Wellington Management's Top Buys: 3 Potential Longs, 2 To Avoid

By Ashish Sharma - May 25, 2012 | Tickers: BSX, CX, ECA, MSFT, TMUS | 0 Comments

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Wellington Management Company, LLP is an investment advisory and hedge fund firm managing over $300 billion in equity assets. The firm’s investment process generally involves understanding global trends and outlooks for securities and sectors, and evaluating potential candidates on valuations, models, opinion and recommendations from different sources. The global strategy focuses on financially sound companies that are out of favor, display potential for above average returns, and are selling at low P/E ratios.

The following is a list of some of the top buys of Wellington from the last quarter as released in its most recent 13F filing with SEC.

I am bullish on Microsoft, Boston Scientific and Encana Corp among the above stocks. However, I would like to avoid Cemex and MetroPCS communications. Here is a detailed look at each of these stocks.

Microsoft Corporation (NASDAQ: MSFT): My Take – Buy

Microsoft has seen 12.13% gain YTD in 2012 versus NASDAQ’s 9.40% gain. The main drivers for this upside have been the strong business trends as evident from its last quarter earnings release and the excitement surrounding Windows 8 launch. With a strong product pipeline and low valuation (9.58x forward earnings), I believe a substantial upside is still left in the stock and investors should use the recent 7-8% correction as a buying opportunity.

In the near term, I believe news on Windows 8 partner build up will likely act as a catalyst for the stock. Medium term drivers include successful Windows 8 launch; NOK-WP7 phone gaining traction; Strong enterprise business momentum driven by Windows 7 corporate refresh cycle; Strong customer momentum on Office 365 and Windows Azure; Reducing losses from Online Service Division and market share gains of Bing; and Multiple product launches including Office 15, Windows Server 2012, System Center 2012 and SQL Server 2012.

Further, Microsoft’s defensive nature of business; net cash holdings of $45 billion and an attractive 2.70% yield should provide downside support in case the broader macros worsen.

Boston Scientific Corporation (NYSE: BSX): My Take – Buy

Boston Scientific is an interesting turnaround story. 2011 was a transition year for BSX in which it absorbed deal-related dilution, reinvested in its business and implemented its new strategic plan. Going forward, I expect the company’s restructuring and reinvestment to yield results over the course of 2012 and the next few years. One thing I will be closely watching is the company’s gross margins and operating expenses trend. The company’s management have announced that their target is to increase the company’s gross margins by a total of 800 bps over the next five years. If the management is able to achieve even half of it, I believe the stock can see significant upside. Other catalysts I will be watching out for are the market share gains from the company’s new pacemaker product and EPS upside from Promus Element which recently got approval in the US and Japan.

BSX is trading at 13.74x current year EPS estimates. However if we remove amortization, the company is trading at ~9x cash EPS which is a discount to its peers like Medtronic and St. Jude Medical. On EV/Sales basis also, the company is at a discount to its peers. I believe it is a good time to start initiating a position in the stock from a medium to long term perspective.

Encana Corp (NYSE: ECA): My Take – Buy

I believe natural gas fundamentals have bottomed and Encana with ~95% production tied to natural gas will be a likely beneficiary of the recovery in gas prices. Natural gas is trading at ~80% discount to crude oil on an energy equivalent basis. I don’t believe this can continue in the longer term. I have presented my bullish argument on natural gas in a previous article. Please visit it here for details.

Encana has just 14% of its production hedged for 2013 and if any recovery happens in the gas prices it will directly reflect on its P&L. In addition, Encana’s management has stated their goal to increase the company's cash position to $3 billion by the end of this year. This will provide support to the company's 3.6% dividend yield (~$600 million annual payout) if the recovery in natural gas prices is delayed.

In addition to improving natural gas fundamentals, another potential positive for Encana is the possibility of a JV on its Oil & Liquid rich plays. ECA holds ~1.5 million net acres in the Tuscaloosa, the Mississippian line, DJ Basin Niobrara, the San Juan Basin and Piceance Niobrara. ECA might unlock shareholder value by a deal similar to the $2.5 billion JV Devon struck with Sinopec.

CEMEX, SAB de CV (NYSE: CX): My Take - Avoid

I don’t like Cemex’s heavily leveraged balance sheet. Thanks to its high debt and risks to covenants, the company’s stock declined to $2.18 in October last year. The company has made some improvement with respect to increasing profitability and improving its balance sheet since then and the stock is now at $5.53. I find the company’s risk rewards balanced at these levels.

From the business perspective trends in US and Central/South America are improving, while Northern Europe and the Mediterranean are likely to experience weaker operating performance. I am also concerned about Cemex’s ability to remain within existing debt covenants and substantial debt maturities in 2014. Hence, I would like to remain on the sidelines.

MetroPCS Communications, Inc (NYSE: TMUS): My Take - Avoid

MetroPCS reported disappointing last quarter results, missing gross adds and margins significantly. MetroPCS has 94% of its 9.5 mn subscribers on its 2G CDMA network. Approximately 40% of its subscriber base is trying to use smartphone on this same network and are experiencing a sub 100 kbps speed. This is causing dissatisfaction among its customers and increasing churn risk. In order to retain customers, PCS is upgrading its’ dissatisfied 2G users to 4G which is hurting its margins.

In what appears to be a recurring story in the smaller US wireless companies, Metro PCS appears to be going on a trajectory similar to Sprint -- spending aggressively to add new customers and retain existing ones causing margin declines. This trend is unlikely to reverse in the near term and I find it very difficult to make a buy case for the company in this environment. The only upside case I see for the company is it receiving an attractive buyout offer from a bigger player. However, I don’t like speculating on M&A opportunities and would prefer remaining on the side-lines.

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