Author Archives: Chris Versace, Chief Investment Officer

In this Week’s Issue:

• No Real Shock in AT&T’s (T) Earnings, However, Some of the Details Have Us Downgrading Dycom (DY) from a “Buy” to a “Hold”
• What We’re Expecting Later This Week in Earnings Reports from Amazon (AMZN), Alphabet (GOOGL) and Starbucks (SBUX)
• Developments in Our Positions in DIS, HACK, IFF, BETR

With the pace of corporate earnings picking up this week, we have a lot to cover so we’ll keep our opening comments rather brief.

You’ve likely noticed the strong rise to the market this week, following the initial round of French elections. That euphoria, however, could be short-lived as the market’s focus returns to earnings and the unfolding drama in Washington. While the earnings reports we’ve received thus far have been encouraging, in sifting between the headlines there are some reasons to be concerned and as we get the bulk of this week’s reports today and tomorrow, we suspect more concerns will bubble to the top.

On the political front, there is the risk of a federal government shutdown (low probability in our opinion), the renewed GOP effort on healthcare reform and now  Trump’s tax proposal. To us, the combination of earnings and Washington happenings are likely to cause some renewed uncertainty in the market, which could lead to some giveback in its recent gains. Yes, we know new records were set in the Dow Jones Industrial Average and the Nasdaq Composite Index, but in our view that only means stretched market valuation are even more so. Given the findings of the Bank of American Merrill Lynch institutional money manager survey we shared in this week’s Monday Morning Kickoff that 83 percent find the stock market over-valued, we suspect that level has only ticked higher in the last few days.

We will continue to be prudent with the Tematica Select List and follow the latest thematic data points. Be sure to tune into the latest episode of the Cocktail Investing Podcast later this week, when we share a number of those data points.

Now let’s get to it…

No Real Shock in AT&T’s (T) Earnings, However, Some of the Details Have Us Downgrading Dycom (DY) from a “Buy” to a “Hold”

Last night Connected Society investment theme company AT&T (T) reported 1Q 2017 results that met bottom line expectations but missed on revenue for the quarter. With our underlying investment thesis intact — the transformation of the company into a mobile content player from simply a wireless services player — despite the wireless led revenue shortfall in the quarter, we will continue to watch AT&T shares with the intention of using weakness below $40 to round out our position size as the shares settle out from last night’s earnings report.

In looking into the details of what AT&T reported, we find that for the March quarter AT&T delivered earnings $0.74 per share on revenue of $39.4 billion vs. the expected $40.5 billion. The culprit in the revenue miss was a combination of lower new equipment sales (roughly 1 million fewer units vs. a year ago), a more challenging pricing environment and a loss of 191,000 postpaid subscribers — pretty much the same issues that plagued Verizon’s (VZ) Verizon Wireless business in the March quarter. The subscriber winner appears to have been T-Mobile USA (TMUS), but we offer our view that being a winner in an increasingly commoditized and price sensitive business is not really winning long-term.

In a somewhat surprising move, AT&T has decided it will no longer give full-year revenue guidance due to the unpredictability of the mobile handset market. Given the combination of the move to no longer subsidizing mobile phone purchases and a domestic wireless market that is more tied to the phone upgrade cycle than new subscriber growth, we are not shocked that forecasting wireless handset revenue has become increasingly difficult. Offsetting the 2.8 percent drop in AT&T’s revenue year over year, the company improved its consolidated margins by 80 basis points vs. year ago levels due to automation, digitization, and network virtualization. The company targets having 55 percent of its network functions virtualized by the end of 2017, which should offer incremental margin improvement opportunities over the coming quarters.

Our thesis on the T shares has centered on the pending transformation that will occur in the business model following the merger with Time Warner (TWX), which will shift the emphasis away from the increasingly commoditized mobile service business. Even ahead of the closing of that transaction, AT&T has taken steps to position itself within the content arena with the acquisition of DirectTV and the subsequent launch of DirecTV Now. On the earnings call, these were areas of focus with AT&T commenting that it continues to expect approval for Time Warner transaction and we’ve shared the environment toward it in Washington has warmed considerably since the 2016 presidential election. We continue to expect more details in terms of guidance and synergies to be had once the transaction closes late this year.

After what some would say was a slow start, DirecTV Now — the company’s s over-the-top service that offers a wide selection of live television, premium programming and On Demand content — continued to add customers in the quarter. AT&T is looking to get a little more aggressive in the second half of 2017 with DirectTV Now, particularly with wireless bundling and we’ve already started to see new TV ads with Mark Wahlberg touting the offering. With just five months under the belt, we expect AT&T to be patient with this business, especially since it is likely to be a direct beneficiary of the Time Warner’s content library in 2018.

The bottom line is while the revenue miss for the quarter was a disappointment, following Verizon’s results it was hardly a shock to the system. The revenue miss at both companies highlights the reasons for our owning the shares very much remain intact. As we said several months ago, with AT&T’s business poised to transform over the coming quarters, its shares are likely to be rangebound until we have some clarity and understanding on the synergies to be had. That same transformation means that investors are likely to look past near-term ups and downs in the wireless business. In our view, in hindsight, AT&T’s move to snare Time Warner shows the management team is rather forward-thinking and the same can be said for its leading wireless spectrum business as it looks to bring select 5G services to market in 2018.

AT&T’s focus on bringing 5G services to market are, of course, rather positive for our Dycom (DY) shares. During 1Q 2017, AT&T spent $6 billion on capital spending and reiterated its plans to invest $22 billion in full for 2017. With that expected spending level at Dycom’s largest customer unchanged to the upside, and following the additional 5 percent move in DY shares over the last few days, we now have just 6 percent upside to our $115 price target for Dycom.

To keep our Buy rating intact on DY shares from current levels, we’d need to see upside in the shares to more than $125; at the same time we recognize that given the 33 percent move in DY shares over the last three months, they could come under pressure should the market get a little rocky this earnings season. For those reasons, we’re downgrading DY shares to a Hold. We’ll continue to evaluate our price target as we other key customers update their 2017 capital spending plans and should we get wind of an accelerating 5G deployment timetable.

• Our price target on AT&T shares remains $45, and we intend to use near-term post-earnings weakness to add to this long-term holding.
• Our price target on Dycom (DY) shares remains $115 for now and given just percent upside to that target we are downgrading DY shares to a Hold from Buy. 

What We’re Expecting Later This Week in Earnings Reports from Amazon (AMZN), Alphabet (GOOGL) and Starbucks (SBUX)

AT&T’s earnings report was just the start of what is to be a frenzied two weeks, as more than 2,000 companies report quarterly results and offer their latest outlook on what’s to come near-term. This week alone we have 40 percent of the S&P 500 reporting, and among that sea of results, we have three more Tematica Select List companies doing the same — Amazon (AMZN), Alphabet (GOOGL) and Starbucks (SBUX) — all after the market close tomorrow (Thursday, April 27).

Here’s what the market’s expecting and our pre-results commentary:

AMAZON (AMZN): Amazon shares have been a strong performer amid the escalating brick & mortar retail death spiral, climbing more than 20 percent thus far in 2017. That sharp move higher compared to just 6.7 percent for the S&P 500 likely means expectations are once again running high for Amazon even though consensus expectations call for EPS of $1.13 on revenue of $35.3 billion. We’ve seen this several times over the years and at times Amazon surprises Wall Street with its investment plans that tend to weigh on its outlook. As we saw last September, that mismatch tends to weigh on Amazon shares, offering a solid buying opportunity for long-term investors.

Amazon is a stock to own for the long-term given several powerful tailwinds that power its various businesses. While the right investment strategy is to use weakness to build one’s position, for subscribers who are underweight Amazon, we would suggest holding off right now from adding more shares until after the company reports.

• For now, our price target on AMZN remains $975.

Alphabet (GOOGL): Over the last week, Alphabet (GOOGL) shares have climbed more than 4 percent, bringing the year to date return to more than 12 percent. As we get ready for the company’s 1Q 2017 earnings report tomorrow, let’s remember the YouTube advertising snafu it had during the quarter, which could weigh on overall results. We would advise subscribers underweight GOOGL shares to be patient as we could see better prices late this week or early next. Longer-term, with the continued move in the Connected Society investment theme that bodes well for the core Search business as well as its own shopping portal efforts plus the launching streaming TV service, dubbed YouTube TV, the company still has several multi-year tailwinds behind it. On Alphabet’s earnings call, we’ll be listening for comments on returning capital to shareholders as well as signs the new regime remains focused on margins.

• Our price target on GOOGL shares remains $975, which offers 10 percent upside from current levels. 

STARBUCKS (SBUX): Over the last week or so, Starbucks (SBUX) shares have broken out of the $54-$58 trading range they have been in over the last four months. Part of that move was due to an upgrade by the research arm of Stifel, which now sees upside to $67 for SBUX shares, which compares to our long-term price target of $74. Expectations call for Starbucks to deliver EPS of $0.45 on revenue of 45.41 billion for the March quarter and for the team to guide the current quarter to EPS between $0.52-$0.59 on revenue between $5.6-$6 billion.

They key for us will be the continued expansion overseas as well as an upgrade in the company’s food efforts, which to us are likely to be key areas of focus on the earnings call following the poor reception of its Unicorn Frappuccino. Coffee prices have abated over the last several months, which could help Starbucks project some additional margin lift in the coming quarters.

• We continue to rate SBUX shares a Buy at current levels. 

Developments in Our Positions in DIS, HACK, IFF, BETR

The Walt Disney Co (DIS): This morning we’re hearing that Disney’s ESPN network could start issuing pink slips at its flagship cable sports channel today. Several reports suggest the layoffs may be more numerous than the expected, with some 70 employees ranging from anchors, reporters, analysts and online writers losing their jobs in coming weeks. We see this as the latest move by Disney to right the cost structure in a business that is finding its way among chord-cutters and Cash-Strapped Consumers seeking more cost friendly streaming services. Disney continues to explore such options, and we suspect more developments to be had on this in the coming quarters.

With the move in Disney shares in recent weeks, our positions are up 14 percent, with another 9 percent to go to our $125 price target. With a robust movie slate over the coming months that includes Guardians of the Galaxy 2 (May 5), Pirates of the Caribbean: Dead Men Tell No Tales (May 26), Cars 3 (June 16) and Spider-Man: Homecoming (July 7), we’re reviewing potential upside to our $125 price target for DIS. 

PureFunds ISE Cyber Security ETF (HACK): This week we  received two quick reminders over the downside to our increasingly Connected Society that fuels ourSafety & Security investing theme and bodes well for the PureFunds ISE Cyber Security ETF (HACK) shares on the Tematica Select List. First, last night at the very end of its earnings conference call Chipotle Mexican Grill (CMG) slipped in that it had detected “unauthorized activity” on a network that supports payment processing at its restaurants. Then this morning, French presidential candidate Emmmanuel Macron’s campaign team confirmed it had been the target of at least five advanced cyberattack operations since January.

• We continue to favor the HACK ETF as a diversified play on the ever-growing need for cyber security, which is just one aspect of our Safety & Security investing theme. 

International Flavors & Fragrances (IFF): During PepsiCo’s (PEP) earnings call last night the company reported higher-than-expected quarterly revenue and profit as it benefits from demand for its healthier drinks and snacks and kept a tight leash on costs. The company has said it now gets about 45 percent of its net revenue from “guilt-free” products — beverages that have fewer than 70 calories per 12 ounces and snacks that have lower amounts of salt and saturated fat.

We see that as a very favorable sign for our International Flavors & Fragrances (IFF) shares, which are up more than 8 percent since we added them, which leaves some 4 percent to our $145 price target.

• Given the accelerating move by PepsiCo and others into health snacks and drinks, we are reviewing that $145 price target for IFF.

Amplify Snack Brands (BETR): As you are probably thinking, PepsiCo’s results mentioned earlier are very much in tune with our Food with Integrity investing theme as well as our decision to add Amplify Snack Brands (BETR) to the Tematica Select List last week. Over the last week, BETR shares slipped some 2 percent, but we’d remind subscribers that stocks under $10 can be volatile week to week. We continue to like Amplify’s expanding offering and footprint, and when the company reports its results we expect to hear more on those efforts.

• We continue to rate BETR shares a Buy with an $11 price target. 

Welcome back and we hope you enjoyed any and all of the various holidays over the last ten days and didn’t gorge on chocolate and jelly beans.

Since our last issue of Tematica Investing, we’ve seen a shift in market sentiment toward the disconnect between the speed of the economy and earnings expectations, something we’ve been discussing for what seems like more than several weeks. We’ll chalk it up to the forward-looking nature of thematic investing. In our view, it’s always best to be ahead of the market and well positioned than be late and caught with your pants down.

During our downtime last week, we’ve rolled up our thematic sleeves on several companies, and today we are adding two to the Tematica Select List as part of our Cashless Consumption and Food with Integrity investing themes (details further down). As we do this, we’re mindful that 1Q 2017 earnings season is only now gearing up with more than 300 companies reporting this week, more than 975 next week and another 1,250 during the first week of May. Previously we’ve said and we continue to suspect these reports will lead to a reset in earnings expectations for the 2Q-3Q 2017 as economists reduce GDP forecasts and Trump initiatives get pushed into the back half of 2017 at best, with any likely impact not being seen until early 2018.

While that may seem like “Debbie Downer” outlook, we’re hopeful any market pullback will provide the potential to either scale into existing Tematica Select List positions at better prices or begin new ones in well-positioned companies at better prices that we’ve seen in January and February.

Finally, we’d also remind you to head to the Tematica website, Apple’s iTunes, Google Play or other podcast outlet to listen to our Cocktail Investing podcast. Recent episodes have included conversations with The Hartford Funds on its new bond ETFs, and Teucrium Trading on its commodity ETFs as well as the weekly dialog between Chris Versace, Tematica’s Chief Investment Officer, and Lenore Hawkins, Tematica’s Chief Macro Strategist. We’ll have another new episode out this week so be sure to tune in — you don’t want to miss it.

Brief Comments on Our Existing Positions

With two new positions on the Tematica Select List to dive into, we’ll keep our larger portfolio comments to the vast majority of positions are little changed over the last two weeks. Of course, there are some exceptions like Dycom (DY) shares, which have climbed more than 8 percent over the last week. We’re also keeping our eyes on AT&T (T) shares, which are hovering just over $40 and look rather tasty given the 4.9 percent dividend yield at current levels. We suspect that yield is bound to attract investors should market volatility ramp over the next three earnings filled weeks.

Oh wait, we’d said we wanted to get to those two new positions… be sure to check back to the Tematica website for additional comments on Facebook (FB), Applied Materials (AMAT), Dycom (DY) and CalAmp (CAMP) and other existing positions later this week.

Adding Cashless Consumption Company USA Technologies (USAT)

Over the last few days, we’ve been digesting one of Facebook’s (FB) new moves, which is bringing digital payments to its WhatsApp app in India. From a fundamental basis, we see the shift toward digital payments expanding for a number of reasons both here at home as well as in the emerging markets. In the U.S., the proliferation of the smartphone and apps like Apple Pay (AAPL), Square (SQ) and PayPal (PYPL) as well as initiatives from American Express (AXP), Visa (V), MasterCard (MA) and Verifone (PAY), is fostering mobile payment adoption. Recently Chris Versace used Apple Pay to pay for gas at an Exxon Mobil (XOM) station.

We see this as a sign that more applications for mobile payments are coming beyond paying at the grocery store, like we’ve seen people do more frequently. One of the markets that is being tapped, no pun intended, is vending machines, which have already migrated from bills and coins to credit cards. One of the companies behind that shift is USA Technologies (USAT) and it is using its ePort acceptance technology to vending machines as well as kiosks, laundry, arcades and other self- serve and unattended retail applications.

All told, USA Technologies has 11,900 customers and over 500,000 point-of-sale cashless payment connections on the ePort Connect platform. In terms of its revenue stream, recurring monthly service plus transaction processing accounted for approximately 77 percent of fourth-quarter 2016 revenue. We like recurring revenue as it offers predictability as well as cash flow, which in turn tends to offer better valuation metrics. Recently, six Pepsi-licensed bottlers have agreed to bring USA’s payment solutions to 2,000 machines, enabling the firms to track the acceptance of cash, credit/debit cards and contactless payments, including mobile wallet payments such as Apple, Android and Samsung Pay. The rollout includes 1,750 of USA’s touch-screen-enabled ePort Interactive payment devices as well as 370 of its NFC-enabled G9 ePorts, for a total of 2,120 units.

What also caught our eye was that USAT’s cloud-based interactive media and content delivery management system will serve up targeted advertising to consumers visiting these vending operators, including multimedia marketing campaigns, delivery of nutritional information and sampling. This media-content business could drive incremental revenue, with potentially far higher margins compared to USAT’s reported gross margin of 29 percent.

With just four analysts covering the shares and institutional ownership near 45 percent, we suspect USAT shares remain largely undiscovered. Looking at the expectations of those four analysts, the consensus view is for revenue to grow almost 24 percent this year to $96 million before climbing to nearly $115 million in 2018. With Apple launching more banks and credit unions on Apple Pay both in and outside the U.S., as well as Alphabet (GOOGL) doing the same, odds are there is upside to be had with that 2018 revenue forecast, especially as more applications by Verifone and others are deployed. We’d note USA Technologies recently appointed a new chief financial officer, and when this happens there tends to be clearing of the decks, or as some call it, “throwing out everything and the kitchen sink,” when it comes to guidance. In our view, should this come to pass it could allow us to scale into the position at better prices.

USAT shares are trading at between 1.3x and 1.5x enterprise value to consensus 2017-18 revenue, and the balance sheet is rather clean with net cash of more than $16 million. Year to date, the shares are up modestly and well off the 52-week high of $5.81, which in our view offers an opportunity to begin building a position for the long term. We see upside to $6 over the coming quarters as more mobile payment applications are deployed and acceptance rises. Given USA’s position in self- serve retail and mobile payments, we would not be surprised if it was scooped up one day by Verifone, Par Technology (PAR) or another entity in the space.

The Bottomline on USAT Shares:

• We are adding USAT shares to the Tematica Select List with a Buy rating and $6 price target.
• Our intention is to build the position out on weakness, scaling into the shares between $3.50 and $3.85, or on signs mobile payment adoption is accelerating faster than expected.
• We intend to be patient investors and hold the shares as mobile payment adoption grows.

BETR Shares are a Foods with Integrity Play

If you’ve wandered the aisles of your local grocery chain, odds are you’ve noticed more shelf space and end-caps increasingly giving way to natural, organic and “better for you” foods. Recent comments from Chipotle Mexican Grill (CMG) that it will shed all artificial additives and Darden Restaurants’ (DRI) Olive Garden focusing on healthier recipes echo similar moves by Panera Bread (PNRA) to offer “cleaner” food to customers.

Beverage companies ranging from Coca-Cola (KO) to PepsiCo (PEP) and Dr. Pepper Snapple (DPS) are exploring ways to reduce sugar in their carbonated beverages, and the same is happening at candy companies. We see these moves as confirming signs for our Foods with Integrity investing theme that is also powering the Tematica Select List position in United Natural Foods (UNFI).

Industry forecasts call for the global organic food and beverage market to grow to $238.4 billion by 2022, up from $89.8 billion in 2015. There are a variety of factors fueling this growth, but the two major ones are growing consumer awareness and increasing interest of large retailers. Over the last several quarters, we’ve seen Costco Wholesale (COST) and Kroger (KR), among others, increase their natural, organic and fresh food offerings. Over the last few quarters, confirming comments from Kroger included “Natural, organic and health and wellness continued to be a food megatrend,” “we continue to focus on the areas of highest growth like natural and organic products,” and“ Our natural and organic sales continue to outpace total sales growth.“

This brings us to Amplify Snacks (BETR), a company whose primary product line is SkinnyPop, a market-leading better for you (BFY) ready-to-eat popcorn brand that uses simple, allergen-free and non-GMO ingredients. Other products include Crisps Topco, Paqui, Oatmega protein snack bars and Perfect cookie products. With the Crisps Topco acquisition that closed in the third quarter of 2016, Amplify acquired a foothold into the international better-for-you snack market, while the Oatmega purchase brings the company into the $6-billion bar category in the U.S.

In terms of customers, Amplify serves the natural, grocery, mass and food service markets across the U.S., with Costco Wholesale and Wal-Mart’s (WMT) Sam’s Club accounting for 22 percent and 12 percent of sales in 2016, respectively. We’d note those percentages have fallen over the last few years from 33 percent and 22 percent as Amplify has continued to grow its revenue from $55 million in 2013 to just under $271 million in 2016.

Current consensus forecast call for Amplify to deliver revenue of $405 million this year before climbing to just under $460 million in 2018. Continued consumer adoption of better-for-you foods, growing distribution both in and outside the U.S. and new product offerings are driving revenue expectations. In 2016, Amplify’s sales in North America accounted for 85 percent of overall revenue, which reflected one quarter of Crisps Topco. Management targets launching SkinnyPop in international markets in the first half of 2017 and Crisps Topco products in the U.S. in early 2018.

Our price target for BETR shares is set at $11, which offers roughly 23 percent from current levels. The shares recently bottomed out at $7.86, 12 percent below current levels, following a modest earnings miss in the fourth quarter. Our strategy for this Foods with Integrity stock will be to use either market weakness or signs that its products are gaining acceptance and incremental distribution faster than the market expects. Should shares fall below $8.50, we’d be inclined to scale into the position given the favorable risk-to-reward dynamics.

While we don’t invest in companies simply on potential takeout speculation, given the trend of larger companies looking to tap into the growing organic/natural food market there is the possibility that Amplify is showing up on acquisition radar screens. Over the last several quarters we’ve seen

• Hershey (HSY) acquire Krave to tap into the paleo and protein snack market,
• Campbell Soup (CPB) bought Garden Fresh Gourmet,
• Mondelez International (MDLZ) scooped up Enjoy Life Foods,
• Danone (DANOY) acquired WhiteWave,
• General Mills bought Annie’s, and
• PepsiCo attempted to acquire Chobani Yogurt.

As Amplify continues to expand its footprint and deliver continued revenue growth, odds are it will pop up on competitor radar screens that include PepsiCo, Kellogg, General Mills, Snyder’s-Lance and other larger snack and food companies. Again, we are adding BETR shares to the portfolio given the fundamental drivers behind the business, but as investors, we certainly would not fight a premium takeout offer on the shares.

During the coming earnings season, we’ll be listening to comments on the organic, natural and better-for-you food adoption from Wal-Mart, Sprouts Farmer Markets (SFM) and Costco as well as product mix data from PepsiCo, Kellogg (K), ConAgra (CAG), General Mills (GIS) and Snyder’s-Lance (LNCE).

The Bottomline on Amplify (BETR) Shares:

• We are adding BETR shares to the Tematica Select List with a Buy rating and a $11 price target.
• We would look to scale into the position below $8.50