Portfolio Review


Focus List changes

This week, we are adding three stocks to the Focus List — AGCO ($47; AGCO), Chevron ($109; CVX), and Google ($612; GOOG) — and dropping two — CSX ($22; CSX) and Walter Energy ($76; WLT). Below, we discuss three of the rank changes in detail.

Google, the dominant search provider and largest seller of ads on the Internet, is on a roll. The company reported 27% growth in September-quarter operating earnings. Google holds an estimated 65% share of the U.S. Internet-search market, and rivals Facebook, Twitter, and Microsoft's ($27; MSFT) Bing are trying to eat into that share. Still, Google has a variety of initiatives that could lessen its reliance on the search business.

Google has a tentative deal in place with General Motors ($25; GM) to provide e-mail and software applications to more than 100,000 employees. Google's YouTube has paired with Disney Interactive to create new content slated for release next year, and the company is also exploring plans to offer programming over the Internet. In addition, Google's Android mobile-phone software continues to attract users, capturing 44.8% of the smartphone market in the September quarter. Wall Street expects per-share-profit growth of 24% this year and 18% next year, and Google seems reasonably valued at 14 times the 2012 estimate. The stock seems capable of reaching $700 over the next 12 months.

Metallurgical coal producer Walter Energy ($76; WLT) has hit some rough ground. In part because of difficult geological conditions, Walter lowered its 2011 production guidance in September. Consensus profit estimates for both 2011 and 2012 are on the decline, hurt by a December-quarter profit warning caused by delayed shipments. Walter says long-term demand for metallurgical coal remains strong, and it does not expect the delays to turn into cancellations.

Walter shares appear cheap on just about every valuation metric. At less than 11 times trailing earnings, the stock trades at a 35% discount to the median diversified metals and mining company and a 36% discount to its own three-year average. The most recent analyst estimates don't reflect Walter's potential production growth in 2012, when the company expects at least 30% higher metallurgical-coal volumes. But given Walter's production issues this year, investors are understandably skeptical of its growth claims. Walter is no longer among our very favorites, but downside seems limited at current levels, and the stock retains a Buy rating.

CSX's ($22; CSX) Overall Quadrix score has eroded over the last four months, reflecting slower operating momentum, declining earnings estimates, and weaker share-price action. The railroad fell short of expectations in the September quarter as shipment volumes rose just 1%. In September, CSX cut its 2011 forecast for coal exports, and sluggish economic growth both in the U.S. and overseas has some worried.

The consensus profit estimate for 2012 has fallen more than 4% over the last two months, but still projects 14% growth. And CSX's role as a conduit for materials reaching manufacturers, utilities, and builders leaves it well positioned to profit from longer-term growth trends. CSX is being dropped from the Focus List and Buy List. But the company seems capable of annual profit growth of 13% to 15% over the next five years and remains a Long-Term Buy.

Wyndham initiated

Wyndham Worldwide ($34; WYN) is being added as a Buy and a Long-Term Buy. One of the world's largest hospitality companies, Wyndham operates 15 hotel brands and sells or rents time-shares. Its Quadrix® Overall score has more than doubled since March, and Wyndham currently earns a 93 Overall, with above-average ranks for all six categories.

Sales growth has accelerated in three consecutive quarters, and operating profit margins have widened. Free cash flow surged 74% to $631 million in the first nine months of 2011. Rather than allow the excess cash to pool on its balance sheet, Wyndham has hiked its quarterly dividend 25% and cleaved 12% from the share count over the last year. Wall Street sees Wyndham earning $2.84 per share in 2012, implying 16% growth, on 5% higher revenue. Shares trade at 12 times the 2012 profit estimate, a 36% discount to its peer group in the S&P 1500 Index.

TV earnings and review

DirecTV ($47; DTV) and DISH Network ($24; DISH) reported lower-than-expected September-quarter profits. Yet the shares of both companies rose for very different reasons.

DirecTV grew per-share profits 27% to $0.70, missing the consensus by $0.03 as costs for programming and customer additions escalated. But DirecTV added 1.14 million net subscribers for the quarter, the largest gain in the company's history. U.S. net subscriber additions soared 88% to 327,000, as DirecTV attracted new customers by giving away a free year of the NFL Sunday Ticket. DirecTV is a Focus List Buy and a Long-Term Buy.

DISH earned $0.71 per share in the September quarter, up 29% but $0.02 short of Wall Street's target. Revenue increased 12% to $3.60 billion, though DISH lost 111,000 net subscribers, worse than analysts had projected. Despite the lackluster operating results, shares surged after DISH declared a special cash dividend of $2.00 per share, payable Dec. 1. The dividend could signal a pause in DISH's aggressive acquisition strategy over the past year. DISH, modestly valued at eight times expected current-year earnings, is a Buy and a Long-Term Buy.

September-quarter earnings

Apache ($105; APA) earned $2.95 per share excluding special items in the September quarter, up 34% and exceeding the consensus by $0.17. Revenue grew 44% to $4.33 billion, also ahead of Wall Street's forecast. Average daily production advanced 13% in the quarter, while energy prices rose across the board. With shares up 6% since the quarterly report, Apache is a Long-Term Buy.

Advance Auto Parts ($68; AAP) reported September-quarter per-share profits of $1.41, up 37% and $0.22 above the consensus. Revenue rose 4%, while same-store sales grew 2.2%. For the December quarter, Advance Auto sees earnings per share of $0.71 to $0.76, versus $0.57 earned last year and Wall Street's target of $0.67. Advance Auto is a Long-Term Buy.

Rank Changes

AGCO ($47; AGCO), Chevron ($109; CVX), and Google ($612; GOOG) are being added to the Focus List. CSX ($22; CSX) and Walter Energy ($76; WLT) are being dropped from the Focus List. Walter remains a Buy, and CSX is also being dropped from the Buy List but remains a Long-Term Buy. Wyndham Worldwide ($34; WYN) is being initiated as a Buy and a Long-Term Buy. We have also changed the target weightings for the Buy List. See the table on page 7 for details. The Vanguard Short-Term Investment-Grade ($10.69; VFSTX) fund now comprises 21.9% of the Buy List and 21.2% of the Long-Term Buy List.

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