Portfolio Review


Three new Buys

This week we are adding three new companies to our Buy List, the two featured below and Dover ($67; DOV), profiled in Income Spotlight.

High oil prices have benefited a host of energy companies. But Apache ($129; APA), one of the nation's largest independent oil-and-gas producers, is poised to augment that price-driven profit boost with a 13% to 17% increase in 2011 production. Production jumped 25% in the March quarter after a 22% gain in 2010, and a series of acquisitions has set the stage for solid growth in coming years.

In the March quarter, per-share profits jumped 38% to $2.90 excluding special items, topping the consensus by $0.31. Wall Street expects both sales and profits to jump more than 30% this year. Despite that excellent growth and solid fundamentals (Quadrix® Overall score of 93 and 87 or higher in both sector-specific scores), Apache looks cheap relative to its peer-group average. Apache is being added as a Buy and a Long-Term Buy.

Alliance Data Systems ($94; ADS) offers credit-card programs, loyalty programs, consumer-database marketing, and e-mail marketing. Broad strength across Quadrix contributes to a score of 96 Overall, along with sector-specific ranks of 91 for Reranked Overall and 85 for 12-Factor Sector. The company set record highs for annual sales, operating earnings, and free cash flow last year. Based on the strength of its March-quarter results, Alliance could set fresh highs in 2012. Yet the shares trade at just 14 times trailing earnings, 24% below their three-year average. Alliance is being initiated as a Buy.

Walter on Focus List

Walter Energy ($131; WLT), already a Buy and a Long-Term Buy, is being added to the Focus List. Walter extracts some of the highest grades of metallurgical coal in the world from mines located in Alabama, and a $3.4 billion acquisition completed in April will extend its reach in Asian markets. The company should benefit from higher production and rising coal prices in the year ahead. The stock earns outstanding Quadrix scores, including a 99 for Momentum and the maximum Overall rank of 100.

Hang up on RIM

On the April 29 hotline we removed Research In Motion ($48; RIMM) from our Buy and Long-Term Buy lists. RIM has alienated investors on two fronts: the handling of its forecast and the execution of its PlayBook launch.

• Although RIM asserts that its full-year outlook remains intact, the company cut its May-quarter expectations for both earnings and revenue barely one month after its last update.

• Even if the PlayBook tablet eventually becomes the chief rival to Apple's ($348; AAPL) iPad, the device seemed rushed to market before it was truly ready for prime time. Consumers will not see the device's full capabilities for a while, and RIM must also wait to reap the resulting benefits. RIM, now rated B (average), should be sold.

March-quarter earnings

MasterCard ($282; MA) said March-quarter earnings per share rose 24% to $4.29, well ahead of the consensus of $4.10. Revenue grew 15%. MasterCard processed 6 billion transactions, up 11%, for purchases totaling $545 billion in local currency, up 13%. Spending on MasterCard's credit cards climbed 12% to $401 billion, while debit-card spending increased 16% to $143 billion. Shares rallied on the results. MasterCard is a Focus List Buy and a Long-Term Buy.

Comcast's ($27; CMCSa) per-share earnings grew 16% to $0.36 in the March quarter, excluding costs related to its purchase of a majority interest in NBC Universal, topping the consensus by $0.02. Revenue climbed 32%, with the acquisition accounting for most of that growth. On a pro forma basis (assuming the NBC Universal transaction took place Jan. 1, 2010, and excluding revenue from the 2010 Olympics), revenue rose 6%. Comcast is a Long-Term Buy.

Microsoft ($26; MSFT) earned $0.56 per share excluding a tax benefit in the March quarter, up 22% on 13% revenue growth. Shares slipped on concerns that Microsoft will be vulnerable if PC sales continue to contract and the Windows operating system (27% of revenue and 44% of operating income in nine months ended March) fails to take hold in the mobile-device market. Microsoft is a Long-Term Buy.

Mergers and deals

After failing to convince NYSE Euronext ($40; NYX) management of the value of their takeover bid, NASDAQ OMX Group ($27; NDAQ) and IntercontinentalExchange ($116; ICE) have taken their $11 billion offer to NYSE's shareholders. NASDAQ and ICE launched a hostile tender offer involving a combination of stock and cash. The offer equates to a premium of less than 5% to NYSE's current share price. In part because of the weak dollar, the value gap between the NASDAQ offer and an accepted bid from Deutsche Boerse has narrowed to 8%, well below the 20% disparity at the time of the NASDAQ offer. Should NASDAQ's bid meet a tepid response, ICE CEO Jeff Sprecher said there is flexibility to sweeten the pot. NASDAQ is a Buy and a Long-Term Buy.

Exelon ($42; EXC) agreed to purchase Constellation Energy ($37; CEG) for roughly $7.7 billion in stock, representing a 15% premium to Constellation's price at the time of the announcement. Exelon expects the purchase will have no effect on earnings in 2012, then boost profits more than 5% in 2013 on the strength of $260 million in cost cuts. The combined company would serve 6.6 million customers and boast a stock-market value of about $35 billion at current prices. Exelon, rated A (above average), is a component of our Top 15 Utilities portfolio.

Corporate roundup

CSX ($78; CSX) announced a 3-for-1 stock split and 38% increase in the quarterly dividend to a presplit level of $0.36 per share, both on June 15. CSX is a Focus List Buy and Long-Term Buy.

Abbott Laboratories ($53; ABT) gained U.S. approval to sell a new form of AndroGel, a clear gel that boosts testosterone levels in men with little or none of the hormone. Abbott also sued Teva Pharmaceuticals ($46; TEVA) for allegedly planning to market a generic version of AndroGel despite a patent valid until 2021. Abbott Labs is a Long-Term Buy.

Johnson & Johnson ($66; JNJ) raised its quarterly dividend 6% to $0.57 per share, payable June 14. J&J also won U.S. approval to market Zytiga, an advanced prostate-cancer treatment expected to eventually generate more than $1 billion in annual sales. J&J is rated B (average). 

Rank Changes

Walter Energy ($131; WLT) is being added to the Focus List. Apache ($129; APA), Alliance Data Systems ($94; ADS), and Dover ($67; DOV) are being added to the Buy List, with Apache and Dover also Long-Term Buys. Texas Instruments ($35; TXN) is being dropped from the Focus List and Buy List. Research In Motion ($48; RIMM) was dropped from the Buy List and the Long-Term Buy List on the April 29 hotline. Lam Research ($47; LRCX) is being dropped from coverage.

Current Hotline

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