For Immediate Release
Chicago, IL – June 17, 2014– Zacks Equity Research highlights RF Micro Devices (RFMD-Free Report) as the Bull of the Day and Select Income Reality (SIR-Free Report) as the Bear of the Day. In addition, Zacks Equity Research provides analysis on TriQuint Semi (TQNT-Free Report), Medtronic (MDT-Free Report), Covidien (COV-Free Report), Johnson & Johnson (JNJ-Free Report), iShares U.S. Medical Devices ETF (IHI-Free Report), Pfizer (PFE-Free Report) and AstraZeneca (AZN-Free Report).
Here is a synopsis of all five stocks:
Bull of the Day:
RF Micro Devices (RFMD-Free Report) is what we call a "deal stock" which means its one of two companies that are getting together. Usually "deal stocks" have limited potential for investors from the time between the deal is announced and when the deal is consummated. Not so for RF Micro and TriQuint Semi (TQNT-Free Report) which announced they were getting together back in February of this year. Today, RFMD is a Zacks Rank #1 (Strong Buy), and it is the Bull of the Day.
Deal Stocks And The Zacks Rank
Knowing that RFMD and TQNT are both deal stocks, it should be noted that it is pretty rare to see either one see a significant increase in earnings estimates. These changes to earnings estimates drive the Zacks Rank, with the lower the number the better the revisions to the consensus.
Most stocks that are involved in some sort of M&A often see the analyst community back off and look for the expected growth to come after the deal is closed. Often the company will even try to push contracts and new customers into future quarters as they will be rewarded for growth when the companies combine.
This is not the case for the RFMD / TQNT entity, as both stocks have been seeing a lot of growth in share price even after the deal was announced. On Friday, RFMD became a Zacks Rank #1 (Strong Buy) while TQNT has been a Zacks Rank #2 (Buy) since late April.
Most Recent Quarter
RFMD reported a strong 1Q14 following the announcement that it was combining with TQNT. On April 29, the company reported earnings of $0.10 per share, $0.03 better than the Zacks Consensus Estimate for a positive earnings surprise of 42%. The topline was also a beat, with revenues coming in $5M ahead of expectations.
As a result of the solid performance the stock moved higher by 4% in the session following the earnings announcement.
Prior To That Beat
Prior to the most recent beat, RFMD was already on a streak of 4 straight beats of the Zacks Consensus Estimate. The company met the number for the December 2012 quarter. The last time RFMD missed the Zacks Consensus Estimate was the March 2011 quarter, so it has been a while.
RFMD Sees Estimates Moving Higher
The Zacks Consensus Estimate for 2014 for RFMD has held constant over the last several months. This could be due to the fact that analysts are waiting for the deal to be consummated and to get some guidance from the company before rolling out new numbers. That said, they don't feel the same way about 2015.
The 2015 Zacks Consensus Estimate saw a big move higher following the earnings release in late April. The estimate moved from $0.50 to $0.68 and has remained at that level since April.
The valuation of this stock is something investors should pay attention to, but also be aware that it soon will be part of a larger entity. The stock trades at a forward earnings multiple of 14.6x compared to a 14.8x industry average. The price to book multiple of 4.1x is well above the 1.7x industry average so value investors might want to look elsewhere. The price to sales multiple shows the stock trading at 2.4x compared to a 1.9x industry multiple.
The question becomes how low were those multiples at the time of the deal announcement with TQNT! As I look at the next fiscal year, I see expectations of 19% topline growth and a whopping 422% in expected earnings growth. The following year is showing 11% expected revenue growth and 116% earnings growth. Those are some huge numbers.
Post Deal Structure
TriQuint shareholders will receive 1.675 shares of the new company and RFMD shareholders will receive 1 share of the new company for each TriQuint or RFMD share held. At the closing of the transaction, the companies will execute a one-for-four reverse stock split resulting in approximately 145 million shares outstanding.
Bear of the Day:
Select Income Reality (SIR-Free Report) forget for a minute that issues with the board and an "activist" stance from a long term investor. The Bear of the Day is more about how a stock becomes a Zacks Rank #5 (Strong Sell). The SIR story has a lot of moving parts, so let's look at a few of them.
Put A Price On Paradise
Select Income REIT (SIR) is comprised of roughly 8 million square feet of single tenant net leases of properties in the mainland US as well as 18 million square feed of commercial lands in Hawaii. SIR was spun out of Commonwealth REIT (CWH) and is externally managed.
Let's just think about that for a minute here, this is a Hawaiian REIT, and not that I have ever been there, but many say it is like paradise on Earth. Of course everything on Earth comes at a price, so just because its a wonderful vacation destination does not mean that any investment in real estate will automatically increase in value.
Despite a beat in the most recent quarter, the company posted two quarters that came up short of the Zacks Consensus Estimate. The Zacks Rank takes this into consideration, but it is not the major reason for #5 Rank.
SIR Sees Estimates Moving Lower
The Zacks Consensus Estimate for 2014 for SIR has been sliding for just about a year now. The number was as higher as $3.05 in June of 2013 but since then we have only seen it move in one direction. By January of this year it was down to $2.91 and it dipped down to $2.79 in June.
The 2015 Zacks Consensus Estimate has also seen a significant drop, with estimates moving from $3.09 in December 2013 to $2.92 in March and are now at $2.73.
Earnings estimate revisions have the largest influence of the Zacks Rank. If estimate fall, from many analysts, the Zacks Rank is very likely to move lower as well.
Why The Drop In Estimates With Recent Beat?
This is where the story gets hairy. Recent events include a secondary of 9M shares and more importantly a letter from a source that isn't normally considered an activist investor.
Funds managed by Lakewood Capital Management (LCM) hold a 5.8% interest in SIR through common stock and cash settled total return swaps. LCM has been in business for seven years and not publicly expressed its opposition to governance in any investment... until now. The activist letter states that the stock is undervalued, and that management decisions have led to 1) dilution, 2) board expansion and 3) a sweetheart deal to CommonWealth REIT allowing it to sell directly to SIR and not making such an offer available to all shareholders.
SIR sent a return letter basically saying thanks for the letter, but we are doing just fine.
Despite the Zacks Rank #5 (Strong Sell), the valuation on this stock is rather attractive. The stock trades at 10x forward earnings compared to 15x industry average. Value investors will love the 1.2x book multiple compared to a 2.7x industry average. A more or less meaningless price to sales multiple of 8.6x seems very high, but it is only slightly higher than the 8.3x estimate.
Investors should keep this stock on their radar as that sort of valuation looks great to me. The only thing I would want to see is the earnings estimates move higher, and you will be tipped off to that idea by watching the Zacks Rank on this stock.
Medical Device ETF in Focus as Medtronic Buys Covidien
The second largest U.S. medical device manufacturer Medtronic (MDT-Free Report) agreed to buy Irish rival Covidien (COV-Free Report) for $42.9 billion in cash and stock in order to cut corporate tax rates. This is because the business tax rate in Ireland is just 12.5%, much lower than that of 35% in the U.S., which is considered the highest tax rate in the world.
As per the terms of the deal, Medtronic will pay $93.22 per share to Covidien shareholders, representing 29% premium on Covidien's stock price as of Friday. The agreement marks the largest deal in the healthcare sector so far this year (see: all the Healthcare ETFs here).
The acquisition, expected to close in the fourth quarter of this year or early 2015, will likely result in annual pre-tax cost synergies of at least $850 million by the end of fiscal 2018. After the completion, business of both companies will be combined to form Medtronic plc. The move will allow Medtronic to take advantage of the so-called ‘tax inversion’ by moving its headquarters to Ireland, which has low tax rates.
While the merger will help Medtronic to reduce its global tax burden by gaining access to almost $14 billion in cash overseas, it would also broaden the company’s scope beyond its array of heart devices, spinal implants, insulin pumps and other products into new areas ranging from surgical staplers to ventilators (read: Medical Device ETF Investing 101).
The merged company will become one of the largest providers of medical devices in the industry with 87,000 employees in over 150 countries. The combination would generate about $27 billion in total revenue, including $3.7 billion from emerging markets, and is expected to be accretive to cash earnings in 2016 and beyond. Further, the combined company would be in a better position to compete with the medical devices’ industry leader Johnson & Johnson (JNJ-Free Report).
Given that the deal was announced in the weekend, these two stocks and the medical device ETFs are in focus. Both stocks have the potential to ride higher on merger synergies in the days ahead and look to fuel a rally in iShares U.S. Medical Devices ETF (IHI-Free Report).
IHI in Focus
This ETF provides targeted exposure to U.S. medical device stocks by tracking the Dow Jones U.S. Select Medical Equipment Index. The fund holds about 49 securities in its basket and charges 46 bps in fees per year. Medtronic takes the second spot at 10.94% of assets while Covidien makes up for the fifth position in the basket with 6.45% share (read: Medtronic Earnings Drags Medical Device ETF Lower).
The product has a definite tilt toward large cap securities with 72% of assets, followed by 17% in mid-caps and the rest in small caps. From a sector look, about one-fourth of the portfolio is allocated to medical equipment while medical supplies and pharmaceuticals take the remainder. In terms of style, the ETF is nicely spread across a variety of growth, value and blend stocks.
IHI is less popular and less liquid in the healthcare space, with AUM of $696.2 million and average daily volume of around 102,000 shares a day. The fund has added 6.3% so far this year, lagging the broad healthcare fund (XLV), which has returned nearly 8% this year. The fund currently has a Zacks ETF Rank of 3 or ‘Hold’ rating with Medium risk outlook, suggesting room for upside.
Lately, ‘tax inversion’ is gaining popularity. Such deals have raised concerns among U.S. lawmakers as these would erode government revenues by giving corporates a way to evade tax. A similar move was attempted by the U.S. largest drug maker Pfizer (PFE-Free Report) to acquire the second-largest British drug maker AstraZeneca (AZN-Free Report) for $120 billion. The deal however failed (read: Deal ETFs in Focus on Flurry of M&A Activity).
Given the slew of M&A activities and changing dynamics of the healthcare industry, investors seeking to tap the latent opportunity could invest in this medical device ETF.
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