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Author Archives: Chris Versace, Chief Investment Officer

About Chris Versace, Chief Investment Officer

I'm the Chief Investment Officer of Tematica Research and editor of Tematica Investing newsletter. All of that capitalizes on my near 20 years in the investment industry, nearly all of it breaking down industries and recommending stocks. In that time, I've been ranked an All Star Analyst by Zacks Investment Research and my efforts in analyzing industries, companies and equities have been recognized by both Institutional Investor and Thomson Reuters’ StarMine Monitor. In my travels, I've covered cyclicals, tech and more, which gives me a different vantage point, one that uses not only an ecosystem or food chain perspective, but one that also examines demographics, economics, psychographics and more when formulating my investment views. The question I most often get is "Are you related to…."
Disney Sets the Stage for Content to Come in 2018 and Beyond

Disney Sets the Stage for Content to Come in 2018 and Beyond

Over the weekend, The Walt Disney Co (DIS) held its latest D-event, which is the company’s showcase of new movie trailers and announcements. This year at D23, Disney shared what’s up and coming for both its animated as well as live action movies. For those of us that have been paying attention, there was only modest new news, but the event did solidify our view that 2017 is a transition year for the company’s core film business.

As a reminder, the film business and its tent-pole properties serve as a key force behind Disney’s other businesses as the management team at this Content is King investment theme company are magicians at extending the influence of a movie from the big screen into licensed merchandise, theme park attractions and other content spin-offs and sequels. As we move deeper into 2017, we continue to expect the transitory nature of the film business to disappear, which sets the stage for a more robust 2018 for Disney and its shares.

Now let’s review what Disney shared over the weekend breaking it down into two categories – animated and live action films. On the animated side, Disney discussed Toy Story 4 (June 2019), Wreck It Ralph 2: Ralph Breaks the Internet (November 2018), Coco (November 2017), a new short film Olaf’s Frozen Adventure as well as Frozen 2 (November 2019) and The Incredibles 2 (June 2018). Additionally, there was a clip from an untitled project, simply referred to as: “The Untitled Pixar Film That Takes You to A Suburban Fantasy World”, which isn’t projected to see screens until 2020 or 2021. On the live-action side of the movie slate, fantasy film A Wrinkle in Time with Oprah Winfrey and Ava DuVernay (March 2018), Star Wars: The Last Jedi (December 2017), and Avengers: Infinity War (2018).

Per reports following the event, the teaser trailer for the next Avengers movie stole the show. This coming weekend, we should get more details if not buzz over that movie when Disney holds it Marvel panel at the San Diego Comic-Con.

Yes, after a somewhat slow 2017, it’s looking like Disney is once again going to wow at the box office.

While we are on the subject of Disney, like many other cable channel operators it has been contending with not only cord cutting, but new “skinny bundles” that are now being offered, moving away from the 250-plus pay-TV bundles that have been the standard the past two decades. In the coming quarters, Disney will be renegotiating contracts with cable operators, and we suspect it will look to offset subscriber declines. As you can imagine, we will be listening closely to these negotiations and what they likely mean for revenue and profits coming out of Disney’s ESPN unit. The first of such negotiations will be with Altice USA (ATUS) when its contract expires this fall.

We acknowledge that DIS shares are likely to be range bound for the next few months until the company’s main content driver, the box office kicks back into gear. Let’s remember, Disney has an ample share buyback program in play and the cash flow as well as the balance sheet to fund it. We will continue to be patient, being reminded in the process by Netflix’s (NFLX) 2Q 2017 results that consumers flock to content or as we like to say, Content is King.

  • Our price target on DIS shares remains $125, which offers 18 percent upside from current levels.

 

 

 

WEEKLY ISSUE: Earnings start off just as we expected, which isn’t a good thing

WEEKLY ISSUE: Earnings start off just as we expected, which isn’t a good thing

In this Week’s Issue:

  • A Picture is Worth a Thousand Words, So Here are Four Thousand Words
  • Investor Uncertainty Pushes AT&T Below Our Stop Price
  • USA Technologies – A Tug of War in the Short-term, but Long-Term Opportunities Remain
  • McCormick Scoops Up Reckitt Benckiser Group Plc
  • Watch-Out for More to Come this Week on Disney and Amazon

 

 

Second quarter earnings season really began late last week, and as we’ve been expecting it’s been anything but smooth sailing. While we’ve only received a handful of reports over the last few days, looking at ones from JPMorgan Chase (JPM), Bank of America (BAC), Goldman Sachs (GS), rail company CSX (CSX) and Harley Davidson (HOG), they’ve been less than well received despite reporting beats relative to expectations for 2Q 2017. As we are fond of saying, the devil is in the details, and in each report, there has been something that has raised investor’s eyebrows.

The clearest case was with Harley Davidson, which slashed its 2017 outlook and now expects motorcycle shipments to be down 6 to 8 percent compared to 2016 vs. its prior call for a flat market year-over-year. We’ve haven’t dug deep into its earnings report, but Harley’s outlook cut could very well be a result of the Baby Boomers slowing down their purchase rate these “hogs” — a headwind to the Aging of the Population theme if there ever was one.

As you well know, a rollback to corporate earnings is exactly what we’ve been expecting. Our position here has been that this rollback was inevitable for the second half of 2017 given the confluence of data showing a clearly slowing economy and the stalled Trump agenda in Washington — both of which have likely revived at least some degree of uncertainty in the c-suite.

Earlier this week, there was another blow as the GOP shifted from repealing and replacing the Affordable Care Act to just simply repealing it. That news pressured the dollar and was another sign of the hamster wheel the Trump administration is caught on when it comes to its agenda. This is but another notch in the uncertainty belt and the question to be pondered now is will team Trump move past healthcare reform to focus on tax reform and other items, like rebuilding domestic infrastructure? Time will tell, but odds are it’s going to be at least several weeks until we have an answer.

 

 

A Picture is Worth a Thousand Words, So Here are Four Thousand Word

In this week’s Monday Morning Kickoff, we ticked off the reasons why the resetting of expectations I alluded to above was, well, expected. If a picture is worth one thousand words, then here are four thousand that provide a great visual summary of what is about to occur.

 

 


Tying these four together, we see the disconnect between the speed of the economy and expected earnings for the back half of 2017.

Current expectations call for earnings-per-share growth of just over 11 percent in the second half of 2017 vs. the first half ­— nearly double the 5.6 percent average of the last several years. As we can see in the above graphs, given the speed of the economy mixed with the push-outs in the Trump agenda, it’s looking very likely there needs to be a walk-back in guidance. Keep in mind, too, that we are only starting to see EPS expectations for oil and energy companies revised lower following the move in oil prices. I make note of this because the energy sector was slated to be the big driver of EPS improvement in the second quarter and back half of 2017.

The bottom line is we are just at the start of second-quarter earnings and we’ve got more than 220 reports to go this week, followed by more than 600 next week, and more than 1,200 to close out the first week of August. It’s going to require a lot of digging, thinking and re-calculating over the next few weeks, but team Tematica will be here to get you through it.

The good news is a pullback in the market will allow us to pick up thematically well-positioned companies at better prices or scale into well-positioned ones that are already on the Tematica Select List at better prices than we have today.

 

Investor Uncertainty Pushes AT&T Below Our Stop Price

This week we were stopped out of AT&T (T) shares as our $36 stop loss was triggered. The net result after accounting for dividends received was a modest loss given the $37.63 buy-in price last November. We continue to favor the pending transformation in the company’s business that adds a Content is Kingmoat around its connective business that will occur when it completes its pending acquisition of Time Warner (TWX) later this year. As we head into further into 2Q 2017 earnings and the dog days of summer, we’ll let the shares cool off and revisit them over the coming week.

 

USA Technologies – A Tug of War in the Short-term, but Long-Term Opportunities Remain

Last week we shared USA Technologies (USAT) was looking to raise additional funds through a stock offering that would likely be dilutive to its bottom line. Our position as shareholders was that while we were less than thrilled with the strategy, we also understood the need for additional capital so it could continue to capitalize on our Cashless Consumption investing theme. This week, we received some rather positive news from the company as it boosted its June quarter outlook.

More specifically, during the quarter USA Technologies received a “substantial” repeat order from an existing customer that dramatically increased its service revenue during the quarter. The company now sees June quarter revenue of $32 million to $34 million compared to the consensus expectation of $27.4 million. Moreover, based on the updated forecast USAT now sees its 2017 annual revenue coming in between $102-$104 million (remember the company is a June fiscal year end). That number is an increase of roughly 33 percent and ahead of the $97 million expected by investors.

Mixing and matching those two items, we would not be surprised to see USAT shares toggle back and forth as the good news (upside relative to expectations) is counterbalanced by the stock offering. We continue to like USA Technology’s positioning in our Cashless Consumption investing theme, which could put it on the acquisition radar screen of larger companies, and we will continue to be patient investors.

  • Our price target on USAT shares remains $6, but should the shares pullback below $4.75 in the near-term we’d be willing to scale deeper into the position.

 

 

McCormick Scoops Up Reckitt Benckiser Group Plc

Early this morning it was reported that McCormick & Co (MKC), which sits between our Foods with Integrity and Rise & Fall of the Middle Class investing themes, will buy the food business of British consumer goods conglomerate Reckitt Benckiser Group Plc for $4.2 billion. Acquired products include French’s Mustard, the world’s leading mustard brand, as well as Frank’s RedHot Sauce (a team Tematica staple) and Cattleman’s line of sauces, which will push McCormick to the forefront of the condiment category in the U.S. as well as bolster its growing international footprint.

Per the company’s press release, McCormick will integrate the acquired business into its consumer and industrial segments, and targets $50 million in cost synergies by 2020. Given its conservative nature, we suspect there could be more synergies to be had, especially once we factor in cross promotion and product extension possibilities.

  • For now, our price target on MKC shares remains $110. As more details, including the financing of this transaction, are revealed we’ll look to revisit that price target, most likely with an upward bias.
  • If shares come under pressure following today’s news, we’d be inclined to scale deeper into the position closer to the $91.80 cost basis we have on the Tematica Select List.

 

 

Watch-Out for More to Come this Week on Disney and Amazon

Last weekend, The Walt Disney Co. (DIS) held its latest D-event, which is the company’s showcase of new movie trailers and announcements. Also, Amazon (AMZN) continued its seemingly daily new feature announcement, this time revealing through recent trademark filings that it is looking to attack the growing meal kit business — not a surprise given the recent agreement to acquire Whole Foods Market (WFM).

Lenore Hawkins
Tematica Research Chief Macro Strategist

Both of those events require a fair level of unpacking and entirely separate reports from this weekly summary issue. Once our analysis is complete, we will post updates here for subscribers. You should also be sure to check the site regularly as well, because not only are all issues posted to the website first, there is also a whole host of other content featured on a daily basis — Macro economic insights from our Chief Macro Strategist Lenore Hawkins in “Elle’s Economy”, Thematic Signals where we trace key thematic happenings that are ripped from the headlines, and Cocktail Investing, our weekly podcast with myself and Lenore.

And then, of course, there is also the Tematica Select List performance charts, which I am happy to say are now being updated at the end of each trading day and are presented in a new, expanded format.  There is lots to read and consume here, with more enhancements planned, so be sure to check it out today.
 

 

WEEKLY ISSUE: Adding a New Scarce Resources Play to the Tematica Select List

WEEKLY ISSUE: Adding a New Scarce Resources Play to the Tematica Select List

In this Week’s Issue:

  • Adding Some CORN to the Select List
  • Amazon – More Than Prime Day this Week
  • What PepsiCo Says About Our Foods With Integrity Investing Theme
  • The Wall Street Journal Serves up a Bullish Case for our AMAT Shares
  • USA Technologies: Arming Itself for the Growing Cashless Consumption Opportunity

 

We’re several days into 3Q2017 and while we’re waiting for 2Q 2017 earnings to kick into gear, we’re once again seeing Washington and all Trump-related shenanigans dominate the headlines. Amid the bluster of renewed chatter among Trump-related ties to Russia, we found more interesting a comment from Treasury Secretary Steve Mnuchin. Mnuchin stated, “the Trump administration hopes to roll out its “full-blown” tax reform plan in early September and sign it into law by the end of the year.” While we are all for tax reform, the issue is the timetable as this, too, has now slipped past the original August deadline.

Yesterday, Senate Majority Leader Mitch McConnell has delayed the start of the August Senate recess until the third week in August in order to allow more time for “work on health care reform” among other tasks. Put together, it continues to look like we should see a reset in GDP expectations as well as earnings expectations for the back half of the year.

This week there are just a handful of S&P 500 companies reporting, and as we discussed in this week’s Monday Morning Kickoff, that will change beginning next week with the up-tempo velocity lasting through August 4. We’re sharpening our pencils and getting ready for the onslaught. Before then, we’re adding a new Scarce Resource play onto the Tematica Select List this week as well as sharing our take on this week’s news for Amazon (AMZN), McCormick & Co. (MKC), International Flavors & Fragrances (IFF), Amplify Snacks (BETR), Applied Materials (AMAT) and Universal Display (OLED).

 

Adding Some CORN to the Select List

Several weeks back, we spoke with Sal Gilbertie, President, Chief Investment Office and co-founder of Teucrium Trading about his commodity-based ETFs, which include the:

  • Teucrium Corn Fund (CORN)
  • Teucrium Wheat Fund (WEAT)
  • Teucrium Soybean Fund (SOYB)
  • Teucrium Sugar Fund (CANE)

Given our past lives that looked at agricultural equipment companies, we were more than familiar with the supply-demand dynamics of commodities before we spoke with Sal. Sometimes it’s either the supply side or demand side of the equation in the driver seat, but from time to time both levers are being pulled, much like we are seeing with oil these days where there is both rising supply and weakening demand. The windup is oil prices have been under pressure and we continue to expect oil earnings to be reset given that price falloff.

 

We’re seeing something very different when it comes to the agricultural commodities, especially corn and wheat as prices for both have been climbing of late. What’s at work here is steadily rising demand associated in part with the “rise” aspect of our Rise & Fall of the Middle-Class that is spurring demand for the protein complex and other food stuffs. There is also the influence of our investing theme given that the world’s population continues to grow and now exceeds 7.4 billion people. Roughly every three months, there are around 20 million more people on our planet, which means that since 2013 there are around 320 million more mouths to feed. We’d also point out that these agriculture commodities are consumables, meaning that once they are eaten they are gone and need to be purchased again. That is especially true with corn given the plethora of uses that span a multitude of food and industrial products including starch, sweeteners, corn oil, beverage and industrial alcohol, and fuel ethanol.

 

 

What explains the rise in corn and wheat prices, however, is the supply side. Over the past four years from 2013-2016, crop yields in the U.S. were at record levels, and inventories rose and that led US farmers to plant fewer acres this year. In turn, at the start of 2017, the U.S. Department of Agriculture projected that the 2017 crop would be more than a billion bushels smaller than the 2016 crop.

Flash forward to the last week of June and we are witnessing a developing drought across North Dakota, South Dakota and Montana, which is boosting grain prices. That drought has led to deteriorating corn crop conditions year over year with 65 percent of the U.S. corn crop being rated good/excellent vs. 68 percent a year ago at this time. While the overall drought situation in the US is far better than this time a year ago per data furnished by the US Drought Monitor, drought conditions have been on the rise, particularly in key corn regions that are North Dakota, Iowa and the Northern Plains.

 

At the same time, we are hearing reports of horrific weather in China that is driving down forecasts for its corn crop. Why do we mention China? Per data tabulated by WorldAtlas, China is the second largest producer of corn behind the US with Brazil a very distant third. Here’s the thing, China recently slashed its 2017/18 corn output forecast to the lowest level in four years after drought and hail hit plantings. Following those events, Chinese Agricultural Supply and Demand Estimates (CASDE) shared that farmers in parts of China’s northeast corn belt regions switched to soybeans and substitute grains after drought made it hard to plant corn, leading to a drop in corn acreage.

Putting it all together, we are seeing a supply-demand imbalance shaping up for corn and that makes it a viable prospect for our Scarce Resources investing theme. While there are a number of indirect beneficiaries to rising corn prices, as well as number that will feel the pinch of rising input costs, the Teucrium Corn Fund (CORN), which reflects corn futures contracts, is the purest play on rising corn prices. We’ll continue to monitor US drought conditions but with The Weather Network forecasting “normal or warmer than normal temperatures during the summer” odds are we could see more supply constraints ahead and that would bode well for CORN shares. We’d note the last time there was a significant drought in the US was 2012, when corn reached a high of $8.4375 per bushel in August 2012 up from roughly $3.30-$3.40 in May 2010. Currently, the spot price for corn price is hovering near $3.85 per bushel.

The Bottomline on CORN:

  • We are adding Teucrium Corn Fund (CORN) shares to the Tematica Select List with a $25 price target.
  • This is a new Scarce Resources position, and we are holding off with a stop-loss at this time as our strategy would be to opportunistically increase the Select Lists exposure while improving the overall cost basis.

 

 Amazon – More Than Prime Day this Week

We are in the afterglow of Amazon’s (AMZN) Prime Day 2017, which concluded early this morning. The company trotted out all sorts of deals, especially on its own products and services, and while we’re still shifting through the day-after data that Amazon management is putting out, by all accounts this year’s event blew the last two years out of the water with the company claiming it took in 6,000 Amazon Prime orders per minute and over $1 billion in sales from this newly created “holiday” event.

Behind the noise of Prime Day, Amazon once again quietly expanded its footprint. The two latest announcements include talk of it is forming its own Geek Squad like offering — a service it is currently testing in several cities out west. That news sent Best Buy (BBY) shares tumbling on Monday, taking nearly $1 billion off the company’s market cap in a single day. And yes, the irony of Amazon raking in the same amount of sales on Tuesday that Best Buy lost in market cap on Monday isn’t lost on us — it’s one of the clearest depictions of how thematic tailwinds for one company become headwinds for another.

 

The second announcement comes in the form of Amazon partnering with King Vintners, a subsidiary of Oregon’s King Estate Winery, for its NEXT private label wine offering. This move continues Amazon’s move into private label products, which tend to carry better margins. As a reminder, Amazon is also expanding its private label business in the food and apparel categories as well. We see Amazon clearly positioning itself to capture greater consumer wallet share as we head into the back half of the shopping year.

Getting back to Prime Day, it’s actually more like 30 hours, which we suspect Amazon is doing to expand its reach across the globe. We also suspect one of the key strategies behind Prime Day is to hook shoppers with either Prime services or entice them with unbundled and discounted Amazon services in order to upsell them to Prime later on. Of course, there is the goosing of its digital sales as well. Early reports from Amazon state that the best-selling Prime Day item thus far is the Amazon Echo smart speaker – talk about a potential Trojan horse to other Amazon offerings. We’ll be watching over the day as more Prime Day data pours out and we try to assess the contribution from outside the US, which in our view offers ample growth opportunities for Amazon.  We’d do so over a glass of Amazon’s NEXT wine, but they, unfortunately, don’t ship to Virginia yet — our loss.

  • As a reminder, we currently rate Amazon shares as a Hold — they are shares to own, not trade.
  • Our price target remains $1,100.

 

 

What PepsiCo Says About Our Foods With Integrity Investing Theme

Shifting gears, yesterday morning PepsiCo (PEP) reported its 2Q 2017 earnings this morning with organic revenue growth clocking in just over 3 percent. At first blush, we would note this is a positive for our McCormick & Co. (MKC) shares given that PepsiCo is McCormick’s largest Industrial Segment customer. The same can be said for Tematica Select List company International Flavors & Fragrances (IFF), as PepsiCo is one of its larger customers as well.  So you can see why were so keen to see what Pepsi had to say about its second quarter performance.

Digging below headlines and listening in on the PepsiCo’s 2Q 2017 earnings call we find even more confirming reasons to be bullish on these two Select List holdings:

“…we continue to transform our beverage portfolio to offer more non-carbonated options and reducing sugar levels across the portfolio.”

“We have reduced added sugars, saturated fat and sodium in many of our products, while continuing to expand our lineup of nutritious foods and beverages to meet growing consumer demand.”

“Lipton tea, over the years we have not only added more variety but we have strengthened the brand by introducing increasingly premium offerings, first with Pure Leaf and more recently with the Tea House Collection, resulting in the leading share position we enjoy today. Or Mountain Dew, where over time we have expanded the trademark from traditional green-bottle Dew and Diet Dew to exciting line extensions like Code Red, White Out and Voltage, and our very successful Kickstart lineup. Or Doritos, where our loyal consumers have embraced flavor extensions to the core product and innovations we have taken to foodservice and quick serve restaurants. Or Quaker, where we have provided increasing portability and convenience to a hearty, healthy breakfast through the introduction of Breakfast Squares and Breakfast Flats.”

“Our product transformation efforts to date have resulted in a portfolio where we now derive approximately 45 percent of our net revenue from products that we refer to as guilt-free. These products include diet and other beverages that contain 70 calories or less from added sugar per 12-ounce serving and snacks with low levels of sodium and saturated fat…”

In sum, PepsiCo’s comments confirm the shift toward healthier, “food that is good for you” products and beverages, which is a key aspect of our Foods with Integrity investing theme. Those same comments also confirm the shift away from unhealthy ingredients that is spurring demand for flavoring solutions at both McCormick & Co. as well as International Flavors & Fragrances — because, after all, once you remove all the sugar and artificial flavors, it still needs to taste good in order to sell. As this tailwind continues to blow, another beneficiary to be had is Amplify Snacks (BETR).

The bottom line as we see it with all this Foods with Integrity news:

  • Our price target on McCormick & Co. (MKC), International Flavors & Fragrances (IFF) and Amplify Snacks (BETR) shares remain $110, $145 and $11, respectively.
  • To date, ETF holdings in each of these three stocks is insufficient, but we will continue to revisit potential ETFs that mesh with our Foods with Integrity investing theme.

 

 

The Wall Street Journal Serves up a Bullish Case for our AMAT Shares

Yesterday, we had positive confirmation on one of the several aspects of our investment thesis in Applied Materials (AMAT) from an article in the Wall Street Journal. The article reminds us of the ramping semiconductor market in China and how that is fueling demand for semiconductor capital equipment at Applied and others.

Per data from Gartner, currently China consumes half the world’s chips, but only produces less than 10 percent of those chips – and this is something China is looking to change as it spends up to $108 billion over the next 10 yeas on its own chip-making industry. According to industry group SEMI, at least 20 fabs are currently under construction in China.

That clearly makes the “China factor” one to watch, but there is also rising demand for memory and other chips as we move deeper into our increasingly Connected Society with the Connected Car, Connected Home, wearable and other connected devices as well as the more industrial focused Internet of Things. The next catalyst to watch will be earnings from Taiwan Semiconductor (TSM), one of largest semiconductor manufacturers, that will be reported tomorrow. Inside those results, we’ll be scrutinizing TMS’s capital spending plans for the coming quarters and what it means for semiconductor capital equipment orders.

Let’s remember too, Applied Materials has other tailwinds on its business, including ramping demand for the capacity constrained organic light emitting diode display industry that is also propelling demand at Universal Display (OLED) as well as demand. While Apple (AAPL) has yet to say a word about its next iPhone model, a growing number of reports project that Apple will have more than half of its iPhones using organic light emitting diode displays by 2020. That action will spur adoption among other smartphone vendors, including lower cost Chinese vendors. In short, we continue to see a strong ramp in demand subsequently capacity for organic light emitting diode displays.

  • Our price target on Applied Materials (AMAT) shares remains $55.
  • In reviewing potential ETF plays that hold AMAT shares, the one with the largest exposure to AMAT shares is First Trust Nasdaq Semiconductor ETF (FTXL), which has more than 8 percent of its assets in Applied Materials. As enticing as that sounds, FTXL’s market cap is just over $20 million and average daily trading volume is thin as a pancake at just under 6,000 shares per day. An option with far greater liquidity would be the VanEck Vectors Semiconductor ETF (SMH), which holds just under 5 percent of its assets in AMAT shares.
  • With the recent slip lower, based on yesterday’s market close we see just over 14 percent upside to our $125 price target for Universal Display (OLED) shares.

 

 

USA Technologies:
Arming Itself for the Growing Cashless Consumption Opportunity

Cashless Consumption company USA Technologies (USAT) saw its shares come under some pressure earlier this week when it filed an S-1 registration statement to offer $34.5 million in common stock with an overallotment option of up to another $5.2 million. If the full amount were sold, another 8 million or so USAT shares could potentially enter the market and there likely would be some EPS dilution, that’s the reason USAT shares moved 10 percent lower over the last week. From a business perspective little has changed in the course of a week, in fact, the outlook for our Cashless Consumption theme in many respects has never looked better.

Google (GOOGL) is preparing to enter the mobile payment space in India, and the latest figures show the Chinese spent $5.5 trillion through mobile payment platforms last year. After launching in Singapore, Australia and Mexico last year, Citibank MasterCard (MA) customers in the US can now begin using Citi Pay, the mobile tap-and-pay service, here in the U.S. More specific to USA Technologies, it recently expanded its merchant services relationship with JPMorgan Chase (JPM).

As shareholders, we may not love the move by USAT and its new stock offering, but it will provide the company with additional firepower in this quickly expanding market. Fundamentally speaking, we continue to like the company’s position as mobile payments grow across the globe. We are also seeing M&A chatter around the Cashless Consumption theme, with some suggesting that PayPal (PYPL) should acquire Square (SQ). With an arguably fragmented playing field that spans software, hardware, services and geographic opportunities there is little question in our minds that we will see consolidation activity in the coming quarters. We continue to see USA Technologies as a prime target.

  • We will continue to monitor USAT shares closely, with an eye to expand our position size closer to $4.50 or below given our initial buy-in price of $4.50.
  • Subscribers looking for an ETF play on our Cashless Consumptioninvesting theme should examine the PureFunds ISE Mobile Payments ETF (IPAY). While it catches our Cashless Consumptioninvesting theme, in our view, the average daily volume is too low to make it a viable recommendation at this time, but we’ll keep it on our radar for when average trading volume hits over 100,000 shares per day. 
QUARTER WRAP-UP: Look Back Before Moving Ahead

QUARTER WRAP-UP: Look Back Before Moving Ahead

In this Week’s Issue:

  • A Recap of Our Moves Over the Second Quarter
  • Ahead of 2Q 2017 Earnings Season We’re Adjusting Several Stop Losses
  • What We’ll Be Watching Near-term for the Back Half of the Year

 

This week, rather than a weekly check-in, we’re going to spend our time wrapping up the quarter that was and all its happenings, as well as offer a look ahead to the back half of the year. Along the way, we’re also using this time to tighten up a few of our protective stop-loss levels. Whether you’re reading this on the beach, or in your lonely office while everyone else is on vacation this week, we’ve got a lot to cover, so let’s get to it . . .

 

A Recap of Our Moves Over the Second Quarter

With last Friday’s market close, we shut the books on not only the month of June, but the second quarter of 2017 and the first half of the year. During the last 90 days, we’ve seen several things unfold as the stock market powered higher despite the Fed boosting interest rates, the Trump Bump become the Trump Slump, and an increasing amount of data pointing to a slowing domestic economy. All told the domestic market indices rose between 2.6 to 4.0 percent during the second quarter. The Nasdaq, which came in at the upper end of that range, pared its gains back over the last few weeks as those items we discussed above have bubbled up in investor minds. Over the last quarter, the Russell 2000, a barometer of small-cap stocks returned 2.2 percent, bringing its year to date return to just over 4 percent.

During the quarter, we added a number of new positions to the Tematica Select List, including Cashless Consumption company USA Technologies (USAT), Food with Integrity play Amplify Snack Brands (BETR) and MGM Resorts (MGM), a Guilty Pleasure company if there ever was one. We also added RF semiconductor substrate company AXT (AXTI), as a food chain play on not only Apple’s (AAPL) upcoming iPhone, but also one for the upcoming 5G rollout by the likes of our own AT&T (T) as well as Verizon Communications (VZ) and other mobile carriers. That same 5G rollout, as well as continued 4G LTE and fiber buildouts, are also powering Dycom (DY) shares. Toward the very end of the quarter, we took advantage of the mismatch between the Cash-Strapped Consumer opportunity with Costco Wholesale (COST) when the herd dragged the share price down thinking it is a casualty of the Amazon (AMZN) – Whole Foods (WFM) tie up. Make no mistake, we see casualties spinning out of Amazon’s acquisition, but as we said previously, those look more like Kroger (KR) and Sprouts Farmers Market (SFM).

In addition to these newcomers, the Select List benefitted from strong moves in several Connected Society positions during the quarter, including Amazon (AMZN), Alphabet (GOOGL) and Facebook (FB) as well as the sleeper move in CalAmp (CAMP) shares that climbed more than 23 percent over the three-month period. As impressive as that was, the real champ on the Tematica Select List was Universal Display (OLED), which soared more than 30 percent during 2Q 2017, bringing our total gain to over 100 percent since we added the shares to the Select List in October of last year.

With all of these positions, we continue to see further gains ahead. While the upside in Amazon, Alphabet and Facebook are much talked about, we’d remind you about the Electronic Logging Device mandate that goes into effect late this year and will be a strong catalyst for CalAmp shares. The industry capacity constraint for organic light emitting diodes is bumping up demand from not only Apple, but other applications. That capacity constraint status will span several quarters as it is likely Apple will only have half of its iPhone production using organic light emitting diode displays by 2020 according to a new report from Trendforce. That’s both good for Universal Display (OLED) shares as well as Applied Materials (AMAT).

Those strong results offset weaker showings at Guilty Pleasure company Starbucks (SBUX), Connected Society play AT&T (T) and Content is Kingstalwart Disney (DIS). From time to time, we need to be patient with a position as we wait for the herd to catch up to the thematic tailwinds we’re seeing. That was the case with Universal Display (OLED) as well as Dycom Industries (DY), and we are seeing that with both Starbucks and AT&T. The key to Starbucks is its international expansion, particularly in China where it will benefit from the Rising Middle Class. While we are seeing deflation hit mobile carriers, the AT&T-Time Warner (TWX) combination should transform AT&T’s business from data driven to one that is a better blend of data, advertising and content. We’ve seen the content moat strategy pay off before at Disney (DIS)and Comcast (CMCSA), and we’ll be patient with AT&T shares given the deal doesn’t close until later this year. As far as Disney goes, it was evident earlier this year that 2017 was going to be a transition year for the company. We saw that in its box office line-up, which was one of the lightest in several years. That means we’re in a holding pattern with Disney until October when it begins to release the next iterations from Marvel, Disney Animation and Lucasfilm.

Toward the end of the second quarter, we saw some declines at Rise & Fall of the Middle-Class company McCormick & Co. (MKC), a dividend dynamo company if there ever was one, and Alphabet (GOOGL) shares following the $2.71 billion (€2.4 billion) fine from EU antitrust regulators and their view that Alphabet must “apply the same methods to rivals as its own when displaying their services.” As a reminder, Alphabet’s Google business has 90 days to end the conduct and explain how it will implement the decision, or face additional penalties of up to 5 percent of average daily global revenue. With more than $92.5 billion in cash, Alphabet has ample funds to swallow the fine, however, the implication of the decision could reshape how Google presents search results in Europe — if not eventually elsewhere. As such, we expect the company will review the decision and consider an appeal. Getting back to McCormick, the shares traded off recently, which has them once again back in the Buy zone given the upside to our $110 price target and current dividend yield.

Also during the quarter, we saw a few strong reminders in the form of the WannaCry and Petya ransomware attacks, both of which impacted our Safety & Security investing theme and why PureFunds ISE Cyber Security ETF (HACK) shares are on the Select List. With North Korea launching yet another missile, and the opening of defense deals under the Trump administration, we’re looking at several other aspects of that theme.

When we added Nuance Communications (NUAN) to fold in January, one of the reasons why was that voice, rather than touch, was the emerging interface for devices. During 2Q 2017 we saw that notion go from emerging to center state. Even today, Samsung is talking about launching a connected speaker as it once again follows in Apple’s footsteps, but this time it is way behind not only Apple, but also Amazon and Alphabet. With voice technology spreading to autos and appliances, we remain in the early innings with NUAN shares.

Finally, during 2Q 2107 we shed three positions:

  • We were stopped out of Aging of the Population play AMN Healthcare (AMN) when the shares crossed $37, which led us with a modest gain.
  • The same occurred with United Natural Foods (UNFI), a Foods with Integrity selection, but the positioned booked a loss near 9.5 percent over the last 9 months.
  • Offsetting those results, given some concerns about the Nasdaq giving back its gains (something that has played out as we expected), we exited PowerShares NASDAQ Internet Portfolio ETF (PNQI) shares last week with a return of more than 23.5 percent.

 

Ahead of 2Q 2017 Earnings Season We’re Adjusting Several Stop Losses

We’ll talk more about what we expect for 2Q 2017 earnings season and the back half of the year in a few paragraphs, but before that event kicks off in earnest by this time next week, we are setting or revising a number of protective stop losses. To head a question off, we are not setting ones for Amazon, Facebook, Alphabet and some others that are core positions for the longer-term. Nor are we setting ones for more recently added positions such as COST, AXTI, MGM, and BETR shares as we’re inclined to use weakness to improve the respective cost basis like we recently did with COST shares.

Okay, here we go:

  • Setting a protective stop loss on Starbucks at $50.00
  • USA Technologies (USAT) at $4.50, which worst case means a break-even position for this Cashless Consumption company;
  • United Parcel Service at $100.00, which locks in a modest gain;
  • McCormick & Co. at $90;
  • Applied Materials at $35;
  • CalAmp at $18, which will lock in a profit of more than 30 percent;
  • We will keep our stop loss for International Flavors & Fragrances (IFF) and AT&T (T) at $125 and $36, respectively, as well as Disney and Universal Display both at $100.

 

What We’ll Be Watching Near-term for the Back Half of the Year

With the Fourth of July holiday now past, odds are this will be a somewhat slow and sleepy week as many have opted to utilize the holiday and how it fell on the calendar to turn a few days into a summer vacation. Who can blame them?

While they are getting some rest and relaxation in, and hopefully enjoy several of our investing themes along the way including Foods with Integrity, Guilty Pleasures, and Fattening of the Population (those last two with some degree of moderation of course), those of us manning the desks will have a compressed week with no shortage of data to look at. This includes the latest FOMC minutes being issued later today, followed by the June ADP Employment Report and ISM Service report on Thursday, and Friday’s June Employment Report. All of that comes after disappointing June auto and trucks sales, but General Motor’s (GM) recent cut to its 2017 auto forecast by several hundred thousand units, was there any real surprise to the June data? We think not and odds are it means another leg down for the speed of the economy.

We get this data every month, so why is it extra important this time around?

It’s the beginning of the last data set for 2Q 2017. As all of this data is digested, we expect to see some movement in 2Q 2017 GDP forecasts. Currently, the consensus tabulated by The Wall Street Journal calls for 3.0 percent GDP in 2Q 2017, with 2.5 percent in the second half of the year. On Friday, the Atlanta Fed trimmed its 2Q 2017 GDPNow forecast to 2.7 percent — down from its 4.0 percent on May 1st. On the other hand, the New York Fed’s NowCast sits at 1.9 percent for 2Q 2017 and 1.6 percent for 3Q 2017. These next data pieces will help us complete the puzzle to see if the economy is more in tune with the Atlanta Fed or the New York Fed, and as we’ve discussed over the last several weeks, that will have implications for what is said in the upcoming 2Q 2017 earnings season.

While many will be watching 2Q 2017 results over the coming weeks, we will also be assessing the potential adjustments to 3Q 2017 and 4Q 2017 earnings prospects. Currently, the “herd” is calling for the S&P 500’s EPS to grow more than 11 percent in the second half of 2017 compared to the first half. Keep in mind, the average growth in second half earnings for the S&P 500 compared to the first half over the 2010-2016 period was 5.6 percent. Not to be repetitive, but rather summative, given the speed of the economy, the Trump Slump, oil earnings revisions and ripple effect of GM’s comments among other things, odds are that 11 percent forecast will be coming down.

What this means is there is a far greater probability of volatility returning to the market as these revisions are had. If we’re right and EPS expectations for the S&P 500 get trimmed back, we’ll be faced with one of two things:

  • Either the market becomes that much more expensive than the 17.9x multiple on expected (but still yet to be revised lower) 2017 EPS it closed at on Friday.
  • Or investors will re-asses the market multiple, likely pushing it lower, as those EPS cuts are made.

What this means is we’ll be watching the data over the coming days as well as the ensuing earnings reports, and adjusting the Select List as necessary. This could mean scaling into existing positions or add new ones at better prices. Either way, we’ll be watching and at the ready.

Pullback in Nasdaq Composite Index has us taking gains on this ETF and moving on

Pullback in Nasdaq Composite Index has us taking gains on this ETF and moving on

You should have received this week’s Tematica Investing Weekly Update earlier this morning. If you haven’t read it yet, you can click here to read it,  as we made the move to add even more Costco (COST) shares to the Tematica Select List, while also providing some thoughts on our positions in HACK, GOOGLand FB.

Soon after that issue was emailed to you, I got my hands on some data that has me rethinking our position in PowerShares NASDAQ Internet Portfolio ETF (PNQI). Let me explain . . .

Over the last few days, the Nasdaq Composite Index and technology, in general, has started to pull back. We’ve shared our views on how expectations for the domestic economy and earnings expectations are poised to be reset and we suspect that view is gaining traction with the larger investment community. As that happens, we are likely to see investors shed positions to preserve gains achieved thus far in 2017.

On individual stocks positions, we continue to see the positive push of thematic tailwinds and we could see opportunity lie in the coming weeks to scale into several positions on the Tematica Select List, like we did with Costco (COST)this morning.

At the same time, we are also prudent investors and that has us issuing a “Sell” call on shares of PowerShares NASDAQ Internet Portfolio ETF (PNQI) and preserving the more than 20 percent gain in the position since we added it last November. While this will modestly reduce our exposure to the Connected Society investment theme on the Select List, we have a number of other positions that offer various exposure points to this multi-faceted theme.

Bottomline on PNQI Shares:
  • We are issuing a sell on PowerShares NASDAQ Internet Portfolio ETF (PNQI) shares and removing them from the Tematica Select List. 

 

 

WEEKLY ISSUE: Doubling down on COST as yet another cyber attack provides support for our HACK position

WEEKLY ISSUE: Doubling down on COST as yet another cyber attack provides support for our HACK position

 

In this Week’s Issue:

  • Doubling Down on Costco Shares
  • More Cyber Attacks, Mean It’s a Good Time to Own HACK Shares
  • Alphabet Gets Wrapped on the Knuckles

 

We’re moving deeper into summer with more schools across the country finishing out the academic year. Most would expect that would mean a slower go of things, but that’s hardly been the case. True, the only economic data point to be had this week was the May Durable Orders report, which simply isn’t going to speed up anyone’s 2Q 2017 GDP forecast. Nondefense capital goods orders excluding aircraft — a proxy for business spending — declined 0.2 percent, while shipments of these same goods, which factor into the GDP computation, also declined 0.2 percent. We continue to think businesses are sitting on the sidelines as the Trump Slump is likely to continue through the summer months and into the fall.

At the same time, we’ve also had commentary from some of the Fed heads about the stock market including this from yesterday from San Francisco Federal Reserve Bank President John Williams:

 “The stock market seems to be running pretty much on fumes.”

He’s not alone in thinking the market is overvalued. A record 44 percent of fund managers polled in a monthly survey from Bank of America Merrill Lynch saw equities as overvalued this month, up from 37 percent last month. The surveyed body included 200 panelists with a combined $596 billion under management participated in the survey.

With the S&P 500 trading at roughly 18x 2017 expectations that have more downside risk than upside surprise potential as we discussed in this week’s Monday Morning Kickoff, we suspect we are likely to see more announcements like the one yesterday from General Motors (GM). If you missed it, GM now expects U.S. new vehicle sales in 2017 will be in the “low 17 million” unit range, versus last year’s record of 17.55 million units. Keep in mind, GM has been hard hit lately and seen its US inventory creep up to 110 days of supply in June, up from 100 in May. As GM said, “the market is definitely slowing” and that means we’re going to see more widespread pressure on the likes of Ford Motor Company (F), Honda Motor Company (HMC) and other auto manufactures. Lower production volume also means reduced demand at key suppliers like Federal Mogul (FDML), Dana Corp. (DAN), Delphi Automotive (DLPH) and similar companies. Pair this with the May Durable Orders report, and it’s another reason to see a step down in GDP for the back half of the year.

At the same time, yesterday also brought the news of the Petya ransomware, which in our view not only serves to reinforce our Safety & Security investing theme as well as our position in PureFunds ISE Cyber Security ETF (HACK)shares (more on that below), but also reminds us of the tailwinds powering all of our investing themes here at Tematica. We don’t look to own sectors, but rather companies that are benefitting from multi-year thematic tailwinds – that has been and will continue to be our guiding light, and if we have the opportunity to improve our cost basis in the coming weeks we’ll aim to take it.

In fact, we’re doing that today with shares of Costco Wholesale (COST) right now…

 

Doubling Down on Costco Shares

Last week we added back shares of Costco Wholesale (COST) to the Tematica Select List given what we saw (and continue to see) as an overreaction to the Amazon (AMZN)–Whole Foods (WFM) tie up. Not only hasn’t the transaction closed yet, and it won’t for several months until that occurs. It will be deep into 2018 before any Whole Foods integration is even close to being done. This tells us the market is shooting first and asking questions later… potentially much later.

With COST shares falling another 2 percent over the last week, bringing the two-week drop to more than 11 percent, we’ll use the current share price to improve the position’s cost basis and grow the respective position size to the overall Select List. As we’ve shared before, the real key to Costco’s profits and EPS is its membership fee income, and with more locations set to open in the coming quarters plus a recent membership price hike, we remain bullish on COST shares.

  • With COST shares closing last night at $159.26, we’re going to use the continued drop in share price to lower our cost basis by adding a second position in the shares as of this morning.
  • Our price target on Costco Wholesale (COST) shares remains $190
  • As we scale into the position today, we are setting a stop loss at $135, but we’ll look to move that higher as COST shares rebound.

 

 

 

More Cyber Attacks, Mean It’s a Good Time to Own HACK Shares

When we added PureFunds ISE Cyber Security ETF (HACK) shares back in February this year to the Select List as part of our Safety & Security investing theme, we acknowledge the frequency of cyber attacks would be a likely catalyst for the shares. Simply put, a higher frequency of attacks would not only spur cybersecurity spending, but odds are it would also act as a rising tide as media attention shifts to these attacks lifting all cyber security boats including our HACK shares.

We recently witnessed the WannaCry ransomware attacks, and as we learned during our Cocktail Investing Podcast conversation with Yong-Gon Chon, CEO of cyber security company Focal Point, following attacks were going to get bigger and bolder. That’s exactly what we saw yesterday with “Petya” ransomware that hit firms both large and small with ransomware in Europe and now the US. The attack was first reported in Ukraine, where the government, banks, state power utility and Kiev’s airport and metro system were all affected. It soon spread to including the advertising giant WPP, French construction materials company Saint-Gobain and Russian steel and oil firms Evraz and Rosneft. The new malware uses an exploit called EternalBlue to spread by taking advantage of vulnerabilities in Microsoft Corp.’s Windows operating system, similar to WannaCry and the infected computers display a message demanding a Bitcoin ransom worth $300. Those who pay are asked to send confirmation of payment to an email address.

According to a study by IBM (IBM), the amount of spam containing ransomware surged to 40 percent by the end of 2016 from just 0.6 percent in 2015. While many ransomware attacks are blocked by security software, the number of infections getting through is growing. Symantec (SYMC) said it detected 463,000 ransomware infections in 2016, 36 percent higher than the year before. Odds are that figure is only to go higher in 2017 and 2018.

  • We continue to have a Buy on PureFunds ISE Cyber Security ETF (HACK) with a price target of $35.

 

 

 

Alphabet Gets Wrapped on the Knuckles

Alphabet (GOOGL) is one of the building blocks of our Connected Societyinvesting theme due primarily, but not entirely to the company’s market share leading position in digital search. We define digital search much the way we do digital commerce – it comprises both desktop and mobile activity. Alphabet is also home to some of the most widely used apps across the various smartphone operating systems including YouTube (#2), Google Search (#4), Google Maps (#5), Google Play (#6), Gmail (#8) and Google Calendar (#11).

Google’s YouTube is expanding not only into original content with YouTube Red, but recently copped to targeting TV advertising dollars as well as eventually creating video content with “big name stars.” Alphabet is also bringing a YouTube TV service to market that will stream broadcast TV much the way AT&T’s (T) DirectTV Now and Hulu do. Let’s not forget Google Wallet or Android Wallet.

Putting it all together, Alphabet has several thematic tailwinds pushing its respective businesses as well as burgeoning ones like its Waymo self-driving car initiative that recently partnered with Avis Budget Group (CAR).

One of the items we’ve been watching and waiting for with Alphabet (GOOGL)has been the pending fine from EU antitrust regulators following the ruling that Alphabet had abused its “search engine” power and promoted its own shopping service in search results. Following several years of investigation, yesterday that EU body hit Alphabet with a decision that included a record $2.71 billion (€2.4 billion) fine and “ordered the search giant to apply the same methods to rivals as its own when displaying their services.” Google has 90 days to end the conduct and explain how it will implement the decision, or face additional penalties of up to 5 percent of average daily global revenue.

On its face, the $2.7 billion is a drop in the cash bucket for Alphabet, which ended the March quarter with $92.5 billion in cash. Alphabet could simply swallow the fine, but the implication of the decision could reshape how Google presents search results in Europe if not eventually elsewhere. As such, we expect the company will review the decision and consider an appeal, thereby dragging this out for another few months.

In the short-term the fine is a bump in the road for Alphabet, but we’ll continue to see how this situation develops further and what its implications are for not only Google, but other dominant technology firms such as Amazon (AMZN)that also rely on displayed search results, but also offer their own proprietary products. As we monitor these and other developments, we continue to Alphabet shares as ones to own not trade as we continue to migrate deeper into an increasingly connected society. The same goes for Amazon shares.

  • Our price targets on AMZN and GOOGL shares remain $1,150 and $1,050, respectively.

 

Costco vs Amazon? We see opportunity for both

Costco vs Amazon? We see opportunity for both

 

In this Week’s Issue:

  • Amazon (AMZN) to Buy Whole Foods (WFM) and We Add Costco Wholesale (COST) Shares Back to the Tematica Select List
  • Investor Short-Sightedness Triggers United Natural Foods (UNFI) Stop-Loss
  • Checking in on Dycom (DY) Shares
  • While Disney’s (DIS) Summer Movie Slate Hasn’t Lived Up to Expectations, We Still See Some Bright Spots

 

 

We’ve given each other some hard lessons lately, but we ain’t learnin’

The quote above is a lyric by Bruce Springsteen, and it came to mind as we look at this week’s market.  So far, we took one step up on Monday, and then one step back on Tuesday, essentially wiping out any gains. Let’s hope we don’t end up following Springsteen’s full lyrics and taking “one step up and two steps back” as the rest of the week plays out.

The biggest hit so far this week was had in the energy “sector” as oil prices continued their move down, officially moving into bearish territory. Crude’s slide is due not only to growing supply, but also weak demand. Not to sound like a know it all, but supply-demand dynamics are pretty much economics 101, and when we see ramping US supply alongside a slowing domestic economy, it hasn’t been hard to guess where the price of oil is headed.

The proverbial second shoe to watch is earnings. We mention this because according to FactSet the energy sector is expected to be the biggest contributor to EPS growth for the S&P 500 in the current quarter. Oil, however, closed last night at $43.34, well below the $51 level it averaged in 1Q 2017 and the $52 mean estimate for the average price of oil for Q2 2017.

What this likely means is we are going to see negative revisions for energy earnings if not for the current quarter then for the back half of 2017. As those revisions happen, the ripple effect will bring down expected earnings growth for the S&P 500 as well. And that’s before we share the New York Fed’s Nowcast for 2Q 2017 GDP hit 1.9 percent this week with 3Q 2017 falling to 1.5 percent.

Then there is the upcoming health care battle in the Senate and the rest of the Trump agenda (repatriation, tax reform, infrastructure), which as we’ve been saying is far more likely to begin anew after the 2017 elections.

The bottom line is, it looks like the market is bound to have a bout of indigestion come 2Q 2017 earnings season that kicks off soon after the July 4th holiday. Of course, here at Tematica, we don’t “buy the market,” but rather capitalize on our multi-year thematic tailwinds. With that in mind, in this week’s issue of Tematica Investing we’re bringing an old favorite back into the fold – Cash-Strapped Consumer play Costco Wholesale (COST). We also share our thoughts on Amazon (AMZN) buying Whole Foods Market (WFM), and check in on both Dycom (DY) and Disney (DIS).

 

 

Amazon (AMZN) to Buy Whole Foods (WFM) and We Add Costco Wholesale (COST) Shares Back to the Tematica Select List

If you were pulling an abbreviated Rip Van Winkle over the last few days and missed the headlines, Amazon (AMZN) is back in the news as it once again looks to implement what we can only be viewed as an amping up of its creative destruction on the grocery industry. Friday morning the company announced it has a definitive agreement to acquire Whole Foods Market (WFM) for $42 per share in all cash transaction valued at $13.7 billion. With $21.5 billion in cash and just $7.7 billion in total debt on a balance sheet with $21.7 billion in equity, we see little if any financing challenges for Amazon.

Per usual, Amazon was scant on details, but we see this acquisition catapulting its position in grocery, particularly organic and natural that continues to be one of the fastest growing grocery categories. Amazon should also be able to utilize Whole Foods warehouse and stores to expand the reach of its Amazon Fresh business at a time when more consumers are embracing online grocery delivery. With companies like Panera Bread (PNRA) sharing that 26% of its weekly orders are now generated digitally, we suspect we are at or near the tipping point for digital grocery. For those unfamiliar with Whole Foods’s existing online delivery offering, it currently offers delivery in under 1 hour from a growing number of locations, which strategically fits with Amazon’s Prime Now offering.

According to the “The Digitally Engaged Food Shopper” report from Nielsen (NLSN), currently a quarter of American households buy some groceries online, up from 19% in 2014. The report goes on to forecast that more than 70 percent will engage with online food shopping within 10 years resulting in online grocery capturing 20 percent share up from 4.3 percent in 2016. When dealing with percentages, we prefer to consider the actual dollar amounts and in this case, it means online grocery jumping to more than $100 billion by 2025, up from $20.5 billion in 2016.

Now, a quick word on this decade forecasts. We tend to ignore the actual numbers, preferring instead to note the vector, which in this case is solidly higher and fits with our increasingly connected society. That said, we know Amazon tends to play the long game, and we see them once again doing this by entering into this transaction with Whole Foods, a deal that offers a solid base from which to flex its logistical muscles. We find this move far more appealing than if Amazon opted to build it from scratch, given the existing infrastructure as well as the simple fact that for the duration Whole Foods management team will continue to run the chain after the deal closes and stores will continue to operate under the Whole Foods brand.

In a nutshell, we see this as a win-win for Amazon as it looks to battle Kroger (KR), Sprouts Farmer (SFM), Wal-Mart (WMT) and others that have ventured into the grocery space like Target (TGT) for consumer wallet share.

We would point out that we are not as negative as some over the potential impact on Costco Wholesale (COST), which derives a significant percentage of its operating profit from membership fees. Costco continues to expand its warehouse footprint, which bodes well for growing its all-important membership fee income.

Following the Amazon-Whole Foods news, Costco shares are off roughly 9 percent and we see this as more than just an overreaction. Rather we see this as an opportunity to get back into COST shares, as the company continues to both expand its footprint as well as continue to help the Cash-Strapped Consumer stretch their disposable income. For those subscribers that have been with us a while, you’ll remember Costco was added to the Tematica Select List last September and we ended up selling half the shares and were stopped out of the second half on a dip of the shares. All told, our positions generated a 14.6 percent return and given the recent dip in the shares, we’re ready to add another batch of shares to our cart:

  • We are adding back shares of Costco Wholesale (COST) back to the Tematica Select List with a price target of $190.
  • As we will look to opportunistically improve the cost basis of this position, there is no recommended stop loss at this time.

Getting back to Amazon, there has been no shortage of headlines speculating what may or may not happen in the grocery sector with the move. Our position is we see Amazon using Whole Foods as a platform that not only expands its Amazon Fresh footprint, it also improves Amazon’s position within our Food with Integrity investing theme. That brings the number of thematic tailwinds pushing on Amazon to 6 – Connected Society, Cash-Strapped Consumer, Content is King, Cashless Consumption, Rise & Fall of the Middle Class and now Food with Integrity. As we share this we once again we find ourselves once again thinking Amazon is business and a stock to own, not trade as it continues to be a disruptor to be reckoned with.

  • We are boosting our price targets on Amazon (AMZN) shares to $1,150 from $1,100 to factor in the existing Whole Foods business.
  • We continue to rate AMZN shares a Buy.

 

 

Investor Short-Sightedness Triggers UNFI Stop-Loss

From time to time, we say our goodbyes to a position on the Tematica Select List. The reasons can be a position has reached its price target, original thematic tailwinds may give way to headwinds or the stop-loss gets triggered.

This last one is what happened with United Natural Foods (UNFI) when the shares crossed below the $38.50 stop loss that was set last week. Interestingly enough, they passed through that stop loss level on the news of Amazon (AMZN) acquiring Whole Foods Market (WFM), which would likely do more good for UNFI’s business than harm. This isn’t the first nor is it likely to be the last of the herd shooting first and asking questions later.

  • We’ll place UFNI shares on the Thematic Contender’s list, and look for a compelling re-entry point should one emerge like it did with Costco shares.

 

 

Checking in on Dycom Shares

We remained patient with shares of Dycom (DY) after the company offered weaker than expected guidance inside its March quarter earnings. Over the last few weeks, we have been rewarded for that patience as DY shares have rebounded 15 percent to current levels. Granted, we’re still a ways off the $105-$100 level high we saw prior to the dip, but flipping that around, it is still an opportunity for subscribers that missed out on Dycom’s sharp move higher from late March through most of April to add to their position. We say this because, over the last few weeks, Dycom and other specialty contractors have been making the conference rounds sharing upbeat comments regarding the accelerating deployment of 5G wireless technologies and gigabit Ethernet over the coming years.

From a thematic perspective, we see the increasing amount of screen time we are all accumulating across our desktops, tablets and smartphones, as well as other burgeoning connected applications (car, home, Internet of Things) choking network capacity. Part of the solution is to roll out these next generation solutions, but also for the carriers to expand existing network capacity – all of which bodes well for Dycom, given its customer base that includes AT&T (T), Comcast (CMCSA), Verizon (VZ) and CenturyLink (CTL).

Hindsight being 20/20, DY shares were more than likely overextended, and odds are no matter what the management had provided as an outlook for the current quarter, it would have fallen short of expectations. That’s the downside of a quick rocket ride higher like the one we’ve enjoyed in Dycom shares, but we recognized this when we opted to keep the position on the Tematica Select List and now we’re reaping the rewards of that decision.

  • Our price target on DY remains $115, which offers more than 25% upside from current levels.

 

 

While Disney’s Summer Movie Slate Hasn’t Lived Up to Expectations, We Still See Some Bright Spots

Since peaking in late April, shares of Walt Disney (DIS) have fallen 10 percent as some of the company’s movies fell short of expectations, especially the new installment of the Pirates of the Caribbean franchise. Granted, Guardians 2 still took the box office, and we’re still determining how successful the latest Pixar film, Cars 3, will be, but it is probably safe to say that Disney’s not hitting it out of the park like it has in recent years. That reflects the thin by comparison movie slate the company has this year and with no new films until Thor: Ragnarok (Oct. 21), Coco (Nov. 22) and Star Wars: The Last Jedi (Dec. 22) it means a relatively quiet summer for Disney’s film business.

The next major event to watch is the Disney-run D23 Expo from July 14-16 at the Anaheim Convention Center in California, which should provide a number of updates on the company’s various businesses. Historically, it’s been a showcase for Disney’s films, including clips of those soon to be released. This year, we expect more details on its extended Marvel and Star Wars franchise plans as well as likely timing for Frozen 2 and The Incredibles 2 from Pixar. After D23 Expo, however, as we mentioned above, it’s likely to be a relatively quiet summer for Disney. With a $10 billion buyback in place and declining capital spending, we see support for the stock near current levels, with upside likely nearing the last few months of the year as Disney returns to the box office.

As we remain patient with this Content is King company, we’ll continue to monitor ongoing at ESPN as well as the parks business. The Parks & Resorts segments is one of Disney’s most profitable business segments and while the business tends to benefit from price increases, there is another reason we see better margins ahead. The factor behind this is Disney’s Shanghai theme park, after 11 million visitors, is close to breaking even after its first full year of operations. Based on performance at other non-US parks, this is far faster than anyone expected and also serves to confirm the power of Disney’s content. As that drag on profitability continues to fade, we see it becoming a positive contributor to Disney’s bottom line and increases confidence in current consensus expectations for the company to deliver EPS of $5.94 this year and $6.75 next year.

  • Our price target on Walt Disney (DIS) share remains $125, which at current levels keeps the shares a Buy.
  • We would be buyers of DIS shares up to $108, which leaves 15 percent upside to our price target.

 

 

Woeful Earnings from Kroger Has Us Tightening Position in UNFI

Woeful Earnings from Kroger Has Us Tightening Position in UNFI

While many have been focused on the retail environment —and we count ourselves among them here at Tematica — we’ve also been watching the painful restaurant environment over the past few months. It’s been one characterized by falling same-store-sales and declining traffic – not a harbinger of good things when paired with rising minimum wages.

For those that are data nut jobs like we are, per TDn2K, same-store sales for restaurants fell 1.1 percent in May, a decline of 0.1 percentage points from April. In May, same-store traffic growth was -3.0 percent. Now for the perspective, the industry has not reported a month of positive sales since February 2016 – that’s 15 months! One month shy of the bad streak the May Retail Sales Report has been on. Clearly not a good operating environment, nor one that is bound to be friendly when it comes to growing revenue and earnings.

Reading those tea leaves, we’ve avoided that the restaurant aspect of our Fattening of the Population investing theme, and with Ignite Restaurant Group filing bankruptcy, Cheesecake Factory (CAKE) warning about its current quarter outlook we confident we’ve made the right decision.

But people still need to eat, and we’ve seen consumers increasingly flock back to grocery stores in 2017. Year to date, grocery retail sales are up 1.7 percent through May. Breaking down the data, we find that in recent months those sales have accelerated, with March to May 2017 grocery sales up 2.8 percent year over year and standalone May grocery store sales up 2.2 percent year over year.

Yet, when grocery company Kroger (KR) reported in-line earnings for its latest quarter, it lowered its 2017 EPS outlook, cutting in the process to $2.00-$2.05 from the prior $2.21-$2.25, with the current quarter to be down year over year. Aside from price deflation in the protein complex and fresh foods, the company cited its results continue to be pressured by rising health care and pension costs for employees, as well as the need to defend market share amid “upheaval” in the food retailing industry. We see that as company-speak for Kroger and its grocery store competitors having to contend with our

We see that as company-speak for Kroger and its grocery store competitors having to contend with our Connected Society investment theme that is bringing in not only Amazon (AMZN), MyFresh, and FreshDirect into the fray, but also leading Wal-Mart (WMT), Target (TGT), and Safeway among others to expand their online shopping capabilities, which in some cases includes delivery. Another reason not to get off the couch when shopping.

Candidly, we’re bigger fans of companies that focus on profits over market share given that short-term market share led strategies, often times with aggressive pricing, tend to sacrifice margins, but focusing on profits tends to lead to better market-share over the long-term. We’ve seen the “strategy” that Kroger is adopting many times in the past and while it may have short-term benefits, increasing prices later on, runs the risk of alienating customers.

Getting back to Kroger’s guidance cut, that news sent Kroger’s shares down almost 20 percent on Thursday and led to United Natural Foods (UNFI) shares to fall more than 3.5 percent, while Amplify Snacks (BETR) slumped by 2 percent. In our view, most of Kroger’s bad news was likely priced into UNFI’s mixed guidance last week when it reported its own quarterly earnings. Without question, 2017 has been a rough ride for UNIF shares despite the Food with Integrity tailwind, but despite Kroger’s guidance cut, management shared on the company earnings call that it continues “to focus on the areas of highest growth like natural and organic products.” Even Costco Wholesale (COST) recently shared it has room to grow in packaged organic food items, excluding fresh), which plays to the strengths at both United Natural Foods and Amplify Snacks.

 

Tightening Our Position in UNFI, But Staying the Course with BETR

With our Food with Integrity thematic tailwind still blowing and UNFI shares down just 7.5 percent relative to our blended cost basis on the Tematica Select List, we’ll remain patient with the position. That said, from a technical perspective the shares are near support levels and if they break through $38.50 the next likely stop is between $33 and $34. Therefore, to manage potential downside risk, we’re instilling a stop loss on UNFI shares at $38.50. As we do this, we’ll acknowledge the tougher operating environment and reduce our UNFI price target to $50 from $65, which still offers upside of just over 25 percent from current levels.

  • We are keeping our Buy rating on United Natural Foods, but trimming our price target back to $50 from $65.
  • We are instilling a stop loss at $38.50 to manage additional downside risk near-term.

With regard to Amplify Snacks, with today’s close the shares are down just 6 percent from our late April Buy recommendation. Generally speaking, these single digit stocks tend to be volatile and require some extra patience, and that’s the tact will take with BETR shares. Our price target remains $11.

  • We continue to have a Buy on Amplify Snacks (BETR) shares and our price target remains $11.

 

 

 

Retail Sales Data for the Month of May Confirms Several Thematic Investment Themes

Retail Sales Data for the Month of May Confirms Several Thematic Investment Themes

This morning we received the May Retail Sales Report, which missed headline expectations (-0.3% month over month vs. the +0.1% consensus) as well as adjusted figures that exclude autos sales for the month (-0.3% month over month vs. +0.2% consensus). Despite the usual holiday promotional activity, retail sales in May were the weakest in 16 months due in part to lower gasoline prices, which had their biggest drop in over a year. In our view, the report confirms the challenging environment for brick & mortar retailers, despite those lower gas prices, while also affirms our decision not to participate in the space with the Tematica Select List as there were some bright spots below that headline miss.

Almost across the board, all retail categories were either essentially flat or down in May compared to April. The exception? Nonstore retail sales, clothing, and furniture — and nonstore obviously mostly comprised of online retailers since the Sears catalog isn’t in the mailbox too often these days. Comparing May 2017 retail sales to year-ago levels offers a different picture – nearly all categories were up with a couple of exceptions, the most notable being department stores. Again, more confirmation to the “why” behind recent news from mainstays of U.S. mall retailers like Macy’s (M), Michael Kors (KORS), Gymboree Corp. (GYMB) and Sears (SHLD).

Some interesting callouts from the report include that year over year, nonstore retail sales rose 10.2% percent, which brings the trailing 3-month year over year comparison for the category to 11.4%. This data simply confirms the continued shift toward digital commerce that is part of our Connected Society investing theme and is a big positive for our positions in Amazon (AMZN), Alphabet (GOOGL) and United Parcel Service (UPS).

We only see this shift to digital accelerating even more as we head into Back to School shopping season in the coming weeks and before too long the year-end holiday shopping season. While it is way early for a guesstimate on year-end holiday spending, eMarketer has published its view on Back to School spending this year and calls for it to grow 4 percent year over year to $857.2 billion. If that forecast holds, it will mean Back to School spending will account for roughly 17 percent of eMarketer’s 2017 retail sales forecast for all of 2017.

Not ones to be satiated with just the headlines, digging into the report we find more confirmation for our Connected Society investing theme – eMarketer sees e-commerce related Back to School shopping growing far faster, increasing 14.8% to $74.03 billion in 2017. As we like to say, perspective and context are essential, and in this case, should that e-commerce forecast hold it would mean Back to School e-commerce sales would account for 8.6% of total retail sales (online and offline) for the period, up from 7.8% last year.

 

The Connected Society Won’t Be the Only Theme In Play for Back to School Shopping

Given the last several monthly retail sales reports, as well as the increasing debt load carried by consumers, we strongly suspect our Cash-strapped Consumer theme will also be at play this Back to School shopping season, just like it was last year. In its 2016 findings, the National Retail Federation found that “48% of surveyed parents said they were influenced by coupons, up five percentage points from the prior year, while others said they planned to take advantage of in-store promotions and advertising inserts, and 53% said they would head to discount stores to finish prepping for the new school year.”

With consumer credit card debt topping $1 trillion, consumers are likely to once again use coupons, shop sales and hunt for deals, and that bodes very well for the shift to digital shopping. With Amazon increasingly becoming the go-to destination for accessories, books and video, computers and electronics, office equipment, sporting goods and increasingly apparel, we see it continuing to gain wallet share over the coming months.

 

Food with Integrity Theme Seen in Retail Sales Report As Well

Getting back to the May Retail Sales report, another positive was the 2.2% year on year increase in grocery stores compared to data published by the National Restaurant Association that paints a rather difficult environment for restaurant companies. The latest BlackBox snapshot report, which is based on weekly sales data from over 27,000 restaurant units, and 155 brands) found May was another disappointing month for chain restaurants across the board. Per the report, May same-store sales were down -1.1% and traffic dropped by 3.0% in May. With that in mind, we’d mention that last night Cheesecake Factory (CAKE) lowered its Q2 same restaurant comp guidance to down approximately -1%. This is a reduction from prior guidance of between 1% and 2%.

Stepping back and putting these datasets together, we continue to feel very good about our position in Food with Integrity company Amplify Snacks (BETR), as well as spice maker McCormicks & Co (MKS) as more people are eating at home, shopping either at grocery stores or online via Amazon Fresh and other grocery services. Paired with the shifting consumer preference for “better for you” snacks and food paves the way for Amplify as it broadens its product offering and expands its reach past the United States. As we shared in yesterday’s weekly update, United Natural Foods (UNFI) should also be enjoying this wave, but the company recently lowered its revenue guidance, so we’re putting UNFI under the microscope as we speak and we could very well be shifting our capital soon.

 

WEEKLY ISSUE: Adding to the Select List as we continue to ride the smartphone wave

WEEKLY ISSUE: Adding to the Select List as we continue to ride the smartphone wave

In this Week’s Issue:

  • As Trump Bump Gives Way to Trump Slump, What Will the Fed Do?
  • Putting UNFI and AT&T Under the Microscope
  • Nuance Communications – Big Deals for this Disruptive Technology Player
  • AXT Inc. – More Than Riding the Smartphone Wave

 

Welcome to this week’s issue of Tematica Investing. Following last week’s addition of Guilty Pleasure company MGM Resorts International (MGM) to the Tematica Select List, we’re adding another new name in compound semiconductor substrate company AXT Inc. (AXTI) – more on it and exactly what compound semiconductors are will be had shortly. But first, let’s have a quick look at what’s coming across our desk this week . . .

 

As Trump Bump Gives Way to Trump Slump, What Will the Fed Do?

We’re just several hours away from the Federal Reserve announcing what is likely to be a modest bump higher in interest rates, a move that is widely expected by investors. We here at Tematica continue to see it as the Fed looking to re-arm itself ahead of the next eventual recession. Note we said eventual, for even though we continue to see step downs in 2Q 2017 GDP expectations, the domestic economy continues to chug along at a sluggish pace. That’s a speed we expect to be with us as we head into the summer doldrums. After today’s market close there will be 12 trading days left in the quarter, which means companies are on the cusp of entering their quiet periods, and before too long we’ll get any and all negative earnings preannouncements.

As we get more June economic data and those preannouncements, we could see the stock market revisit last week’ move lower for reasons that we recapped in this week’s Monday Morning Kickoff. With the Eurozone elections being a non-event, a sense of calm returned to the market this week, but once we’re past the Fed’s expected action, the next item to preoccupy investors will be expectations for the second half of 2017. We continue to suspect expectations for both GDP and earnings will have to be adjusted given the Trump Slump, but that’s for the market, not the positions we’ve identified as benefitting from thematic tailwinds that reside on the Tematica Select List:

  • We will continue to keep shares of Amazon (AMZN), Alphabet (GOOGL), Dycom (DY), Facebook (FB), Applied Materials (AMAT), Universal Display (OLED) and others on the Select List.
  • We will be revisiting stop loss levels over the following weeks in order to have them in position for 2Q 2017 earnings, which will commence soon after the July 4th holiday weekend.

 

 

Putting UNFI and AT&T Under the Microscope

We are putting shares of United Natural Foods (UNFI) on notice, as they’ve slumped after reporting above-consensus quarterly earnings of $0.77 per share on an 11.1 percent year-over-year jump in revenue to $2.37 billion, which was shy of expectations. Looking ahead, UNFI reaffirmed its bottom-line guidance for the full year, expecting earnings between $2.53-$2.58 per share. However, revenue guidance was lowered and the company now expects below-consensus sales between $9.29 billion and $9.34 billion after previous guidance called for sales between $9.38 billion and $9.46 billion.

  • As we review our position in UNFI, we’ll be recalculating our price target, which currently sits at $65. Expect more on this in the coming days and weeks.

We’re also keeping close tabs on AT&T (T) shares. We’ve been patient with this position, but year to date it’s fallen 9 percent before factoring in dividends paid. Our thesis over the changing business model following the merger with Time Warner (TWX) remains, and we expect more concrete details to emerge in the coming months given the timetable to close the deal by year-end.

  • Our inclination is to scale into T shares below $38, which would modestly improve our cost basis.
  • Stay tuned for more on this as well.

 

 

Nuance Communications – Big Deals for this Disruptive Technology Player

It’s been a bit since we updated subscribers on speech recognition and virtual assistant provider Nuance Communications (NUAN), but that’s primarily because until recently the business has been chugging along. For its March quarter, the company hit consensus expectations and guided the current quarter in line with Wall Street forecasts, which laid the groundwork for the shares to climb more than 8 percent over the last three months. More recently, however, things are once again shaking at Nuance as the company inked deals with Amazon (AMZN), Apple and Alphabet (GOOGL) to bring its Nina platform to power customer service chatbots on iMessage, Alexa and Google Home devices.

Already, Nuance’s Nina platform powers customer service bots for about 6,500 companies and organizations, including many telecoms, banks, and airlines. The reality is, you may have already used this Nuance solution and not recognized it. Per Nuance, Nina-powered bots can resolve 80 percent of customer requests, such as transferring money, or changing airline seats.
We’d point out this is in addition to Nina powering other messaging services, including Facebook Messenger, WeChat, and text messaging applications.

As it relates in particular to Apple, the chatbot capability is scheduled to appear within iOS 11, and the plan is to integrate Nuance’s solutions with Apple Business Chat to enable a new breed of artificial intelligence (AI)-based intelligent assistants within Messages. What this means is users will see a messages icon pop up on brand websites, in search results, and elsewhere that will allow people to contact those brands with one tap.

From our perspective, this could prove to be an interesting behind the scenes development that if it were to spread to Siri and Apple’s new HomePod, could make for more robust offering that currently expected. It also reaffirms our view that at some point Nuance is likely to be a takeout candidate.

  • With 13 percent upside to our $21 price target, we continue to have a Buy on NUAN shares.
  • As we get a better understanding, and some hands-on experience with these new capabilities across Apple, Amazon and other recent wins, we’ll look to revisit our price target.

 

AXT Inc.  – More Than Riding the Smartphone Wave

Over the last decade, RF semiconductor companies like Skyworks Solutions (SWKS) and Qorvo (QRVO) have seen strong moves in their businesses as well as stock prices. RF semiconductors are what allows that cellphone in your pocket to communicate wirelessly with networks (RF stands for radio frequency) and it enables that communications at a far more battery efficiency than its silicon semiconductor counterpart.

As the Connected Society investment theme plays out in the marketplace, it’s easy to see the two factors driving demand for these semiconductors.  First, the move from 2G to 3G and 4G technologies has resulted in greater RF semiconductor content per device, beginning in mobile phones and now in smartphones. The second factor is the
adoption of wireless technologies across multiple devices ranging from gaming controllers to tablets, GPS devices, and wearables to name a few.
We are now on the cusp of seeing these two forces step up once again as mobile carriers get ready to beta 5G technologies, which will add another layer of RF content to connected devices, and newer connected markets, like the Connected Home, Connected Car and the Internet of Things approach their tipping points. Speaking of Connected Car, later this week, we’ll have more on the Connected Car market when Ted Cardenas from Pioneer joins us on this week’s Cocktail Investing Podcast. Be sure to catch it on TematicaResearch.com or head on over to iTunes and subscribe.

Back to the matter at hand, each of these connected devices requires a bevy of RF semiconductors ranging from switches and filters to power amplifiers. In the silicon semiconductor world, chips are fabricated on wafers. With RF semiconductors, they are grown on substrates based on elements found on the periodic table. We’ll keep it simple here when it comes to compound semiconductors, and will post more background information on the website. For now, what you do need to know is RF semiconductors’ performance characteristics across their varied applications lend themselves to our Disruptive Technology investment theme.

Again, the basic building block of these disruptive semiconductors is the substrate and brings us to AXT Inc. (AXT) a worldwide manufacturer of compound and single element substrates that include Gallium Arsenide (GaAs), Indium Phosphide (InP), and Germanium (Ge) flavors. The company has manufacturing facilities and investments in 10 subsidiaries and joint ventures in China that produce raw materials as part of its vertically integrated supply chain. Applications for the company’s InP substrates include fiber optic networks, passive optical networks and data center connectivity among others. Moving to Ge substrates, key markets for the material include satellite solar cells and optical sensors and detectors including infra-red detectors.

The substrate category that has the greatest volume opportunity remains GaAs, which as mentioned above is used in smartphones and other burgeoning connected device markets such as augmented and virtual reality devices, gaming applications as well as facial recognition security applications like the one in beta by Jet Blue (JBLU) as well as SmartTV, auto, medical, gaming and industrial applications. Pretty much any device is poised to include RF semiconductors, but let’s remember the single largest market by volume remains the smartphone market. With greater RF semiconductor content per device as more of the globe migrates to 4G and LTE technologies, we see rising demand for AXT’s GaAs substrates. With RF semiconductor content taking another step up with 5G, the outlook for AXTI’s GaAs substrates looking favorable over the next several years.

Given the wide array of end markets served, no particular customer accounted for more than 10 percent of revenue in 2016, but we suspect key customers include Skyworks Solutions and Qorvo, given their position in the RF semiconductor space. Consensus estimates call for Skyworks to grow its revenue 10 percent this year and again next year, while forecasts for Qorvo call for its revenue to grow 4-9 percent over the next several quarters. As we’ve noted with Applied Materials (AMAT), we are seeing China invest heavily in developing its in-country semiconductor capabilities, and based on order books for both Applied and Veeco Instruments (VECO), this includes compound semiconductors. As such, we could see the mix of customers and geographies at AXT shift over the coming quarters. In our view, that plays to AXT’s strength given its existing operations in China.

Much the way we are watching Applied Materials and Veeco for cues on organic light emitting diode demand, we will also be watching them for compound semiconductor capacity additions. Applied in particular has reported strong order growth, which led the company to recently boost its outlook. As part of its first-quarter results, Veeco reported a third consecutive quarter with bookings above $100 million vs. $94 million in revenue for the quarter, bringing its backlog at the end of the quarter to more than $200 million.

Let’s Have a Look at AXT Fiscal and Stock Performance

Current expectations call for AXT to deliver revenue of $91 million this year, up from $81.3 million last year, but there could be upside based on the deployment of 5G networks as well as reception for Apple’s (AAPL)next iPhone. As several compound semiconductor technology applications mature over the coming quarters, revenue at AXT is expected to rise to $103-$107 million, with EPS forecasted to climb to $0.31 per share, up from $0.19 this year. We’d note that over the last year, AXT has managed to beat analyst expectations in all four quarters, even as EPS expectations have ticked higher. One other item to point out, the company has no debt and $77 million in cash (roughly $2 per share) and is generating positive cash flow.

Historically, smartphone demand has ramped in the second half of the calendar year. Apple (AAPL) is set to take the wraps off its latest iPhone model this fall. Given the likely competitive response from Samsung, HTC, LG and others, we expect the seasonal pattern to hold, which means we should see a pick-up in demand for AXT’s substrates in late July. Other connected devices, ranging from connected speakers, gaming consoles and so on, should also see a seasonal bump in the back half of the year as part of the year-end holiday shopping season. With the seasonal pattern expected to hold, this likely means AXT shares will move higher as revenue and earnings are poised to climb meaningfully in the second half of the year compared to the first half. While the positive is that tends to result in favorable multiple expansion, it also means that we need to be mindful about the typical revenue fall off from the fourth quarter to the first quarter, given the seasonal drop off in smartphones and other volumes as we move into late January and February.

With all of that said, we see AXT shares reaching $9 over the coming months. We derive that price target through a confluence of historical P/E and enterprise value (EV) to revenue metrics. Our plan will be to either use market weakness during the summer months to scale into the shares, or to build our position on signs the seasonal smartphone ramp is trending stronger than expected.

The Bottom Line in AXT Inc (AXTI):

  • We are adding AXTI Shares to the Tematica Select List, which at market close yesterday traded at $6.45 per share.
  • We are setting a price target on the shares of $9, and anticipate it reaching that level over the coming months. We derive that price target through a confluence of historical P/E and enterprise value (EV) to revenue metrics.
  • Our plan will be to either use market weakness during the summer months to scale into the shares, or to build our position on signs the seasonal smartphone ramp is trending stronger than expected.