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Trifecta Stocks

Trifecta Stocks

Volatility Tied to Fed's Rate Policy

BY Bryan Ashenberg and Bob Lang | 09/17/14 - 01:00 PM EDT
Stocks in Focus: ADP, ALL, BA, C, COP, CVS, DOW, EMC, FL, GK, IP, ITW, KLAC, MA, MGA, MMM, MRK

All eyes turn to the U.S. Federal Reserve today for insight as to when it will begin to tighten interest rates and how fast they plan to proceed. We believe the market volatility is directly related to the tightening policy and not to the Alibaba IPO or eastern European political unrest.

Since our most recent summary update, we have trimmed 13 shares from our position in Boeing (BA:NYSE), 50 shares of Citigroup (C:NYSE), and 50 shares of EMC (EMC:NYSE) for a gain of 14%, a 2% loss, and an 8% gain, respectively. The move is entirely for risk management and not indicative of a change in our fundamental outlook on the companies.

We also closed out our 174-share stake in Xilinx (XLNX:Nasdaq), locking in an 8% gain when the stock was trading higher a bounce. We have little confidence that management has the ability to improve its execution.

As a reminder, One-ranked stocks are names that we would buy at their current levels and Twos are stocks we would not purchase at their current share prices.

(Each company paragraph begins with the stock's most recent closing price and its percentage weighting in the model portfolio.)

Fundamental Approval and Analysis:


Allstate (ALL:NYSE, $61.71, 4.08%, $65 price target) is the second-largest personal insurer in the U.S. This interest-rate play has a modestly improving fundamental business. The shares have traded sideways since our last update on little company-specific news. We remain bullish on the shares and the company’s modestly improving fundamental business.

Automatic Data Processing (ADP:Nasdaq, $83.41, 4.33%, $87.50 price target) is a business software and services company that is poised grow steadily along with an improving economy, job growth and rising interest rates. The stock has traded a fraction lower since our most recent summary. ADP has announced that it anticipates the distribution date for its dealer services unit (CDK Global) will take place on Sept. 30 to ADP shareholders of record after the market close on Sept. 24. ADP shareholders will receive one share of CDK Global common stock for every three shares of ADP stock. We plan on immediately liquidating our CDK position. We continue to focus on ADP's traction within its human capital management (HCM) suite as its key growth driver.

Boeing's (BA:NYSE, $127.32, 5.05%, $150 price target) stock gained a bit of altitude, trading up 1% since our last summary update. Last week, Bloomberg reported that Boeing is set to receive an $11 billion order for its 737 Max jets from Ryanair Holdings (RYAAY), Europe's largest discount carrier. Boeing CEO James McNerney said he expects "strong pressure" to increase the 737's production rate above current targets. We remain convinced that investors have unduly soured on what we consider a still-robust commercial aerospace cycle, and we remain bullish on the company.

ConocoPhillips (COP:NYSE, $80.75, 3.32%, $94 price target). ConocoPhillips is a global oil-and-gas exploration and production company. The company has assets in 19 countries and is one of the largest North American shale acreage holders. The stock has increased 1% since our most recent summary update, as the price of oil has continued to be weak. This week, The Financial Times reported that the company is auctioning off its stake in the Clair oilfield in the North Sea. This, if substantiated, continues COP’s progress in disposing of international assets to align its focus on the domestic market. Based on its shale exposure, strong dividend yield and below-average net-debt ratio, we consider the company's current valuation attractive.

CVS Health (CVS:NYSE, $82.22, 5.41%, $87 price target) is trading 3% higher since our last summary update. As a savvy PR move, the company announced that it has changed its name from CVS Caremark to CVS Health to reflect its broader health care commitment. CVS also announced that the company had ended tobacco sales at its stores on Sept. 3, which was almost a month earlier that its target date of Oct. 1. The company also announced a smoking cessation campaign. We remain bullish on the shares as the company continues to successfully expand its services and offerings and remains fiscally innovative.

Dow Chemical (DOW:NYSE, $53.48, 4.24%, $57 price target) has closed mostly unchanged from our last summary update. Investors continue to focus on potential asset sales as the company works to right-size its businesses. The company announced the retirement of CFO William Weideman, who has been with the company for 38 years. Management named Howard Ungerleider his replacement. Ungerleider has been with the company since 1990 and a part of the senior executive team since 2012. We expect a smooth transition. Our investment thesis for the stock is built upon management’s continued restructuring and streamlining of its businesses and we believe investors should focus on these positive actions. EMC (EMC:NYSE, $29.55, 3.25%, $35 price target) is the largest global storage vendor and the company also owns 82% of VMware (VMW:NYSE), which has brought it into the cloud-computing marketplace. The stock has gained a fraction since our last summary update. The recent attention the company is receiving -- instigated by activist investor Elliot Management’s involvement in the stock -- is helping to unlock some of its value. Last week, The New York Post reported that EMC was considering a sale of its stake in VMware. We do not believe this is likely and note that management has said as much. EMC is extremely well positioned in the hottest technology marketplaces: big data, cloud computing, security and data storage. We expect improving economic environments worldwide will boost the sales environment for storage and data management equipment, software and services.

Foot Locker (FL:NYSE, $57.98, 5.48%, $62 price target): Shares of this leading athletic footwear and apparel retailer have gained 1% since our most recent summary update. Last week, JPMorgan reiterated its Overweight rating on the stock and bumped its price target to $60 from $51. In addition, almost two weeks ago, The Daily Mail reported on private equity buyout rumors surrounding the stock at $70 per share. We doubt these rumors are true, but we sure hope they are! The company offers robust cash flow generation, a strong balance sheet, share repurchases and a 1.5% dividend yield, which allow for extra breathing room in a competitive and capital intensive industry. This cash- rich, undervalued retail play has a growing European presence and we expect it will benefit from increasing consumer sentiment as well as its new store remodeling program.

G&K Services (GK:NYSE, $56.06, 4.94%, $60 price target): G&K is the fourth-largest uniform services company in the U.S. The stock gave back 1% since our last summary update on little company specific news. A recent strong fiscal fourth- quarter results and continued progress with its rate of organic growth have reinforced our bullishness on the name. Recent strength in domestic economic data bode well for increasing levels of demand.

Illinois Tool Works (ITW:NYSE, $88.70, 4.79%, $95 price target): Shares of this diversified global manufacturer of industrial products and equipment have traded fractionally higher since our last summary update. Management recently reiterated its target to use 25% of its operating cash on organic investments, 25% on dividends and 50% on mergers and acquisitions (M&A) and/or share repurchases. Management is now focused on organic growth and improving the company's operating margin through restructuring its businesses. Last week, FBR Capital raised its price target on the stock to $105 from $97, citing its increased conviction in the company’s long-term 2017 earnings model. We expect the company’s ongoing restructuring efforts will lead to upside relative to its conservative guidance when volumes return.

International Paper (IP:NYSE, $49.08, 4.15%, $58 price target): Shares of this global paper and packaging company climbed 1% since our most recent summary update. Last week, IP management announced that the company will increase its annual dividend to $1.60 from $1.40. The company also said Mark Sutton, the current COO, would succeed John Faraci as CEO on Nov. 1. The move was anticipated though the timing was ahead of expectations. Management also commented that they are studying the master limited partnership (MLP) structure and are evaluating whether it makes sense for IP, which would create significant cost advantages for the company. IP's strong dividend yield and its active share repurchase program continue to mitigate downside from current levels. We believe improved economic conditions could fuel upside, though pricing trends will be monitored carefully.

3M (MMM:NYSE, $144.85, 4.47%, $155 price target): Shares of this broad, high-quality, industrial products company have gained a fraction since our last update. Two-thirds of the company's sales come from international markets. Management plans to repurchase $17 billion to $22 billion of its shares from 2013-17. The company is scheduled to present at the Citi 2014 Industrials Conference on Sept. 22. The event will be webcast on the company’s website at 12:50 p.m. EDT. The stock currently offers a 2.4% dividend yield, and we consider 3M a defensive way to play an expanding economic recovery.

Merck (MRK:NYSE, $59.99, 4.77%, $62 price target): Shares of this leading pharmaceutical company have moved up slightly since our last update. We are especially attracted to Merck's defensive drug company characteristics, strong cash flows and 2.96% dividend yield. On Monday, Merck reported data from its phase III fracture outcomes study of its osteoporosis drug odanacatib. The study was positive and showed a marked reduction in vertebral, clinical hip, and clinical nonvertebral fractures. However, questions about odanacatib's cardiovascular safety profile were maintained. Merck plans to file the product with the FDA in 2015. We believe management’s solid execution along with upcoming catalysts will push the shares higher.

Paccar (PCAR:Nasdaq, $59.20, 3.65%, $75 price target): Shares of this high-quality manufacturer of medium- and heavy-duty trucks (which make up about 80% of sales) and after-market parts (around 17% of sales) gave slid 6% since our most recent summary update. The entire group continues to be under pressure as some investors believe new orders have peaked. Last week, the company’s board of directors declared a quarterly cash dividend of $0.22 per share, which is payable on Dec. 5 to stockholders of record at the close of business on Nov. 14. Market rumors that Volkswagen is planning to make a bid for Paccar is not part of our investment thesis (though we would love for that to happen). Growth in the commercial-vehicles market, which is being driven by replacement of aging fleets in developed market and growth and replacement in emerging markets, will continue to benefit the company.

PepsiCo (PEP:NYSE, $92.57, 2.99%, $109 price target): Shares of this global food and beverage company have increased 1% since our last summary. On Monday, Cowen and Company initiated research coverage on the name with an Outperform rating and a $106 price target. We believe increasing operating leverage, cost savings, modest commodity inflation costs and activist shareholders' influence will combine to provide a nice tailwind for the stock and make it a satisfying investment.

Vanguard Total Stock Market ETF (VTI:NYSE, $103.54, 3.65%): We are using the VTI as a cash proxy as we roll out new names while allowing the cash balances to be invested in the market. The ETF seeks to track the performance of the CRSP U.S. Total Market Index. The VTI invests in large-, mid- and small-cap equity diversified across growth and value styles and employs a passively- managed, index-sampling strategy. Shares of the ETF closed 0.4% below the level of our last update.

VF Corp. (VFC:NYSE, $66.34, 4.97%, $68 price target): Shares of this global clothing manufacturer and marketer traded up 3% since our most recent summary update. We believe the stock continues to be buoyed by the decrease in raw material input costs. We remain bullish on the name and are impressed with the company's traction with Timberland and the strength its European business. We expect to see upside from the company's overseas expansion as it fully builds out each of its portfolio brands. We believe the company will continue to outgrow the weak retail peer group.

Whirlpool (WHR:NYSE, $152.60, 2.02%, $193 price target): Shares of this leading global appliance manufacturer have decreased fractionally since out most recent update. Last week, General Electric (GE:NYSE) announced that it had reached an agreement to sell its appliance business to Electrolux for $3.3 billion. We view the consolidation as positive as larger competitors generally bring better price discipline to the industry. On Monday, the company received final written approval from the China Securities Regulatory Commission for its acquisition of a 51% stake in Hefei Sanyo. The announcement was widely anticipated is important to the expansion of Whirlpool’s presence in the Chinese marketplace. Management has stated that the acquisition will be accretive in its first full year of integration. We believe strong secular tailwinds will aid this stock’s ascent as management restructures, revitalizes and grows its global presence.


Citigroup's (C:NYSE, $52.36, 5.00%, $58 price target) shares added 1% since our last update. Wells Fargo recently reiterated its Outperform and $56 to $58 valuation target range after leaving a meeting with CFO John Gerspach convinced that the stage is set for a brighter 2015. Citigroup’s second- quarter performance proves Citi is a financial powerhouse that has lost investors’ confidence, but it clearly has the potential to battle its way back. As the stock is trading below its tangible book value of $56.40, it remains attractive for long-term investors. Management commented on the second- quarter earnings call that they are expecting better revenue performance in the second half of the year. We believe investors are not focusing on the near term as they await Citi's response to the Fed's concerns about Citi's capital plan in light of the 2014 Comprehensive Capital Analysis and Review (CCAR) results. For now, expectations of an increased share buyback program and increased dividend will not materialize. Citigroup offers investors an attractive long-term opportunity as the company regains its former prestige and as global economies recover.

KLA-Tencor (KLAC:Nasdaq, $78.28, 3.93%, $82 price target): Shares of this leading designer, manufacturer and marketer of process control and yield management solutions for the semiconductor industry have traded 1% higher since our most recent summary update. Following the company’s recently lowered forward guidance, investors are gravitating back toward the stock. As a reminder, management said they expect the weakness to persist in the first quarter, but anticipate sequential improvements in quarterly shipments for the rest of fiscal 2015 as its customers resume spending in rolling out new technologies (20, 16 and 14 nanometer). We believe the weakness remains an industry issue and not a competitive or technological problem. Increasing semiconductor complexity and the company's dominant market share position should powerfully drive revenue and earnings.

Magna (MGA:NYSE, $108.48, 3.19%, $120 price target): Shares of the world's largest diversified auto supplier have stalled and retreated 4% since our most recent summary update. Last week, BMO Capital Markets pointed out that August dales from German Manufacturers slowed below the rate of growth they have achieved year- to-date causing the analyst to take note as Germany accounts for approximately 70% of Magna’s European business. We believe European auto production (38% of Magna's revenue) should provide a tailwind to results. This couples nicely with the company's restructuring efforts in that region, which should yield improving operating leverage. We remain bullish on the stock as a play on the continued global recovery of automotive sales.

MasterCard (MA:NYSE, $76.59, 2.14%, $80 price target) is the world’s second-largest payments solutions company. The stock added 1% since our last update. On Monday, Sterne Agee initiated research coverage on the name with a Buy rating and an $85 price target. Management indicated on their second-quarter earnings call that they remain confident they can bring the numbers in at the lower end of their multi-year guidance range of an 11%-14% net revenue compounded annual growth rate (CAGR), and at least a 20% EPS CAGR. MasterCard is an interesting investment opportunity with broad exposure to the transition away from cash and the growth in global consumer spending.

Union Pacific (UNP:NYSE, $107.92, 4.12%, $117 price target) is the largest public North American railroad. The stock has chugged 2% higher since our last summary. On Tuesday, BMO Capital Markets reiterated its Outperform rating on the stock and raised its price target on the name to $122 from $115. We view Union Pacific as a play on a broad economic recovery and will consider adding more shares to our position on a further pullback as the fundamentals look strong.

Technical Approval and Analysis:

Dow Chemical (DOW) has now come in nicely and planted a higher low on the chart. On Tuesday, it posted a higher low, higher high from the previous day so now would be a great time to add to existing positions. The channel is well defined and the pattern is very evident. Volume this month has been strong and, while it corrected a bit, it was more than 5% off the top. Momentum indicators are ready to move higher.

View Larger Chart Here

One of our better performers since last year, MasterCard (MA) is showing a nice wedge formation that is about to be resolved. It appears from the latest action that this will be resolved higher. Volume has been good this month and momentum indicators are “hanging in there” as buyers and sellers converge. Drops have been picked up by buyers each time. One more day, and the MACD will be on a new Buy signal.

View Larger Chart Here

Chip company KLA-Tencor (KLAC) has been on a tear since we last talked about it in early July. While the stock came down and corrected with the rest of the market, we note that it fell less than 5%, found a bottom later in the month and has been on a great run. The %R is showing some amazing strength, as is the RSI, which may be flashing a buy signal -- see the arrow on the chart below. MACD is also bullish and is crossing over. Tuesday's bullish engulfing bar (daily bar) needs some follow-through, but this stock has shown power.

View Larger Chart Here

Quant Approval and Analysis:

Here are the initial and current letter grades for the model portfolio stocks:

-- Allstate: Initial and current letter grade, A+.

-- Automatic Data Processing: Initial and current letter grade, A-.

-- Boeing: Initial letter grade, A-; current letter grade, A.

-- Citigroup: Initial letter grade, A-; current letter grade, B.

-- ConocoPhillips: Initial letter grade, B; current letter grade, A-.

-- CVS: Initial letter grade, A-; current letter grade, A+.

-- Dow Chemical: Initial letter grade, A; current letter grade, A+.

-- EMC Corp: Initial letter grade, A-; current letter grade, A.

-- Foot Locker: Initial letter grade, A-; current letter grade, A+.

-- G&K Services: Initial letter grade, A-; current letter grade, A.

-- Illinois Tool Works: Initial and current letter grade, A+.

-- International Paper: Initial and current letter grade, A-.

-- KLA-Tencor: Initial letter grade, A-; current letter grade A.

-- 3M Company: Initial letter grade A-; current letter grade A+.

-- Magna International: Initial and current letter grade, A+.

-- MasterCard: Initial and current letter grade, A+.

-- Merck: Initial and current letter grade, A.

-- Paacar: Initial letter grade A; current letter grade A-.

-- PepsiCo: Initial and current letter grade, A+.

-- Union Pacific: Initial letter grade A-; current letter grade A+.

-- VF Corp.: Initial and current letter grade, A-.

-- Whirlpool: Initial and current letter grade, A+.

-- Xilinx: Initial letter grade A; current letter grade A-.

For the Trifecta stock selection methodology, click here.

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Trifecta Extra: Be Wary of IPOs
Stocks in Focus: TWTR, FB

In general, it's best to wait until a newly listed company has had time to settle in before you invest in it.

09/16/14 - 03:12 PM EDT
Positive News for Whirpool
Stocks in Focus: WHR

China's regulators have cleared the way for Whirpool to take a majority stake in Hefei Sanyo.

09/15/14 - 11:03 AM EDT

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