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Trifecta Stocks

Trifecta Stocks

Global Markets Keep the Pressure On

BY Bryan Ashenberg and Bob Lang | 12/24/14 - 08:00 AM EST

An accommodating-sounding Fed, which said it is seeing strength in many areas of the U.S. economy but will still only move slowly to raise interest rates, helped push stock higher this week. Meanwhile, global markets have been pressured as the Russian ruble continues its rapid descent and the price of oil continues to be depressed.

Since our most recent summary update, we have exited our entire 140-share position in PepsiCo (PEP:NYSE) for a fractional gain, due to the company’s significant Russian exposure and the fact that we believe this (at best) stalls a growth engine for the company.

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:

ONES

Allstate (ALL:NYSE, $70.75, 4.39%, $73 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 up 3% since our last update. Last week, RBC Capital Markets reiterated its Overweight rating on the stock and increased its price target to $75 from $70. We remain bullish on the shares and continue to view Allstate as an interest-rate play with a modestly improving fundamental business.

Boeing's (BA:NYSE, $130.03, 4.84%, $150 price target) stock was in a holding pattern, trading sideways since our last summary update. Boeing recently announced that its board of directors has authorized the company to repurchase up to $12 billion in stock and raise its quarterly dividend by 25% to $0.91 per share. The repurchase authorization replaces the previous authorization under which it had $4.8 billion remaining. We remain convinced that Boeing continues to be a solid play on a still-healthy commercial aerospace cycle.

ConocoPhillips (COP:NYSE, $71.05, 2.74%, $80 price target) 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 popped 9% since our last summary update, as oil-related stocks have seen some of the pressure ease from upon them. The stock now offers a 4.1% dividend yield (which we believe is safe) as we await stabilization in the commodity. The company recently announced its 2015 capital budget would be down 20% from 2014 as a result of the weakness in the price of oil. Production focus will continue to be on operations in the Eagle Ford and Bakken shale plays. Based on its shale exposure, strong dividend yield and below-average net-debt ratio, we consider the company's current valuation attractive over the long term.

CVS Health (CVS:NYSE, $97.87, 6.05%, $105 price target) is trading 7% higher since our last summary update on the heels of a well-received analyst day last week. At its investor meeting CVS issued 2015 guidance looking for revenue growth of 7-8.25% and EPS in a range of $5.05 to $5.19, bracketing consensus at $5.11. The company also announced a 27% increase to its quarterly dividend and a new $10 billion share repurchase authorization. Management reiterated its target of five-year adjusted EPS growth of 10-14%. The company continues to successfully expand its services and offerings and remains fiscally innovative.

Danaher (DHR:NYSE, $87.06, 3.84%, $93.50 price target) is a diversified industrial conglomerate that is a serial acquirer of businesses and is widely lauded for its proprietary business integration system. The stock is trading 3% higher since out last summary update. Danaher hosted a bullish 2014 investor and analyst meeting on Dec. 11 and offered initial 2015 guidance that fell in line with expectations. The company is guiding to 8.5% earnings growth in 2015 at its midpoint ($4.35 to $4.45) on 3-4% core revenue growth. We believe the company will boost its pace of acquisitions and potentially increase its sales and restructuring of underperforming assets over the near term.

Dow Chemical (DOW:NYSE, $45.98, 3.42%, $57 price target) shares continued to slump, losing 5% since our last summary update. On Tuesday, JPMorgan reiterated its Neutral rating and lowered its price target on the shares to $46 from $49 as the analyst points out that the decreases in the price of oil is a headwind to the company’s earnings and EBITDA. We believe the stock is also suffering from the company’s recent announcement that it and Third Point, Dan Loeb’s activist hedge fund, have agreed to a one-year customary standstill and voting agreement in exchange for the addition of four new independent directors to the company's board. Management has a year to continue to execute its business and restructuring plan. So, investors who were hoping for a realization of a near-term event have been disappointed. 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, $30.55, 5.27%, $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 added 2% since our last summary update. Activist investor Elliot Management’s involvement in the company continues to unlock some of the stock’s value as the sum-of-the- parts story becomes better known. It also brings a fire to management’s feet to drive improved business execution. Last week, Credit Suisse published a report that examined EMC after a spinoff of VMware and concluded that EMC is worth $36 on a sum-of-the-parts valuation analysis. We believe EMC is extremely well positioned in 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, $55.22, 4.90%, $63 price target): Shares of this leading athletic footwear and apparel retailer slid 2% since our most recent summary update. The stock traded with increased volatility as the shares were negatively impacted by poor Finish Line (FINL:Nasdaq) quarterly results. Though Finish Line looks to have some company-specific issues and we believe Foot Locker will still achieve expectations of a 6% same-store sales rise in the fourth quarter, investor caution and concern has been increased. The aforementioned weakness and a management change at Foot Locker are increasing investment consternation on the name. Foot Locker company offers robust cash flow generation, a strong balance sheet, share repurchases and a 1.6% 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, $70.57, 5.84%, $72 price target): G&K is the fourth-largest uniform services company in the U.S. The stock has gained 5% since our last summary update. Recent domestic economic data, supported by the Fed’s recent commentary about an improving domestic economy, and solid results with strong commentary from its competitor’s Cintas’ (CTAS:Nasdaq) second quarter earnings report last week, continue to portend increasing levels of demand.

Harman International Industries (HAR:NYSE, $105.19, 4.64%, $136 price target): Harman develops, manufactures and markets audio products, lighting solutions, electronic systems and digitally integrated automotive infotainment systems. The stock has slipped 3% since our last summary update. Last Friday, the stock was hit hard after Reuters article about Google’s automotive operating system was understood as an attack on Harman. We don’t view Google as trying to unseat the company and, in any event, view such an attempt as a likely failure. We believe Wall Street is underestimating the adoption rate of infotainment systems in automobiles. Harmon is the leading player in this segment, with material margin leverage and incremental revenue upside to further industry adoption. We believe global auto production is tracking ahead of Wall Street expectations, which will contribute to the potential upside in the name.

Illinois Tool Works (ITW:NYSE, $97.21, 4.93%, $100 price target): Shares of this diversified global manufacturer of industrial products and equipment have tacked on 1% since our last summary update. Management hosted an analyst day a month ago and boosted its 2017 operating margin target by 300 basis points to 23%. They guided its fiscal 2015 earnings in line with Wall Street expectations. Revenues were guided up 0.5% to 1.5%, which is based on 2.5% to 3.5% organic growth and a 2% drag from currency. Management said they expect weak oil prices will have a negligible effect on its business. The company continues to focus on organic growth and improve its operating margin through restructuring its businesses. We expect the ongoing restructuring efforts will lead to upside relative to its conservative guidance as volumes return to typical levels.

International Paper (IP:NYSE, $54.54, 4.33%, $58 price target): Shares of this global paper and packaging company have given back 1% since our most recent summary update. The industry continues to see positive trends in containerboard consumption, which has led to a decline in supply. The stock has been weighed down by its significant exposure to the decline in the Russian ruble through its debt exposure to its Ilim joint venture. The company will be required to take a non-cash charge to account for the impact paying off the JV’s debt would have on the company today. While the debt does not have to be repaid in the short term, the amount of the charge could easily wipe out this quarter’s earnings. This issue is well known and we believe investors will look past these charges and focus on the cash flow generation of IP’s core operations. We note that 4% of IP’s EBITDA comes from Russia and that will be negatively impacted by the country’s economic woes. Meanwhile, the conversion to a master limited partnership (MLP) talk has cooled as the process rolls on (such a conversion would create significant cost advantages for the company). The company’s strong dividend yield, its active share repurchase program and potential for an MLP conversion continue to mitigate downside from current levels. We believe improved economic conditions could fuel upside, though pricing trends must be monitored carefully.

Magna (MGA:NYSE, $107.58, 3.71%, $120 price target): Shares of the world's largest diversified auto supplier stalled, trading fractionally below its price at our most recent summary update. We expect that the company will benefit from the recent strength in automobile sales. Russia accounted for just 1.3% of the company’s revenue in 2013 and is home to six out of the company’s 312 manufacturing facilities worldwide. We believe European auto production -- which accounts for approximately 40% of Magna's revenue - - will provide a tailwind to results. This pairs well with the company's restructuring efforts in that region, which should yield improving operating leverage.

Merck (MRK:NYSE, $57.21, 4.28%, $63 price target): Shares of this leading pharmaceutical company have slumped 5% since our last update. The shares have been weak since the company announced it would acquire Cubist Pharmaceuticals (CBST:Nasdaq) to learn shortly after that Cubist’s blockbuster drug Cubicin lost an important patent battle in the courts, which will bring generic competition faster than initially expected. Merck cannot back out of the deal and the deal remains accretive, just less than so initially anticipated. We are especially attracted to Merck's defensive drug company characteristics, strong cash flows and 3% dividend yield. It is clearly taking action to shed the old pharma image we believe it had attained. Management has demonstrated solid execution and upcoming catalysts, such as data on Merck’s immune-oncology and HCV drugs, will be the next drivers for the stock.

Union Pacific (UNP:NYSE, $120.68, 4.99%, $130 price target) is the largest public North American railroad. The stock has gained some steam, chugging 4% higher since our most recent summary. The stock has gotten a reprieve from the pressure it felt with the weakness in oil prices. We believe the rails will benefit from a reduced fuel cost, though the benefit is likely offset by weaker volumes in shipments of the commodity. We expect transportation out of the shale plays will remain robust. We remain bullish on the shares and view Union Pacific as a play on a broad economic recovery.

Vanguard Total Stock Market ETF (VTI:NYSE, $107.01, 5.93%): 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 0.72% above the level we posted in our last update.

VF Corp. (VFC:NYSE, $74.64, 5.25%, $75 price target): Shares of this global clothing manufacturer and marketer have traded 2% higher since our most recent summary update. We believe the stock continues to be buoyed by the decrease in raw material input costs and some cold weather that benefits the company’s The North Face brand. Additionally, the lower price of oil typically puts additional discretionary cash into the hands of consumers, which bodes well for spending on apparel. 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 outperform its retail peer group.

Whirlpool (WHR:NYSE, $191.13, 2.37%, $193 price target): Shares of this leading global appliance manufacturer have continued to push higher, gaining 2% since our most recent summary update. The company hosted a bullish investor day last week. Initial guidance for fiscal 2015 is sales of $24 to $25 billion, non-GAAP EPS of $14.00 to $15.00, free cash flow of $700 million to $800 million, and ongoing operating margins of 7.8% to 8.2%. Management also guided to longer-term targets (as expected) with fiscal 2018 EPS projected at $22 to $24 and the ongoing operating margin to between 9.5% and 10.5%. Management expects its 2015 growth to predominately come out of North America with that region looking to be up 4-6%, along with 2-5% growth in Asia, while expectations are for Latin America and EMEA to be flat. The company said about 3% of its sales are in Russia. We believe the drop in the price of oil could add more discretionary cash to consumers’ pockets that could in turn lead to increased sales for Whirlpool. We believe strong secular tailwinds will aid this stock’s ascent as management restructures, revitalizes and grows its global presence.

TWOS

Citigroup's (C:NYSE, $54.42, 4.88%, $58 price target) shares have traded down 3% since our last update. As the stock is trading below its tangible book value of $57.73, it remains attractive for long-term investors. The stock has been weak given the company’s exposure to Russia and oil. Citi has $1.6 billion of net investment in Russia and total third-party assets of $7.4 billion in the company’s Russia subsidiary. Citi stated that the company’s exposure to the petroleum, energy, chemical, and metal industry is 21% of the company’s direct outstanding and unfunded lending commitments of $215 billion, of which oil is an undisclosed portion. While we recognize that these risks will impact earnings, this comes with the territory of owning a global bank. We believe investor expectations are set low in the near term as investors 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. As the company regains its former prestige and as global economies recover, Citigroup offers investors an attractive long-term opportunity.

KLA-Tencor (KLAC:Nasdaq, $72.63, 3.43%, $72 price target): Shares of this leading designer, manufacturer and marketer of process control and yield management solutions for the semiconductor industry continued their vertical ascent by tacking on an additional 4% since our most recent summary update. The company has already paid out its special one-time cash dividend of $16.50 per share. Despite a slow start to the year, management anticipates sequential improvements in quarterly shipments in the back half of fiscal 2015, as its customers resume spending in rolling out new technologies (20, 16 and 14 nanometer). Yesterday, the company received a $500 million order from Taiwan’s TSMC. 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 will -- eventually -- powerfully drive revenue and earnings. We believe the company’s valuation is full, but we respect the stock’s price momentum and will continue to hold the shares.

MasterCard (MA:NYSE, $87.63, 2.30%, $90 price target) is the world’s second-largest payments solutions company. The stock traded sideways since our last update. We believe MasterCard is an interesting investment opportunity with broad exposure to the transition away from cash and the growth in global consumer spending.

Technical Approval and Analysis

Since August, G&K Services (GK:NYSE) has been one of our best performers. We can see the strong uptrend line supporting price on the recent pullback, which was a minor 4%. GK broke out of the channel the upside, often with a stock that bases at a high level. Even better, the stock rose from that base on higher turnover, what we like to see. Notice the pullback, the %R showed a great spot to get on board. This could base here soon, but find more upside down the road. We'll stay with the name.

Click here for a larger chart

The industrial names have had some tough sledding since oil started to slide. In fact, most of the highest-quality names like Dow Chemical (DOW:NYSE) have come under severe pressure. But, at some point, that will turn as the cream rises. We can see the resistance on the chart lay ahead at $53 and coming down each day, but the potential formation of a giant W is apparent The MACD is about to flash a buy signal soon. We can see some resistance here on the chart at $46 from the steep downtrend line, but through there will target the gaps at $48 and then $51.

Click here for a larger chart

MasterCard (MA:NYSE) may show a potential h/s (bearish pattern), but unless the neckline is penetrated under $82 then it may not be valid. I like the recent consolidation after reaching a new all-time high early in the month. The stock is less than 4% away from an all-time high. The MACD is setting up for a buy signal, but needs some more upside traction in price. The stock is improving its relative strength after a hot move from mid-October through Thanksgiving. We like the name here and would add.

Click here for a larger chart

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 and current letter grade, A-.

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

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

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

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

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

-- EMC Corp: Initial and 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 B.

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

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

-- Merck: Initial and current letter grade, B+.

-- 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+.

Best Ideas for 2015: FEYE
Stocks in Focus: FEYE

FireEye is ready for prime time.

12/23/14 - 02:02 PM EST
Selling Out of PepsiCo
Stocks in Focus: PEP

The Russian ruble collapse will hurt the company.

12/17/14 - 08:27 AM EST
Boeing Hikes Buyback Plan and Dividend
Stocks in Focus: BA

We believe the company's capital return plan for 2015 will be positively received.

12/15/14 - 04:50 PM EST
Global Markets Keep the Pressure On

We jettisoned Pepsi due to its Russian exposure.

12/24/14 - 08:00 AM EST

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