How to Fed-proof your Portfolio

Worried that the Fed may go ahead an raise interest rates later this week, even in the face of deteriorating economic news out of China and tepid results from the ECB’s version of central bank intervention? If so, then you may want to focus on stocks that should be mostly immune from concerns over the possibility of higher bond yields in the near future. One way to do that is to own companies that pay a dividend yield far higher than that of the current 30-year Treasury bond, currently around 3%.

Coincidentally, 3% happens to be the average yield of all the current holdings in the STI Investments Portfolio currently rated a ‘buy’ or ‘hold’, even with Micron’s 0% yield added in. While dividend yield may not have counted for much during the 2009 – 2014 rally fueled by trillions of dollars of quantitative easing being pumped into our economy. But since that spigot has been turned off our stock market has also stalled, meaning dividends are the only form of economic benefit being realized by shareholders.

For that reason, we believe high dividend-paying stocks will garner increasing investor interest as the reality of working within a two-tier stock market becomes more apparent. In short, companies with strong cash flow that can sustain a high cash flow will supplant bonds as the only source of both high income AND capital appreciation now that the long term super-cycle in bond prices is coming to an end.

One such company that we believe will attract an entirely new set of investors is AT&T, which Linda McDonough updates in her article below. Over the past couple of months Linda has reviewed other Investments Portfolio holdings that pay a high dividend (August 24th – Qualcomm; July 27th – Western Digital), and will continue to do so in the months to come as the stock market goes through the repricing process.

Investments Portfolio Update – AT&T

by Linda McDonough

Paying your utility bills this month: Heat, hot water, electricity and phone? Check.  A large majority of citizens in the developed world have a fifth utility bill to pay these days – internet access.  Most of us expect our Internet service to be as ubiquitous as any other utility and rely on it for our daily dose of news, communication and entertainment.  

AT&T, the industry goliath most of us recognize as a phone utility, has been leveraging its network to provide mobile and landline phone and internet to its customers for some time. Its recent purchase of DirecTV helps it secure a strategic spot in content streaming, an increasingly critical ingredient in luring new customers and keeping them as loyal subscribers.

Seismic changes in the distribution of video content have altered the balance of supply and demand for content programming.  A burgeoning supply of new distribution channels has increased demand for quality content. DirecTV brings a robust menu of programming to AT&T, most importantly its coveted NFL Sunday Ticket contract.

Historically, most media content was purchased by the big cable companies. There was little difference in channel bundles or pricing tiers.  As the market for new homes looking to subscribe to cable became saturated, the cable companies tried to lure customers with price promotions. Despite slow growth these cash cows felt they had little to worry about.

It’s likely cable companies barely blinked when a little company named Netflix offered unlimited DVD rentals to subscribers in 1999.  After all, video rental had been an option for some time and didn’t seem to impact the steady flow of cable subscribers.

Yet Reed Hastings, Netflix’s wily CEO had bigger plans for the service.  Netflix’s 2007 launch of streaming on demand service which offered both movies and television shows, would be the first nip in cable’s seeming monopoly on content.  Netflix went on to offer its streaming service via Sony PS3 gaming consoles, Apple iPads, iPhones and any other Internet connected device.  The days of consumers watching TV from their couches with the cable remote in hand were officially dwindling.

Netflix’s streaming service was one of the first Over the Top (OTT) services which stream content to consumers over someone else’s network.  These “bring your own pipe” options offer customers more variety at lower prices.  Hulu, Amazon Instant Video and Sling TV all offer great viewing options without excessive monthly cable pay TV fees.

With 87% of U.S. households being connected to the Internet, the trend of subscribing to one of these services and cancelling or shifting to a lower priced cable package is gaining steam.

The wave of new OTT services has helped to propel the disaggregation of entertainment content.  Instead of the cable giants holding all the cards and proclaiming what fees would be shared with content providers, the content providers themselves have many distribution options to negotiate with for the most attractive pricing.

The Wall Street Journal recently reported the problems that Sony, who is launching a nationwide roll-out of its Playstation Vue streaming service, encountered when trying to negotiate access to network programming. The networks and their local affiliates balked at the low price Sony offered them leaving Sony scrambling for more content.

DirecTV brings a whole package of already negotiated content to the table, allowing AT&T to hit the ground running with streaming services. The $49 billion purchase closed on July 24th.  AT&T Randall Stephenson described his vision for the combined company,

“Combining DIRECTV with AT&T is all about giving customers more choices for great video entertainment integrated with mobile and high-speed Internet service. We’ll now be able to meet consumers’ future entertainment preferences, whether they want traditional TV service with premier programming, their favorite content on a mobile device, or video streamed over the Internet to any screen.”

In fact AT&T is already wrapping DirecTV into its product line-up.  It is one of the only companies offering a quadruple play package to customers – mobile and fixed phone, Internet and pay-TV.  Cable competitors Comcast and Verizon can boast only a triple play.  Offering customers more services from one provider dramatically lowers churn, the insidious profit thief of any subscription business.

The combined company is now the largest pay TV provider in the country with 20 million customers coming from DirecTV and 6 million from AT&T’s U-Verse service. At the company’s analysts’ day in August it described the multitude of cross-selling opportunities now at its disposal. Any customer subscribing to any one of AT&T’s services or any of those 20 million DirecTV subscribers can now be offered a bundle of any of the four services.

Management expects $2.5 billion of cost synergies over the next 3 years.  Half of those cost savings are related to better content terms, illustrating the importance of size in these negotiations.  A little less than half the savings will come from cutting duplicative office and administrative functions and the balance from improved supply chain expenses.

Even before the merger AT&T was doing a bang up job of beefing up its operations. In the second quarter ending June cash flow grew 13%. Free cash flow, the measure of cash generated by a company after deducting capital expenditures, grew from $5.3 billion to $7.5 billion in the first half of the year. Free cash flow is a particularly important number for AT&T because it represents the funding available for dividend payments, debt repayments and share repurchases.

After the closure of the DirecTV deal, management updated guidance, increasing earnings growth estimates for the years 2016-2018 from low single digits to mid-single digits or better.  Free cash flow for the current year was increased to $13 billion up from $12 billion despite a $3 billion increase in expected capital spending.

AT&T offers an incredibly delicious 5.7% dividend yield.  The company currently pays out roughly 67% of its free cash as a dividend but has promised to bring that percentage up to 70%, offering the potential of an even higher dividend.

Investors can enjoy the best of both worlds with AT&T- stable cash flow generation and now increased earnings growth with DirecTV, as the company transforms itself into a seamless provider of digital content and access.
AT&T carries one of the highest ratings in our Smart Tech portfolio.  Its 10.2 STR is awarded due to its high yield and relative value.

Portfolio Update – Medical Profits

By J. Duarte MD

In this issue:

  • The Big Picture: Gauging Biotech Before the Federal Reserve Meets
  • In Depth: New EBIS Pick – Greatbatch Inc. (GB) Continues Surge
  • EBIS Portfolio Alerts: Alert: EBIS Portfolio Pricing Update
  • News Update: Gilead Raises $10 Billion – Is Buyout Frenzy Ahead?

The Big Picture: Gauging Biotech Before the Federal Reserve Meets

The Federal Reserve meets September 16th and 17th and the market’s response to whatever the central bank decides to do with interest rates is likely to have an impact on the entire stock market, including the biotech sector. Thus, it makes sense to look at where things stand ahead of this important week, and what happens after the announcement on interest rates on the 17th.

Fundamentally speaking, the overall healthcare sector is at a crossroads due to the effects of the affordable care act. This dynamic can be summarized in one statement: money spent in the healthcare system will be either reduced, redistributed or both. What this means, if we are correct, is that biotech companies, especially those with expensive drugs may find it more difficult to meet their earnings expectations as well as to fund their research.   Thus biotech and health care companies are looking to adjust their strategies to the new reality of less money being available to pay for therapies and related items.

That means that there could be more earnings and acquisitions by the upper tier of companies as they look to expand their operations and diversify their abilities to make money. It also means that there may be some research stage companies that may simply not survive this period. Our news section, below, has more on what one company, Gilead Sciences, may be doing in order to adapt to this new reality. We also recommend review of the past three issues of our weekly column for those interested in reviewing the dynamic.

stibwschart             stibiotechchart
Our chart review this week will be focusing on where money is flowing in the biotech sector by comparing two ETFs, the BIS (left) and the IBB (Right). The IBB is a bet on rising biotech stock prices, as measured by the Nasdaq Biotech Index (NBI), while the BIS is a bet on a decline in prices in the same index.   As you can see the charts are nearly mirror images of each other with the BIS falling while the IBB is rising in the current market. More important are the two indicators at the bottom of both charts.

The upper indicator in the lower part of the chart is the Accumulation/Distribution (AD) indicator. The lower indicator is the Money Flow Index (MFI). Both indicators measure whether money is moving in or out of any particular stock or ETF. MFI tends to turn earlier than AD, which is what is starting to happen on both charts.   On the IBB chart, MFI is starting to turn up, while AD has been moving sideways with an upward bias. The exact opposite is happening on BIS.  

What this is telling us is that money is trying to find its way back into biotech.   What we need to see is what these two indicators, and prices, do in response to the Fed. Our conclusion is that, more than even in the last few volatile weeks, current conditions warrant that we make no changes to our overall strategy, as what is working is working. So, we continue to suggest the following:

  1. Monitor the price of all current positions in your biotech portfolio.   If your holdings are holding their own, keep them in your portfolio.
  2. Watch the response of your positions to external forces, especially the Fed, China’s economy, and the current political climate.   Always monitor your portfolio’s response to the market and only sell stocks that are showing significant weakness and fall below their sell stop.
  3. Consider using BIS to hedge your biotech portfolio during periods of weakness for the market and the biotech sector. Our July 27th, 2015 update has an excellent tutorial on how you may go about doing this. Also, see below for our latest BIS recommendation. For further reading on portfolio protection techniques and risk management also consider a copy of Dr. Duarte’s “Trading Options for Dummies.”

In Depth: New EBIS (Emerging Biotech Investment System) Greatbatch Inc. (GB) Continues to Surge

Alert New Pick Update: Greatbatch Inc. (GB) – New Buy Range at 58-62. Sell Stop raised to 51.

Greatbatch Surges behind Surprise Acquisition

Greatbatch Inc. (GB) Buy issued at 51-55 on August 17, 2015. August 17 entry point at the close was 53.51. 9/11/15 closing price 61.20. New Buy range 58-62. Stop loss: Raised to 51. Dr. Duarte owns shares in GB.

Greatbatch surprised the market on 8/27/15 when it announced that it was buying privately held medical equipment maker Lake Region Medical for $1.73 billion in cash and stock. The merger expands Greatbatch’s market share in the outsourced medical equipment manufacturing sector to the 10-12% range. It also increases its exposure to big customer names like Medtronic (MDT), Johnson & Johnson (JNJ) and St. Jude Medical (SJM), all big players in the cardiac pacemaker and related areas.

As we noted in our initial coverage of the stock (8/17/15), Greatbatch is a restructuring story which, at the time we began coverage looked “ready to move higher over the next 6-12 months.” It looks as if management didn’t want to wait that long to make the stock rise. The company manufactures medical equipment under contract to original equipment manufacturers with a focus on the cardiac pacemaker, orthopedics, and spinal cord stimulation segments. GB also has a defense contract division, which gives our EBIS portfolio an interesting edge, since Emergent Biosolutions (EBS) is a major player in vaccines and has a large government and military contract base with its Anthrax and Smallpox vaccines.

GB received an 8 EBIS rating, garnering a BUY recommendation. Now, we have to see what the stock does over the next few weeks to months as the company consolidates its new purchase. We will be paying special attention to the balance sheet and future earnings, as well as how much debt the company has to take on to finance the Lake Medical purchase. We still like the company because it has proven that it can make money a in a challenging environment. Yet, it has clearly been busy over the last few months and it has a lot to consolidate.   Consider the following:

  1. GB is spinning off its spinal cord stimulator business into a separate company it will call Nuvectra, while it continues to generate revenue from manufacturing the equipment for Nuvectra. It’s uncertain what it GB will do with the spinal cord stimulation business that it will get with the Lake Regional purchase. Spinal cord stimulation could become troublesome and it may turn out to be a money loser or a reduced revenue generator under the Affordable Care Act, despite the fact that it may be expanding its focus beyond pain management into the treatment of paraplegia.  

This is a key point, though. Spinal cord stimulation is moving toward a new innovation phase, as implantable devices will be moving toward an external wireless control model based on mobile phones. This means that patients will no longer have to have a battery implanted along with the leads that deliver the stimulation to the spinal cord. What this may have to do with the acquisition remains to be seen.

  1. Prior to the Lake Medical acquisition GB bought CCC Medical, enhancing its cardiac neuromodulator equipment line and has already seen an increase in sales contribution from the acquisition. Cardiac remains profitable for now. We could see a similar situation develop with the Lake Medical acquisition.
  2. GB has been growing its orthopedics equipment business. Although the Affordable Care Act could lead to some pricing pressure on this line of products, the demographics for joint replacements are only improving as the population ages. Also, the trauma related product line, including equipment to repair fractures, could benefit from defense related developments in the future if the geopolitical climate worsens.
  3. The company is still on schedule to move significant manufacturing capacity to Mexico, expecting significant cost reductions and a positive contribution to the bottom line. This could be a negative in the current political environment but it is something that could lower costs and increase earnings for GB.
  4. Most of the company’s product lines are growing except for the vascular related segment, which is separate from its cardiac product line. In its recent conference call, the company cited improving visibility for this line of business in the second half of 2015 and into 2016; as its customers work through inventory and new products are introduced, especially in GB’s catheter line.
  5. GB has a strong engineering and design team which is addressing issues in the energy sector, including improving design for batteries and exploration equipment. Any turnaround in energy could also provide a boost to the stock price.

Here are the EBIS details:

The EBIS Score for GB is 8 based June 30, 2015 data, prior to the Lake Medical acquisition.  

  • Cash on hand: (+1) GB reported $72.34 million on hand up from $61.58 million in September 2014.
  • Cash on Hand growth (year over year) (+1): The year over year cash grew by 17.4%.
  • Revenues (present or not): (+1): The company delivered a small revenue growth rate in its June quarter compared to the year earlier. What is important is that its revenues are not falling even as the company restructures.
  • Revenue growth (10% or greater): GB is not growing its revenues currently but has given positive guidance for the second half of 2015 and 2016.
  • Trailing Total Liabilities/Current Assets (<1=+1 , >1=0): (+1)GB has a 0.91 worst case scenario ratio. That means it can cover all of its liabilities in a worst case scenario without borrowing money.
  • Earnings (Present or Not Present): (+1): GB reported flat earnings growth in its June quarter. Again the company is restructuring and still makes money.
  • Net Income Growth (Year over Year): (+1): The company has delivered stable but not growing earnings.
  • Products on the market: (+1): GB has a broad array of products on the market and a broad customer base.
  • Pipeline Strength: (+1): GB is working with its customers and has a credible pipeline in place.
  • Late Stage Clinical Trials and Product Launches: (+1): The company’s pipeline is nearing launch of new products later in 2015 and 2016.

The EBIS system consists of eleven fundamental criteria that are updated every quarter after the earnings results for each company are published. Each criterion gets a value of +1 or zero. A total of 8 or more points earn a Buy rating. A total of 5-7 points earn a Hold rating. Less than 5 points delivers a Sell or Avoid rating. EBIS was introduced in the June 15, 2015 issue of the Biotech Report.

Portfolio Update: EBIS Portfolio Survives Crazy Market Week – Suffers Casualties Due to Volatility

Alert: Our EBIS portfolio triggered some sell stops this past week. Repligen and Bio-Rad have been removed from the portfolio. However, due to some potential pricing issues in the Flash Crash on 8/24/15 some of the pricing may or may not have been accurate. Thus, we are not removing Neurocrine Biosciences from the portfolio but are downgrading the shares to a HOLD. See details below:

Masimo Corporation (MASI) – Buy at 40-44. (Buy issued July 20, 2015. MPP: 40.65). 9/11/15 closing price: 41.64

Masimo slipped out of our buying range in the week that ended 9/4/15 but has rebounded as of 9/11/15 and is back on track. It is still acting much better than other biotech and medical stocks and is worth continuing to accumulate at these levels.

Masimo manufactures equipment modules that monitor vital signs during difficult clinical and logistical circumstances.   Masimo pioneered Signal Extraction Technology (SET) a process that lets the pulse oximeter measure the oxygen content of blood without punctures of arteries at states of low blood pressure, where it become a most critical piece of data.

MASI reported adjusted earnings of 43 cents per share, 13 cents ahead of expectations in the second quarter of 2015, while revenues came in at $ 155 million ahead of the $147.93 million estimate. The company raised its full 2015 guidance to total revenues of $621 million, up from $608 million and earnings per share from $1.48 to $1.51.   The stock remains well within its buying range of 40-44 and keeps a 9.5 EBIS rating based on its June 2015 quarter. MASI is a well run company with plenty of cash on its balance sheet and a growth agenda. We like Masimo because it has innovative products, an excellent growth rate, and a nice stash of cash on its balance sheet which it could use to make acquisitions or to plow into research and development.

Meridian Biosciences (VIVO) Buy 18- 21 – 9/11/15 closing price 17.78.

Meridian remained within its buy range on the week that ended on 9/4/15. We remain positive on the stock.

Earnings/Dividend update: VIVO met its earnings expectations on 7/23 but fell short on its revenues estimates. The company delivered net income of $9.1 million, 22 cents per share on revenues of 48.2 million vs. expectations of 48.9 million.

On September 9, management adjusted expectations for the full year of revenues of $195 to $200 million and expects revenue growth in the 3-5% range with earnings in the .86 to .90 cents range for the full fiscal year. The stock remains near the lower part of its trading range.   Vivo paid dividend of 0.2 per share on July 20th. The dividend yield is a nifty 4.4%, while the stock price is not particularly volatile. This is a combination which makes having a long term perspective worthwhile.

VIVO has a market cap near $800 million but is a consistent money maker. The company develops, manufactures, and markets diagnostic testing kits focused on gastrointestinal infections, virus detection, and parasitic illnesses. It also produces reagents and key testing and DNA amplification and enzyme related materials used in research. It has recently released a new product, the Para Pak single vial transport system for parasite testing which simplifies the transport of samples to the lab by using one vial instead of the more complicated multiple package systems that are currently on the market.

We expect VIVO to benefit from the global immigration trend and the potential for infectious diseases to expand their territory via travel related transmission channels. The company has a well established global platform including a recently opened office in Beijing (January 2015). Dr. Duarte owns shares in VIVO.

Neurocrine Biosciences (NBIX) (BUY 6/16/16 at 46 – 9/11/15 closing price 54.09 – Sell Stop 40)

Alert: Neurocrine is rated HOLD. Neurocrine hit its sell stop on the Flash Crash but we still like the stock as a speculative play and recommend holding on to the shares if you didn’t use the sell stop. The stock held its own on the week that closed 9/4/15 but due to its inherent volatility is best avoided in the short term. When this scenario changes we will update it.

Neurocrine Biosciences reported a net loss of $24.0 million, or $0.28 loss per share, compared to a net loss of $13.4 million, or $0.18 loss per share, for the same period in 2014. For the six months ended June 30, 2015, the Company reported a net loss of $25.2 million, or $0.30 loss per share, as compared to net loss of $25.2 million, or $0.35 loss per share, for the first half of last year.   Estimates were for revenues of $650,000 and a loss of 29 cents per share.

The stock has the potential to move to the 55-58 area over the next few weeks to months. We originally highlighted NBIX in our 5/29/15 update. We like the stock based on the prospects of its Elagolix drug for treating endometriosis a condition of pre-menopausal women linked to the menstrual cycle and pelvic pain. Dr. Duarte owns shares in NBIX. Neurocrine is also advancing phase III clinical trials of its NBI-98854 drug aimed at the degenerative neurological disease tardive diskynesia.   Neurocrine expects further input on Elagolix by early 2016.

Neurocrine is a speculative stock. This is a research stage company with no products on the market but several potential blockbusters at key stages of development and nearing the FDA approval process.

Upgrade: Emergent Biosolutions – Buy until 36.

Emergent Biosolutions (EBS) (Buy 5/11/15 MPP* 30.63 – 9/11/15 Closing price 32.58) –

EBS reported earnings of 36 cents per share for its second quarter of 2015 beating analyst estimates of 26 cents. Revenues climbed 14% from the year-ago period to $126.1 compared to an estimate of 124.25 million.   The company also announced that it will spin off its biosciences unit, whose focus is oncology to investors.   See our news section for details and commentary below.

EBS showed some weakness in the week that ended 9/4/15. We are still constructive on the stock but are watching its activity very closely.

EBS announced receiving a $44 million contract from the Centers for Disease Controls to increase the supply of smallpox vaccine. The previous week EBS announced a $19.7 million two year contract from the Biomedical Advanced Research and Development Authority (BARDA) on July 20th an agency of the U.S. Department of Health and Human Services. EBS also makes BioAnthrax, a preventive anthrax vaccine and is working on a new generation of the vaccine. Dr. Duarte owns shares in EBS.

Update: Trend Following ETF Model

Alert: Our remaining biotech ETF, the ProShares Dynamic Biotech and Genomics ETF (PBE) was stopped out on 8/24/15. We are removing it from our portfolio for now. That leaves the ProShares Ultrashort Biotech ETF (BIS) as the only ETF in the model for now. It is rated hold.

  • ProShares Dynamic Biotech and Genomics ETF (PBE) (Buy 5/11/15 MPP 55.80 – 8/24/15 Stopped out 48.71. Return (-) 14.55%.
  • ProShares Ultrashort Biotech ETF (BIS) – Buy until 29. Stop Loss 27. (Buy 7/27/15 MPP* 27.99. 9/11/15 closing price 29.)

*MPP – Median Purchase Price

Dr. Duarte owns shares in BIS.

News Update – Gilead Raises $10 Billion – Is a Buyout Frenzy Ahead?

The biotech world started buzzing on September 9, 2015 when Gilead announced it had secured $10 billion in new financing for “generate corporate” purposes.

Gilead Sciences (GILD) has a blockbuster franchise of drugs which treat HIV, and Hepatitis C. Its quarterly revenues from the Harvoni and Sovaldi franchise for Hep C in its second quarter of 2015. But its blockbusters are maturing, and there are likely to be pricing pressures ahead as the Affordable Care Act (ACA) continues to change the environment in the health care sector. Gilead’s history suggest that its pondering some sort of buyout.

According to Fierce Biotech, the potential target list could include Vertex (VRTX), Incyte (INCY), BioMarin (BMRN), Medivation (MDVN) and Alexion (ALXN).

To be sure, those large drug producing biotechs could be on Gilead’s radar. Yet, it is also plausible to consider that Gilead could acquire some smaller companies. That could be a boom for our portfolio in several ways. One way would be that Gilead actually bought one of the companies in our EBIS lineup. It’s hard to know which company may fit its goals at this point. More likely, though, any kind of Gilead led buyout could ignite buyout fever in the biotech sector. If that happens, it is possible that the whole sector, which often moves in tandem, could start rising.

NASDAQ Composite Index:                                                                       

Friday, September 11 = 4,822.34                                                  

Trailing 12 months = + 5.2%                                        

Trailing 4 Weeks = + 2.5%

Trailing 7 Days = + 3.0%             

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