Portfolio Review


Raytheon in, Ross up, Hewitt out

While all defense contractors face risks in the current political climate, Raytheon ($55; RTN) appears better-positioned than most to thrive in coming years. A focus on intelligence, surveillance, and reconnaissance has helped fuel per-share-profit growth of at least 13% in seven of the last eight quarters — and should render Raytheon less susceptible to future contract losses.

At 11 times expected year-ahead earnings, the stock trades at a 23% discount to its five-year average forward price/earnings ratio. Raytheon is earning a reputation for quality in the defense group, which could translate to a higher P/E ratio going forward.

Wall Street projects per-share-profit growth of 2% this year and 6% next year. Profits topped the consensus by at least 5% in each of the last four quarters, and expectations for 2010 seem conservative. Raytheon, already rated A on our Monitored List, is being added to the Buy List.

Ross Stores ($47; ROST), profiled in Analysts' Choice, is being added to the Focus List. The stock was already a Buy and a Long-Term Buy.

Benefits administrator Hewitt Associates ($38; HEW) is being dropped from the Buy List and Focus List. The stock has climbed 6% since we initiated coverage in late September, versus a 4% gain in the S&P 500 Index. In 2010, however, the shares have sputtered in the wake of disappointing December-quarter profits. Hewitt’s declining earnings estimates and Quadrix® scores also suggest it is time to cut the stock loose. Hewitt is being dropped from the Monitored List.

H-P tops estimates

Hewlett-Packard ($49; HPQ) grew per-share profits 18% to $1.10 excluding special items for the January quarter, $0.04 better than the consensus estimate. Revenue jumped 8% to $31.18 billion, also beating the consensus. For fiscal 2010 ending October, H-P provided sales and profit guidance that exceeded Wall Street projections.

In other news, H-P received approval from the European Union to purchase 3Com ($8; COMS) for about $3 billion. The acquisition of 3Com, which sells networking and security products, will expand H-P’s product portfolio and strengthen its foothold in China. In the past four quarters, more than half of 3Com’s $1.23 billion in sales came from the rapidly growing country. H-P is a Buy and Long-Term Buy.

December-quarter earnings

In the December quarter, Laboratory Corp. of America ($39; LH) grew profits 6% to $1.16 per share excluding special charges, topping the consensus estimate by a penny. LabCorp, a diagnostic-testing company, reported sales of $1.17 billion, up 3%. The company also authorized a $250 million stock-repurchase program, enough to reduce the share count by about 3% at current prices. LabCorp is a Buy and a Long-Term Buy.

In the December quarter, Advance Auto Parts ($43; AAP) reported earnings of $0.39 per share excluding a charge for store divestitures, down 5% and $0.07 below the consensus. Total revenue increased 4%, while same-store sales advanced 2.4%. For 2010, Advance Auto expects same-store sales to increase at a low- to mid-single-digit rate. Advance Auto could be volatile on the earnings miss, but profit guidance for 2010 looks solid. For now, the stock remains a Long-Term Buy.

Wireless wrap-up

NII Holdings ($38; NIHD) agreed to sell 30% of its Nextel Mexico unit to Grupo Televisa ($19; TV) for $1.44 billion in cash. That price tag implies Grupo Televisa values NII’s Mexico business (42% of sales and 55% of operating income in the nine months ended September) at more than $4 billion. NII’s total stock-market value is about $6.64 billion.

The sale is contingent on NII and Televisa winning licenses in Mexico’s spectrum auction in May. Nextel ranks fourth in Mexico’s mobile market with a 4% share, well behind America Movil (72%) and Telefonica (20%). The deal could boost the Mexico unit’s profile and allow for bundled telecom packages. NII is a Focus List Buy.

Looking to recover share in the mobile market, Microsoft ($28; MSFT) unveiled its Windows Phone 7 software designed to run smartphones. Device makers Hewlett-Packard ($49; HPQ), Dell ($14; DELL), and Samsung have agreed to use the software, and the first phones are due out later this year. H-P is a Buy and Long-Term Buy. Microsoft is a Long-Term Buy. Dell is rated C (below average).

Motorola ($7; MOT) said it will split into two independent, publicly traded companies in 2011. One company will focus on mobile and home devices, including television set-top boxes, while the other will combine the corporate business and wireless-network equipment. Motorola stockholders will receive a tax-free distribution of shares in the new companies. Motorola is rated C (below average).

Dolby Laboratories ($53; DLB) and LG Electronics displayed a new smartphone that features Dolby’s multichannel surround sound. Dolby is a Focus List Buy.

Health-care report

Abbott Laboratories ($55; ABT) completed its $6.2 billion acquisition of Solvay’s drug unit after the European Union cleared the deal. As a condition of approval, the EU will require Abbott to sell off Solvay’s cystic fibrosis testing business. Even so, the deal will improve Abbott’s international exposure and should augment 2010 sales by roughly $2.9 billion. Abbott is a Long-Term Buy . . . One of Baxter International’s ($57; BAX) clients, Cadence Pharmaceuticals ($10; CADX) had a drug application rejected by U.S. regulators because the product was manufactured in a Baxter facility that failed a routine inspection. Baxter is a Long-Term Buy . . . AstraZeneca ($44; AZN) will pay $100 million as part of a marketing agreement with Rigel Pharmaceuticals ($9; RIGL) for an experimental rheumatoid arthritis treatment. Milestone and sales-related payments could push the final cost to $1.25 billion. AstraZeneca is rated B (average) . . . U.S. regulators set new guidelines for physicians who treat patients with certain anemia drugs, including Johnson & Johnson’s ($64; JNJ) Procrit and Amgen’s ($57; AMGN) Epogen and Aranesp. The rules require physician training and documentation that patients have been told about the risks of these drugs. A 2006 study found that patients treated with such drugs faced a higher risk of cardiovascular problems and death. J&J is a Long-Term Buy. Amgen is rated B (average).

Corporate notes

Transocean ($83; RIG) seeks shareholder approval to disburse $1 billion in the form of a special dividend worth about $3.11 per share that would be spread over four equal installments starting in July. The company also authorized the repurchase of up to $3.2 billion in stock. Transocean is a Focus List Buy and a Long-Term Buy . . . Walgreen ($34; WAG) agreed to purchase Duane Reade, a drugstore chain with 257 stores in New York and the surrounding metro area, for $618 million in cash, plus the assumption of $457 million in debt. Duane Reade posted sales of $1.8 billion in 2009. Walgreen is rated A (above average).

Top 15 Utilities update

FirstEnergy ($39; FE) agreed to purchase Allegheny Energy ($23; AYE) for $4.7 billion in stock, a 32% premium to the stock’s closing price prior to the announcement. FirstEnergy shares fell on the news. FirstEnergy’s Quadrix scores and growth rates have deteriorated in recent months, and the stock is being downgraded to a B rating in the Utility Update and dropped from the Top 15 Utilities portfolio.

Entergy ($79; ETR), an electric utility and power generator in Arkansas, Mississippi, Texas, and Louisiana, has seen operating income rise in each of the last two quarters, and in four of the last five years. Wall Street expects continued growth in 2010 and 2011, with estimates on the rise. Entergy also owns nuclear power plants in Vermont and New York and plans to split off those nonregulated plants into a stand-alone business. Entergy, reasonably valued at 12 times trailing earnings and yielding 3.8%, earns an A ranking in our Utility Update and is being added to the Top 15 Utilities portfolio.

Raytheon ($55; RTN) is being initiated as a Buy. Ross Stores ($47; ROST) is being added to the Focus List. Hewitt Associates ($38; HEW) is being dropped from coverage. In the Top 15 Utilities portfolio, Entergy ($79; ETR) is replacing FirstEnergy ($39; FE).

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