3 Stock Picks: UNH, DLM, LULU

Investors showed symptoms of health-care-reform fatigue Thursday and sold off UnitedHealth Group (UNH) after the insurer received a key downgrade. Shares fell 8% during early trading.

Carl McDonald, an analyst at Oppenheimer & Co., said on Wednesday he was cutting his rating on UnitedHealth to Underperform from Perform, citing a Medicare strategy he said could cut the heath insurer's margins and reduce earnings by as much as 45 cents a share next year. He said the Minneapolis-area company is assuming that physician costs drop 21% next year, which would require Medicare to adjust its reimbursement plans quickly, a scenario he described as unlikely.

The downgrade to UnitedHealth takes place against the backdrop of increasingly aggressive government efforts to reform health care. President Barack Obama last week urged legislators to craft a health-care proposal by October. That makes prospects for the entire sector all the more uncertain.

"I strongly believe that Americans should have the choice of a public health insurance option operating alongside private plans,” the president said last week. “This will give them a better range of choices, make the health-care market more competitive and keep insurance companies honest.”

In McDonald's view, neither policy nor process will work out well for UnitedHealth.

"Congress isn't planning on passing health reform legislation until early September, which is probably aggressive. Either way, it will be far too late for the Centers for Medicare and Medicaid Services to adjust reimbursement, since the 2010 Medicare marketing season begins on Oct. 1," he wrote. "Therefore, 2010 will be United's third consecutive year of declining operating earnings, which will make it difficult for the company to sustain its industry-leading multiple, particularly since the market currently believes next year is when all of United's pieces will fall back into place. It doesn't appear that will be the case."

Bottom Line: Sell
This may be the time to do some preventative profit-taking with UnitedHealth.

Del Monte Foods (DLM) posted strong quarterly earnings Thursday and offered positive guidance. Shares jumped 8.7% during early trading.

The San Francisco-headquartered company, owner of Contadina and the company's namesake food brands, reported fiscal fourth quarter earnings of 36 cents a share, up from 25 cents a share a year ago. Revenue also rose to $1.06 billion. Wall Street analysts expected earnings of 26 cents a share on revenue of $957 million.

Del Monte CEO and Chairman Rick Wolford said that cost cuts and price hikes combined to produce the results. The company’s pet foods division was also a strong contributor.

"This performance largely reflects aggressive fiscal '09 pricing actions taken to combat inflationary cost increases, which more than offset modest category volume declines," he said on a conference call.

The company said it now expects fiscal 2010 earnings in a range of 76 cents to 80 cents and sales growth of 4% to 6%. Wall Street analysts had forecast earnings of 75 cents a share with sales growth of 4%.

Tim Ramey, an analyst at D.A. Davidson, said Del Monte has benefited from the "trade down thesis" during the recession, as shoppers eat out less, and buy more groceries. "That's really playing into their wheelhouse," he says. "They were able to control trade spending and figure out how to raise prices without having to give it all back to the grocer."

One concern, though, is that the company will have to refinance a heavy debt load soon, and terms could be expensive. "If there's a cloud on the horizon, that's it," Ramey says.

Bottom Line: Hold
This is a decent defensive play that's benefiting from improving management as well as its place in the business cycle.

Sportswear manufacturer Lululemon Athletica (LULU) beat earnings forecasts for the quarter, but couldn’t stretch its guidance to satisfy Street expectations. Shares fell over 7% Thursday morning.

The yoga-centric retailer reported fiscal first-quarter earnings of nine cents a share, down from 12 cents a share a year ago. Wall Street was expecting eight cents a share. Same-store sales declined 8% from a year ago, though total sales rose 6% to $81.7 million because of new store openings. (It runs 67 stores world-wide.)

"Given our high level of productivity and the strong double-digit same store sales we produced a year ago, we see our Q1 sales trend as a small victory and believe it reflects the resiliency of our brand and validates our position in the marketplace," CEO and President Christine Day said on a Thursday conference call.

However, the Vancouver, B.C.-based company said it sees second-quarter earnings of eight cents to nine cents a share, below Street expectations of 11 cents a share.

Retail figures for May released Thursday showed the first uptick in three months, though specialty shops like Lululemon aren't making much of a contribution. PNC chief economist Stuart Hoffman said the 0.5% increase is due mostly to higher gas prices and improved sales at building supply stores.

Thomas Weisel Partners analyst Liz Dunn wrote Thursday that as a debt-free operation that's been able to keep expanding at a measured pace, Lululemon deserves to trade at a premium to its competition.

"Even if the company does not meet its 300-store goal, the company still has more growth potential than the majority of our coverage universe," she said.

Bottom Line: Buy
Like yoga itself, it will take patience and discipline to profit, but this is a potential long-term success story.