Portfolio Review


June-quarter earnings

IBM ($127; IBM) earned $2.61 per share, up 13% and $0.03 above the consensus estimate. Revenue rose 2%, shy of Wall Street’s expectations for 4% growth. IBM signed $12.3 billion in services contracts, down 12% from the year-earlier quarter. Management blamed the decline in contract signings on recession-driven renegotiations, adding that the trend is “in the rear-view mirror.” But despite management’s comments and a slight increase in 2010 profit guidance, IBM shares dipped on the news. Despite expectations for double-digit profit growth, the shares seem cheap at 11 times the 2010 estimate. IBM remains a Focus List Buy and a Long-Term Buy.

Johnson & Johnson ($59; JNJ) earned $1.21 excluding special items, up 5% and in line with the consensus on sales growth of less than 1%. Revenue fell short of Wall Street expectations, and J&J trimmed its 2010 profit guidance for the second time this year, citing product recalls and a factory shutdown. J&J’s valuation of less than 13 times the midpoint of 2010 guidance already reflects plenty of bad news. While drug stocks are currently out of favor, J&J’s diversified business mix should drive modest top-line growth over the next two to three years. J&J, yielding 3.6%, is a Long-Term Buy.

Abbott Laboratories ($47; ABT) earned $1.01 per share excluding special items, up nearly 14% and $0.01 above the consensus. Sales rose 18% to $8.83 billion, helped by the acquisition of Solvay Pharmaceuticals. Abbott’s Humira, a treatment for rheumatoid arthritis, managed sales growth of more than 21% and accounted for 18% of company sales. Also generating strong revenue growth were the TriCor/Trilipix cholesterol-drug franchise and coronary stents. Abbott confirmed profit guidance for 2010, projecting per-share-profit growth of about 12%, in line with the consensus.  Abbott is a Buy and a Long-Term Buy.

Stryker ($47; SYK) delivered per-share earnings of $0.80, up 10% on 8% sales growth. Profits matched consensus expectations, but sales fell short. Revenue from medical and surgical equipment rose 16%, offsetting the orthopedic-implant business, which saw sales growth of just 2% in the quarter. The company reiterated expectations for per-share-profit growth of 8% to 12% this year, in line with the consensus. At 16 times trailing earnings, Stryker trades at a 20% discount to its three-year average P/E ratio. Stryker remains a Buy and a Long-Term Buy.

General Electric ($15; GE) grew per-share profits from continuing operations 15% to $0.30, topping the consensus by 11%. CEO Jeff Immelt reiterated GE’s expectations for higher profits and a dividend hike this year, but that confidence did not sway investors. The stock fell on the news, hurt by a larger-than-expected decline in revenue. GE, which depends heavily on cost-cutting to drive profit growth, is rated B (average).

Financial review

On July 21, President Obama signed into law a far-reaching package of financial reforms that directs regulators to create more than 500 new rules. While details on most of the measures have yet to be worked out, key provisions include:

The creation of an oversight council to monitor big-picture problems in the financial sector.

A system for “orderly liquidation” of troubled firms, working with investors and counterparties to avoid panic and, hopefully, eliminating the need for bailouts.

New layers of oversight for banks and insurance companies.

Registration of large private-equity and hedge funds with the Securities and Exchange Commission.

Guidelines designed to limit the investment risks of large banks.

While the ultimate effects of these reforms are impossible to predict, it is likely that the end result will be higher costs for financial-services firms as well as limitations on how and how much they can invest. Banks with the most to lose are those with substantial exposure to capital markets, such as Bank of America ($14; BAC), Citigroup ($4; C), Goldman Sachs ($149; GS), Morgan Stanley ($25; MS), and J.P. Morgan Chase ($40; JPM). The passage of the reform bill eliminates only a portion of the uncertainty that has weighed on the banking group, and the Forecasts still does not like the risk-reward profile of most of the largest financial companies.

Bank of America and Citigroup both slumped after reporting June-quarter results, hurt by weakness in business loans and investment banking. Bank of America delivered better-than-expected profit growth but offered a downbeat take on the effects of financial reform. The bank projected the rules could reduce its credit-card revenue by $1.8 billion to $2.3 billion annually, starting in the third quarter of 2011 . . .  Citigroup reported better-than-expected profits but would have lost about $4 billion if not for the sale of its Smith Barney brokerage. Revenue fell 33% from year-earlier levels and, like Bank of America, Citigroup cited low demand for business loans . . . J.P. Morgan earned $1.09 per share in the quarter, $0.42 above the consensus and up from $0.28 per share a year earlier despite an 8% decline in revenue. J.P. Morgan, considered among the best-run of the large banks, is the only one of the five largest U.S. banks to manage six consecutive profitable quarters . . . Goldman Sachs rallied 4% on news that it agreed to settle the SEC’s fraud case for $550 million, then jumped again three days later after reporting June-quarter earnings. The company earned $0.78 per share in the quarter, well below the consensus of $2.08. But excluding a U.K. bank payroll tax and the SEC settlement, Goldman would have earned $2.75 per share. Bank of America and Citigroup are rated C (below average). Goldman and J.P. Morgan are rated B (average).

Energy update

BP’s ($35; BP) latest effort to stop the gusher from a ruptured oil well a mile below the surface of the Gulf of Mexico has been successful so far. A new cap appears to be holding the oil, offering hope of minimal additional leakage until the permanent fix — relief wells — can be implemented next month. But the problems for BP and other firms connected with the spill are far from over.

BP faces more than 300 U.S. lawsuits related to the disaster, some of which also name other companies, notably Anadarko Petroleum ($46; APC), Transocean ($49; RIG), and Halliburton ($30; HAL). Cleanup and legal expenditures could cost BP in the tens of billions of dollars. Legal exposure for Anadarko, Transocean, and Halliburton is unclear, and that uncertainty could weigh on the stocks.

In related news, BP agreed to sell $7 billion in onshore oil and natural gas assets to Apache ($88; APA). Anadarko and Halliburton are rated C (below average). Apache, BP, and Transocean are rated B (average).

Tech/telecom roundup

NII Holdings ($37; NIHD) and partner Grupo Televisa ($18; TV) won a block of Mexico’s wireless spectrum at auction for about $3.7 billion. In February, the TV giant agreed to purchase 30% of NII’s Mexico unit for $1.44 billion if the two were successful in their spectrum bid. The spectrum purchase opens up lucrative opportunities in a market long dominated by one company, America Movil ($49; AMX). NII is a Focus List Buy . . . Motorola ($8; MOT) agreed to sell a portion of its network-equipment business to Nokia Siemens Networks for $1.2 billion. Motorola is rated C (below average).


No changes were made this week in Dow Theory Forecasts.

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