 above the consensus. Revenue rose 13% excluding the accounting change, helped by demand for digital-audio and 3-D movie systems. For fiscal 2010 ending September, the company offered revenue and profit guidance above market expectations. Dolby is a Focus List Buy . . . National Oilwell Varco ($43; NOV) shares bounced after the company reported profits of $0.96 per share, down 33% but $0.19 ahead of the consensus. Revenue declined 18% to $3.13 billion. The backlog stands at $6.4 billion, down 12% from the end of September. National Oilwell Varco is a Buy and a Long-Term Buy . . . Microsoft’s ($28; MSFT) per-share profits surged 57% to $0.74, $0.15 above the consensus. The company generated $19.02 billion in revenue, up 14%, lifted by strong demand for its new Windows 7 operating system. Recognition of previously deferred revenue related to Windows 7 was $1.71 billion and accounted for all but $0.01 of the per-share-profit surprise. Microsoft said it has not yet seen a rebound in corporate spending but still expects a recovery later this year. Microsoft is rated a Long-Term Buy . . . Hewitt Associates ($39; HEW) grew earnings 4% to $0.71 per share, $0.03 shy of Wall Street’s forecast on roughly flat revenue. Hewitt also said it will spin off its executive-consulting business into a separate company to ease fears of conflicts of interest. Hewitt did not disclose terms of the transaction but said the business accounts for 2% to 3% of company revenue. The deal will reduce profits by $0.02 in fiscal 2010 ending September and $0.07 to $0.10 a year thereafter. Hewitt is a Focus List Buy . . . Chevron’s ($74; CVX) profits plunged 37% to $1.53 per share, missing the consensus by $0.17. The upstream business increased earnings 27%, but downstream operations posted a $613 million loss, compared to a $2.08 billion profit in the year-ago quarter. Operating revenue rose 10%, helped by 9% higher production. While the refining business flounders, the production growth is encouraging. Chevron remains a Long-Term Buy.

Health-care review

Baxter International ($58; BAX) earned $1.03 per share excluding a restructuring charge in the December quarter, up 13% and matching the consensus estimate. Sales jumped 11%. The midpoint of 2010 profit guidance was $0.04 below the consensus, but Baxter is known for its conservative projections. Baxter is a Long-Term Buy . . . Boston Scientific ($8; BSX) will pay Johnson & Johnson ($64; JNJ) $1.73 billion to settle a lengthy legal battle over patents for drug-eluting heart stents. Boston Scientific agreed to pay $1 billion up front, with the balance due next January. J&J is a Long-Term Buy.

General Mills ($71; GIS) is being added to the Focus List. AstraZeneca ($45; AZN) and Qualcomm ($39, QCOM) were dropped from our buy lists. Ross Stores ($47; ROST) and Advance Auto Parts ($41; AAP) were initiated as Long-Term Buys. Ross was added to the Buy List.

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