Author Archives: Chris Versace, Chief Investment Officer

Since our last Tematica Investing update, the Trump Bump rally has continued and the Dow Jones Industrial Average continues its trek toward 20,000. At last night’s close, the Dow stood less than 100 points away from that level and if it hits it, as many speculate it will, it will stand as of the fastest 1,000 point moves for the index. To put some context around that, on Nov. 4 the Dow closed at 17,888,28 and has since climbed more than 1,110 points.

During that same time, all the major indices have put in record high after record high, with many pointing to what is to come under the Trump administration after the January 20, 2017 inauguration. As we wrote in this week’s Monday Morning Kickoff, there are scant signs of selling pressure given the prospect that tax rates will be lower come 2017 than they are today. This means that even though the indices are in overbought territory, we’re likely to soon see the Santa Claus Rally emerge and push stocks even higher.

NOVEMBER RETAIL SALES REPORT — OUR FIRST LOOK AT THE 2016 HOLIDAY SHOPPING SEASON

While we are full swing into the holiday shopping season, this morning we received the November Retail Sales Report, which includes the Black Friday to Cyber Monday shopping bonanza. Per the Census Bureau total, November Retail & Food sales rose 0.1 percent month over month. Stripping out food and auto, Retail sales were flat month-over-month and up 3.6 percent year-over-year. Given the data, we’ve seen and shared about Black Friday — Cyber Monday, it comes as little surprise the strongest category of growth was once again Non-store retailers, which were up 11.9 percent year over year. We see that as confirming for our Connected Society positions in Amazon (AMZN) for obvious reason as well as Alphabet (GOOGL) given its search and Google Shopping businesses.

The next strongest category, which reflects our Aging of the Population investment theme, was Health & Personal Care Stores, up just over 6 percent year-over -year.  Given our position in Starbucks (SBUX) we’d also call out the 3.1 percent year-over-year increase in Food & Beverage Stores for November. Finally, we always say the monthly Retail Sales Reports put context around Costco Wholesale’s (COST) monthly sales figures and once again comparing the two it become rather obvious that Costco continued to take consumer wallet share during the month as Cash-strapped Consumers looked to stretch their spending dollars once again.

WHAT’S IN STORE COMING OUT OF THE FOMC MEETING TODAY

Later today we’ll hear from the Federal Reserve and the widely held expectation is the boost interest rates by 25 basis points. Our concern is that based on recent data they could surprise the market with a 50 basis point hike. As such, we’re going to hold off adding any new position this week, but we anticipate sharing a new recommendation in next week’s Tematica Investing, if not sooner if conditions are right, so be sure to watch your email and the website closely.

UPDATES, UPDATES, UPDATES

Given the market move, the pickings have certainly slimmed down compared to several weeks ago, but we’re already looking at the intersection of thematic tailwinds and stock laggards. You may be surprised to know there are more than a few potentials from our Contenders list and beyond, and now we’re digging in and putting some of those through their paces.

Now with just over two weeks to go until we close the books on the current quarter and 2016, let’s take a look at the current positions on the Tematica Select List. As we get ready to do that, we’d note that we’ve seen a number of positions added in late 3Q 2016 and early this quarter, like AMN Healthcare (AMN), Universal Display (OLED), and CalAmp Corp (CAMP) climb double digits. Quarter to date, we also added new positions in McCormick & Co. (MKC) as well as Facebook (FB) and scaled into International Flavors & Fragrances (IFF), AT&T (T), Amazon (AMZN), Dycom Industries (DY). We’re happy to report each of those positions is nicely profitable with the vast majority offering additional upside from current levels.

The are a couple of sore points on the Select List. One is Under Armour (UAA), but we see the company’s efforts to grow its International, women’s and footwear business starting to pay off and if the number of Under Armour items on our kids’ Christmas lists are an indication, it should be a strong holiday season for the athleisure player. We’d say dividends would also point to a bright future, but UA isn’t a dividend payer.

The other sore point would be the ProShares Short S&P 500 ETF (SH) position, which has come under further pressure as the Trump Bump has pushed the S&P 500 higher over the last several weeks. With that index well in overbought territory, we’ll continue to keep SH shares on the Select List for now, but remember we have these positions in the portfolio as a hedge if the market gets too far into overbought territory, so even though its down right now, it’s doing its job.

Amazon (AMZN)    Connected Society

Amazon rebounded nicely since last Wednesday, but the shares remain well below late-October levels. There was a lot of chatter on Amazon’s essentially self-automated grocery store that launched for employees and will be opening to residents of Seattle in 2017 (yes, there are residents in Seattle that don’t already work for Amazon). Despite a colorful discussion, Amazon denied it plans to open 2,000 such locations. As we have seen before with its own logistics initiatives, Amazon tends to zag when people expect it will zig. We view its self-automated store as the latest example.

According to comScore (SCOR), holiday season-to-date online desktop spending is up 12 percent year-over-year, with growth picking up significantly since Thanksgiving. Anecdotally, we’ve never seen so many FedEx and UPS trucks making the rounds as early and as late as they are this year. We’ve also even seen quite a few U.S. Postal Service trucks on Sundays — we know, it’s crazy . . . Chick Fil A is closed, but the mailman is working. Who would have thought?

In another key area for Amazon, Amazon Web Services, which is the company’s most profitable division, it was recently revealed that Netflix (NFLX) is partnering with Amazon cloud services group for its infrastructure work. Netflix chief product officer Neil Hunt confirmed that Netflix is “100 percent operating out of AWS.” This is a huge win for Amazon’s higher-margin services business, and likely clears the path for other companies to outsource their data center and cloud operations to Amazon.

• We see no slowdown in the shift to digital commerce, streaming video consumption, and other drivers behind Amazon’s business and believe the current share price offers more-than-favorable upside potential to our $975 price target.

AMN Healthcare Services (AMN)    Aging of the Population

Over the last week, AMN shares surged more than 10 percent with the bulk of the move coming after the October JOLTS report. While that report showed a 5.5 percent month-over-month increase in health care and social assistance hiring, that paled in comparison to the 14 percent rise in health care and social assistance job openings in October relative to September. That mismatch underscores the current nursing and health-care shortage fueling AMN’s business.

The softening of President-elect Trump’s position on certain aspects of the Affordable Care Act signals a potentially smoother revamp than was expected under Candidate Trump, which also bodes well for AMN.

We will see how that  ACA overhaul by Congress plays out, but we continue to like the longer-term favorable dynamics driving AMN’s business. By 2020, forecasts say the U.S. will need 1.6 million more direct-care workers than in 2010, which equates to a 48 percent increase for nursing, home-health and personal-care aides over the decade due primarily to the aging of 78 million baby boomers.

• Our price target on AMN shares remains $43, which offers 21 percent upside from last night’s close. As such, we would commit fresh capital at current levels to AMN shares.

AT&T (T)    Connected Society

AT&T shares rose more than 5 percent for the week, and are now back to late September quarter levels. Last week, the planned acquisition of Time Warner (TWX) took center stage in both Washington, D.C., at a Senate Judiciary Meeting, and at the UBS Global Media & Communications Conference. Despite candidate-Trump’s criticism of the merger during the election cycle, we are encouraged by President-elect Trump’s pro-business perspective as it relates to this pending transaction and his recent comment that AT&T’s intention to acquire Time Warner would be looked at without prejudice. Obviously, a far softer position than his earlier statements that he would block the deal.

Details still need to be sorted out on the regulatory front, including the potential unloading of certain Time Warner TV channels and satellite dishes, which could eliminate a potential review by the FCC. However, we suspect AT&T is open to such options as it looks to transform its business with this transaction, and comments by AT&T CEO Randall Stephenson that consumers will get “better-priced options than they have today” helps thwart concerns about price gouging.

We view the combination of AT&T and Time Warner as bringing content to consumers where and when they want it and a competitive offering to Verizon (VZ) and Comcast (CMCSA).  More competition is a bound to be a good thing, despite what Senator Al Franken who stated during the Senate hearing that he is “skeptical of any further consolidation in the media and telecommunications industries that could lead to higher prices, fewer choices, and even worse service for Americans.” Few choices? Has he looked at all the streaming services out there?

In the coming months, we expect the market to focus on AT&T’s new DirecTV Now subscriber metrics to gauge potential churn, as well as measure how successful the service will be relative to expectations.

• Our $44 price target on T shares till stands, but we are likely to revisit it as more details on the pending merger with Time Warner emerge.

CalAmp Corp. (CAMP)    Connected Society

CAMP shares continued to make headway this past week, pushing our shares further into the green. The only company-specific news last week was CalAmp setting its next quarterly earnings report date for Dec. 21 when current expectations call for it to deliver EPS of $0.25 on revenue of $83.9 million.

During the week, Goodyear (GY) launched a new pan-European business, comprised of vehicle-to-fleet operations management solutions. The offering is a telematics-based solution that leverages Big Data and predictive analytics and enables fleets to monitor their vehicles and tires in real time to avoid breakdowns and lower total cost of operations (TCO). We see this as confirming for the strategies underway as well as potential opportunities at CalAmp.

Meanwhile, at Trucking.com, Scott Perry, chief technology & procurement officer for Ryder System (R), discussed several factors behind the eventual adoption of semi-autonomous vehicle technologies in fleets, including the driver shortage, which is estimated at 70,000 this year, and may rise to 175,000 by 2024.

We see these as additional signposts for the burgeoning Connected Car, Truck and Equipment market for which CalAmp is well positioned. As that market opportunity develops further, we continue to focus on the fundamentals, and near term that means watching public and private fleet management companies deploy telematics solutions to drive productivity and contain costs.

• With ample upside to our $20 price target, we continue to rate CAMP shares a Buy.

Costco Wholesale (COST)   Cash-strapped Consumer

Shares of the warehouse retailer climbed more than 5 percent over the last several days following upbeat comments made on the company’s earnings call last week.  Although Costco will continue to feel the impact of food deflation in the near-term, the company targets growing its warehouse count further over the coming year, which bodes well for sales as well as membership fees. As management overhauls the company’s e-commerce business, it could be a sleeping catalyst for the shares over the coming year.

• With just over 5 percent to our $170 price target, we are holding steady with COST shares and not adding to the position at current levels.

Dycom Industries (DY)    Connected Society

The latest edition of the Ericsson’s Mobility Report forecasts there will be 550 million 5G subscriptions in 2022, with the fastest uptake in North America, which is forecasted to account for roughly 135 million 5G subscriptions. While we’ve seen these hockey stick-like forecasts before with both 3G and 4G adoption, the reality is networks will need to be in place over the coming quarters at companies like AT&T and Verizon, which bodes rather well for both wireless and wireline infrastructure spending.

We see this as further confirmation of the industry investing to be done to deliver faster network speeds and incremental capacity as service providers bring more services to market, and Dycom is a prime beneficiary of that spending. At the same time, we see incremental spending to address capacity bottlenecks on existing networks, which is also good for Dycom.

• The current share price offers subscribers who are underweight DY an excellent opportunity to acquire the stock at better prices than we’ve seen the last few weeks.
• Our price target remains $110.

Walt Disney (DIS)     Content is King

Disney shares climbed another 3 percent this past week, raising its return to more than 12 percent over the last three months, putting both positions on our Select Investment list back into the green — our patience has paid off.

Concerns certainly still linger over the health of Disney’s ESPN business, which has prompted some chatter questioning whether it might be wise for the company to unload the business, but Disney’s strength at the box office has continued with Marvel’s Dr. Strange and its latest animated family-friendly film Moana. Of course, that’s all ahead of this Friday’s release of Rogue One: A Star Wars Story. Color us excited, but in our view, Friday cannot come soon enough.

We expect Rogue One and related merchandise to perform well this holiday season and in follow up quarters. Looking into 2017, it’s apparent it will be a transition year for Disney due in part to costs associated with ESPN’s new NBA contract that spans to the 2025/2026 season, the launch of new attractions at Disney World and Disneyland and a tough film comparisons year over year due to Star Wars: The Force Awakens.

Earlier this week was the dividend record date (Dec. 12) for the recently hiked semi-annual dividend to $0.78 per share, a 9.9 percent increase from the prior dividend of $0.71. The new dividend is payable on Jan. 11.

We are inclined to be patient with Disney as we see it as THE Content Is King company, with its international efforts propelled by rising disposable incomes and a brand-conscious rising middle class. We continue to see Disney making the right investments (streaming media and turning studio content into park rides and attractions) to drive revenue and profits.

• Our price target remains $125.

Alphabet (GOOGL)    Asset-lite Business Models

GOOGL shares soared 5 percent over the last week, but that only brings them back to levels last seen at the end of September. There was no blockbuster news this week, but there were several minor developments worth noting — the company helped form the Global Virtual Reality Association,  and its self-driving car team made additional hires and launched a new China-based developer site, marking a partial return to the Chinese Web. These are all positive developments that are likely to bear fruit over the medium to longer term. Near-term the core business driver will remain the search and advertising business.

We remain bullish on GOOGL as we see no slowdown in the tailwinds that are propelling the company’s businesses— specifically, the increasing shift toward digital from analog lifestyles that is driving incremental advertising dollars to online and mobile; streaming video consumption; and online shopping. Those drivers have the company tracking to grow earnings more than 20 percent and the shares are trading at 20x consensus 2017 EPS expectations of $40.97, essentially a PEG ratio of 1.0. Alphabet’s board authorized a new $7 billion share repurchase program following completion of the prior one.

• Our price target on GOOGL shares remains $975.

Facebook (FB)    Connected Society

After sliding over the last few weeks, FB rose 2.5 percent over the last five days. Helping move FB higher was the overall uptick in the Nasdaq, but also that the news that company is developing tools to deal with the increasing concern of “fake news.” The company also announced new tools for estimating reach and audience size, which should help ease recent concerns over audience metrics data.

From our perspective, FB remains very well positioned to capture the shift in advertising dollars to digital platforms, not just from radio and print, but broadcast as well. In other words, the key to the shares will be progress on its advertising/monetization strategies (especially video) and international revenue per user growth, and other opportunities that help grow its user base. Those are the factors behind its revenue and EPS expectations, which call for continued growth over the coming years.

Consensus expectations have FB earning $4.10 per share this year, up from $2.28 in 2015. But the valuation story and bullish demeanor across the investment community for FB is really a 2017-to-2018 one. As FB continues to grow and improve its global monetization efforts, EPS expectations rise to $5.20 for 2017 and $6.55 for 2018. The recently announced $6 billion share repurchase program that begins in 1Q 2017 has the potential to shrink the share count by around 2 percent near current share price levels, which should help in meeting those earnings expectations as well as giving the stock some support.

• Our price target on FB remains $150.

International Flavors & Fragrances (IFF)   Rise & Fall of the Middle Class

IFF shares were essentially unchanged over the last week. As with our recently added position in McCormick & Co. (see below), we see IFF as well-positioned as a result of rising disposable income, particularly in the emerging markets, but also from the shift in consumer preferences to natural/organic flavors. At the same time, soda companies, such as Coca-Cola (KO) and PepsiCo (PEP), are looking to reformulate their products to exclude sugar or to utilize organic flavors and fragrances, which bodes well for IFF’s solutions.

In its latest report, “Global Markets for Flavors and Fragrances,” Research and Markets forecasts the global market to grow from $26 billion in 2015 to $37 billion by 2021 — an overall increase of more than 40 percent!

• We would say there is nothing iffy to us about our position in IFF or our $145 price target.

McCormick & Co. (MKC)   Rise & Fall of the Middle Class

Ahead of the Thanksgiving holiday, we started a position in McCormick given the company’s history of annual dividend increases, the shift in consumer preferences that has people favoring eating at home over restaurants, and the rising disposable income outside the developed markets that is spurring a step-up in diets (protein consumption, flavor).

McCormick tends to be a somewhat sleepy name when it comes to news flow, and this week was no exception. That said, MKC shares were recently rated a new “Buy” at Bank of America Merrill Lynch with a $100 price target. Our long-term price target remains $110. As a reminder, the company boosted its quarterly dividend to $0.47 per share from the prior $0.43 — a 9.3 percent boost. These annual dividend increases tend to result in a step function in the share price. This 31st consecutive dividend increase will be paid on Jan. 17, 2017 to shareholders of record this coming Dec. 30.

We see the company as well-positioned to capitalize on “seasons’ eatings” over the coming weeks. Ask anyone that plans on baking if what they’ve paid for vanilla extract this year, and you’ll see what we’re getting at.

Starbucks Corp. (SBUX)    Guilty Pleasure

At Starbucks there’s been much a brewin’ as we like to say, as we saw its shares climb more than 3% last week bringing our return on the position to more than 8 percent.

The recent management change sees longtime CEO Howard Schultz stepping down and handing over the reins of the company to Kevin Johnson, the existing COO. While Schultz will remain the Chairman of the Board, he will shift his efforts to the company’s premium segment, Starbucks Reserve Roasteries, and Starbucks Reserve Retail stores, as the company looks to expand these businesses globally. We suspect the day to day details of this management shift have largely been in play behind the scenes for some time. Unlike the last time Schultz left the company that resulted in some misdirection, this time Schultz remains its Chairman, which should allow him to keep a steady read on the overall business.

Soon after that news, Starbucks hosted its biennial Investor Conference at which it presented its five-year strategic plan to grow revenue by 10 percent, EPS by 15-20 percent, and drive mid-single-digit comp growth each year. As part of that plan, it expects by 2021 to add 12,000 stores globally — to a total of 37,000 — while focusing on its Roasteries and Starbucks Reserve stores to elevate the Starbucks brand and customer experience. The company also shared that it will continue to innovate on mobile and expand the menu at its Starbucks store locations.

There is little question that Starbucks will continue to grow as it extends its global reach, particularly in China and other emerging economies. We do find it interesting that the once Affordable Luxury experience offered by Starbucks needs to be reinvested in the form of its Roasteries and Starbucks Reserve stores. That new experience bears further investigation and we’re up for the task. We do see the menu expansion as a positive development as it should help drive the food-beverage attach rate higher.

Finally, as the cold weather and holiday shopping intersect, we can expect long lines at many a Starbucks as consumers look to not only get warm but also plunk down their money for gift cards.

• With 25 percent upside to our $74 price target, we continue to rate SBUX shares a buy.

Under Armour (UAA)    Rise & Fall of the Middle Class

Before we get under way, a quick reminder that last week the ticker symbol for Under Armour’s Class A shares was changed to “UAA” from “UA” This was a little confusing in an unnecessary way, if you ask us, especially since not all quoting services updated the ticker information in a timely fashion last week. But that appears to be all sorted out now.

Despite that disruption, Under Armour shares rose more than 4 percent over the last week, following the positive reception for its recently announced deal with Major League Baseball. In recent quarters, the company has continued to expand its retail presence with Macy’s (M), Foot Locker (FL) and other brick-and-mortar retailers. Versace’s recent holiday mall walks (a holiday season staple) showed Under Armour’s footwear and apparel are clearly on display.

Also receiving some positive buzz last week was the company’s Under Armour Sportswear (UAS) line, which has launched several pop-up shop locations as a showcase. UAS designer Tim Coppens was also featured on the fashion blog Fashionista last week, which should help position UAS differently compared to Under Armour’s expanding athletic apparel and footwear line.

We’ll continue to monitor holiday shopping channel checks for sports apparel and footwear as well as gauge Under Armour’s efforts to bring new footwear and women’s products to market during this all-important season. Longer term, Under Armour is poised to grow its revenue and operating income as its initiatives (footwear, International, women’s and UAS) take hold.

• Our price target for UAA is $40, which offers attractive upside potential.

United Natural Foods (UNFI)    Food with Integrity

Last week, UNFI reported underwhelming quarterly results, largely due to the impact of food deflation, but the company maintained its outlook for the coming quarters. We’ll continue to monitor food deflation trends, but given the expected record corn crop, odds are that deflationary pressure will persist. The silver lining is it is driving consumers back to grocery stores and eating at home. This, of course, will pressure restaurant companies and an early look at 2017 from Fitch Ratings sees the pain continuing for restaurants as grocery spending remains on top.

With the ongoing shift toward natural, organics and “good for you foods” we continue to see United as a prime beneficiary. A recent report from Research and Markets forecasted the global market for organic food would grow at “a CAGR of over 14 percent during 2016-2021, on account of high demand for organic food.”

• We will continue to be patient with the shares as the company regains investor confidence after stubbing its toe during 2015, but we’ve trimmed our price target to $60 from $65.

Universal Display (OLED)     Disruptive Technologies

Universal Display shares catapulted 6.5 percent over the last week following a Wall Street Journal article that said, “Analysts widely expect the next iPhone to adopt a technology called organic light-emitting diode, at least for high-end versions. OLED displays, which are thinner, more flexible and give better contrast, will eventually replace the current liquid-crystal displays, or LCDs.”

Outside of Apple (AAPL) speculation, we continue to hear more reports of increasing industry capacity to meet rising demand from smartphone, TV and other markets that are set to adopt OLED technology. All of this points to improving demand for OLED technology, which bodes well for both the chemical and licensing business at Universal Display. We’ll continue to monitor OLED equipment order activity at Applied Materials (AMAT), Aixtron and Veeco Instruments (VECO) as well as new product announcements and OLED applications from consumer electronics companies at events such as CES 2017.

• Our price target is currently $68, however, based on the number of new products announced at the upcoming CES event in January, it could be revised higher.

The stock market continued to move higher over the last week, as oil sold off this week and we inch closer to what seems like an inevitable interest rate hike. As we wrote in this week’s Monday Morning Kickoff, the stock market increasingly looks to be ahead of itself and now we are starting to see the conversation regarding 2017 earnings expectations shift to one with an upward bias – analyst code for thinking expectations need to be raised – despite the fact that earnings for the S&P 500 have been flat for the last few years. Let’s remember, those 2017 expectations already call for an 11 percent increase and odds are the earliest we would see any Trump Bump to the economy would be in the second half of 2017.

Yep, it’s looking like the froth is getting a little thick, which is why we’re holding off from adding any new positions to the Tematica Select Investment List. But rest assured, we still have a packed issue this week as we provide updates on many of our positions — most of which have enjoyed the recent market rally — as well as a look inside at an internal debate we’ve been having as we discuss adding a new theme to the line up of our investing themes.

Updates, Updates, Updates

We recently added Facebook (FB) as our latest Connected Society investment theme pick as well as McCormick & Co. (MKC), which announced a nice increase in its annual dividend – just like we expected. While both have seen slight short-term setbacks, such retreats we see as an additional opportunity to get in on them if you haven’t already. We continue to rate both as a Buy. 

We’ve also started to see our Amazon (AMZN) and Alphabet (GOOGL) shares rebound – as we said recently, the thematic drivers remain very favorable for those two positions as well as Facebook and we’re going to be patient with all three. The same goes with Dycom Industries (DY) as network capacity issues are only going to get worse as streaming continues to overtake broadcast TV viewing as part of our Connected Society investing theme.

With a deal between CBS Corp. (CBS) and AT&T (T) that would bring the broadcaster’s content to AT&T’s new DIRECTV Now service — which by the way Tematica CIO Chris Versace is enjoying immensely — we continue to be bullish on AT&T shares. Our larger concern remains the uncertainty over AT&T’s acquisition of Time Warner (TWX), which through our thematic lens would transform AT&T into a Connected Society and a Content is King player. President-elect Trump was negative on the proposed merger during the campaign, calling it “an example of the power structure I am fighting.” Of course, we’ve already seen a difference between candidate Trump and President-elect Trump. Capitol Hill hearings on the proposed merger begin today, so we’ll continue to watch all of these developments as we collect on that enviable dividend stream given AT&T’s dividend yield of 5.0 percent.

Our Disney (DIS) positions have continued to rally and are up meaningfully from their summer lows. With the next Star Wars (Rouge One –  A Star Wars Story) installment set to drop at the end of next week — yes, the Tematica team will be there with a large tub of popcorn in hand! — it once again looks to be a very Star Wars Christmas toy season.

Finally, the industry chatter over Apple (AAPL) adopting organic light emitting diode (OLEDs) technology across its iPhones and iPads continues, but come CES 2017 — the big consumer electronic trade show — Sony (SNE) will be introducing its first OLEDs TV. As competitors like LG, Samsung and others look to bring their OLEDs TVs to market, industry capacity will need to expand. Good news for Universal Display’s (OLED) chemical and licensing business, that also happens to be good for our shares of this Disruptive Technology company.

While we know you can find the finer points for those companies in the Select List table that can be found on page 7, each of those companies remains a Buy at current levels. 

What does it take for an investing theme
to make the thematic cut?

One of the dangers that we’ve seen others make when attempting to look at the world thematically is they confuse a trend or a “flash in the pan” for a sustainable shift that forces companies to respond. Examples include exchange-traded funds (ETFs) that invest solely in smartphones, drones or battery technologies. To begin with, there aren’t enough publicly traded companies to fill out such a strategy, but the reality is those are beneficiaries of the thematic shift, not the shift itself. You would think for all the smart people running around Wall Street they would see this, but they don’t.

We’ve talked with several firms that are interested in incorporating Environmental, Social and Governance — or ESG — factors as part of their investment strategy. Some even have expressed the interest in developing an ETF based on an ESG strategy alone. While we can certainly understand the desire among socially conscious investors to ferret out companies that have adopted that strategy, we do not see it as a sustainable differentiator given that more and more companies are complying.

In other words, if everyone is doing it, it’s not a differentiating theme. Moreover, compliance to an ESG movement does not alter the long-term demand dynamics for a category, even if certain businesses enjoy a short-term surge in revenues.

For example, does the fact that Alphabet (GOOGL) targets using 100 percent renewable energy by 2018 alter the playing field or improve the competitive advantage of its core search and advertising business? Does it do either of those for YouTube?

The result is a trend that is likely to be medium-lived, if not short lived. Said another way, it looks to us to be more like an investing fad, rather than a pronounced thematic driver shift that has legs.

As you know we are constantly turning over data points, looking for confirmation for our thematic lens as well as early warning flags that a tailwind might be turning into a headwind. As we collect those data points, we mine the observations that bubble up to our frontal lobes and at times ask if perhaps we have a new investing theme on our hands. Sometimes the answer is yes, but more often than not, it’s a no.

Now you’re in for a treat! Some behind the scenes action if you will on how we think about new themes and why one may not make the cut…

On-Demand economy enough to become a new investing theme?

Recently we received a question from a subscriber asking if the number of “on-demand” services and business emerging were enough to substantiate the addition of a new investment theme to go along with the other 17 themes we currently track.

By on-demand, we’re talking about those services where you can rent a car (Lyft or Uber) or apartment (AirBnB) with the click of a button for only the time you need it. Or the many services that will deliver all the ingredients you need to prepare a gourmet meal in your own kitchen. We’re talking about things like Blue Apron or Hellofresh.

It was an interesting question because frankly, it’s something we have been debating at Tematica Research for quite some time. Ultimately, we came to the conclusion that the real driver behind the on-demand economy is businesses stepping into fill the void created by a combination of multiple themes, rather than a new theme in of itself. Here’s what we mean . . .

Take the meal kit delivery services like Blue Apron.

What’s driving the popularity of this service? We would argue that it’s not the fact that people like seeing their UPS driver more (although we do know many women that seem to have a thing for the brown shorts and socks). Rather it is the result of underlying movement towards more healthy and natural foods that omit chemicals and preservatives — something we have discussed as the driver behind the Foods with Integrity theme.

The key barrier to this movement towards healthier cooking that is Foods with Integrity is the amount of work it takes to cook such foods — the shopping, the measuring, the cutting and preparation time, not to mention the cost. In steps Blue Apron and consumers flock to it. So we see the meal delivery services as an enabler of Foods with Integrity rather than a theme itself.

There is also a clear element of the Connected Society investment theme behind these services, given how customers order the ingredients to prepare the meals – via an app or online – as well as Cashless Consumption given the method of payment does not involve cash or check. So we are clear, the primary theme at play here is Foods with Integrity, but we do like the added oomph from those other themes.

Let’s look at Uber, the on-demand private taxi service. 

We’re big users of the service, particularly when we are traveling, and we love the ease of use. We also like the payment experience — or the lack of an experience. We’re talking about having the ride fee automatically charged to our account. No cash, no credit card swiping or inserting, no awkward “how much do I tip?” moments. It’s our Cashless Consumption theme in all of its glory.

The big users of the Uber and Lyft services and the ones driving the firms’ valuations to stratospheric levels are the Millenials who are opting to just “Uber “ around town — it’s become a verb — or use a car-sharing service like a ZipCar (ZIP) or the like.

Sure, the Millenials have the reputation of being a more thrifty, frugal group compared to previous generations. But we have to wonder is it them being thrifty or just coming to grips with reality? With crushing costs of college and student loans, as well as stagnant wage growth and many young workers having to cobble together part-time and contractor jobs rather than a full-time salaried position, what choice do they have? So why buy a car and pay for it to sit there 75% of the time when you can just pay for it when you need it? We call that the Cash-strapped Consumer theme and many businesses have stepped into this void as part of what has become known as the “sharing economy.”

Finally, what is the underlying function of all these on-demand services?

As we mentioned earlier, it’s the ability to connect and customize the services through a smartphone app or desktop website, or from our thematic perspective, the Connected Society.

Now let’s tackle the headwind, which involves those companies that are not able to capitalize on the thematic tailwind. In many respects, it reminds us of how Dollar Shave Club beat Gillette, owned by Proctor & Gamble (PG), and Schlick, owned by Edgewell Personal Care (EPC), by addressing the pain point of the ever-increasing cost of razor blades with online shopping.

Boom! Cash-strapped Consumer meets Connected Society. While Gillette has flirted with its own online shave club, the price of its razor are still significantly higher and as far as we’ve been able to tell Schick has no such offering. As Dollar Shave Club grew and expanded its product set past razors to other personal care products, Unilever (UL) stepped in and snapped it up for $1 billion.

Going back to the beginning and the impact of the food delivery services like Blue Apron — are we likely to see food companies build their own online shopping network? Most likely not, but they are likely to partner with online grocery ordering from Kroger (KR) and other such food retailers. That still doesn’t address the shift toward healthy, prepared meals and it’s requiring a major rethink among Tyson Foods (TF), Campbell Soup (CPB), The Hershey Company (HSY), General Mills (GIS) and many others. Fortunately, we’ve seen thematic signals for many of those companies doing just that.

The key takeaway from all of this is a thematic tailwind can be thought of as a market shift that shapes and impacts consumer behavior, forcing companies to make fundamental changes to their businesses to succeed. If they don’t, or for some reason can’t, odds are their business will suffer as they fly straight into an oncoming headwind.

As thematic investors, we want to own those companies with a thematic tailwind at their back — or maybe even two or three! — and avoid those that either seem oblivious to the headwind or won’t be able to reposition themselves like a sailor looking to tac across a body of water to where the wind is blowing.

Of course, when it comes to these “On-Demand Economy” darlings — Uber, Dollar Shave Club, Airbnb —few if any of them have been publically traded, which frustrates us so, since most of them are tapping into more than one thematic tailwind at once. If and when they do turn to the public markets for some added capital and we get a look into the economics of these business models, then we’ll also get to see the key performance metrics and financials behind these businesses. One can only hope . .  .

We took our own advice and used the Thanksgiving holiday and the Black Friday shopping weekend to rest up and do some online shopping along the way. We even visited a couple of malls, gathering our first data point on what would end up being a record-setting online shopping weekend, given the ease of finding parking and the sparse crowds inside the stores.

As we shared in this week’s Monday Morning Kickoff, digital shopping blazed the consumer spending path over the last several days, firmly cementing the shift that is driving our Amazon (AMZN) shares as well as lending a helping hand to our Alphabet (GOOGL) shares.

Despite the late day fade in the market yesterday, week over week all the major market indices are once again higher, which means a deeper step into overbought territory for the majority of the market. There are opportunities to be had, including Facebook (FB)shares, which we’ve had in our Connected Society investing theme crosshairs for some time and in today’s issue we’re stepping into them.

Also in the following pages, we give an overview of AT&T’s (T) DirecTV Now service, which is available today, touch on what it means for Dycom (DY) and why we still think its shares are a buy. Recently added McCormick & Co. (MKC) made a nip and tuck acquisition, and we give you some flavor on it.

Before we let you get to the meat of the issue, over the coming weekend we have the Italian referendum vote coming up this weekend that could bring volatility back to the market next week.  We’ll be drilling down on it and most likely have newly added Tematica Chief Macro Strategist Lenore Hawkins share her views on it given that she lives in Italy.

Okay, let’s get to it…

Adding Connected Society Company Facebook to the Fold

We’ve long had our eye on Facebook (FB) as part of the Connected Society investing theme, a theme that focuses on the accelerating shift from analog to digital that is at the heart of our position in Alphabet (GOOGL), Amazon (AMZN) and AT&T (T) positions — for more on AT&T see below.

One would think we would have added Facebook earlier, but lofty price valuations have kept shares of the largest social networking player just beyond reach. Over the last few weeks, however, its shares have come under some pressure for a variety of reasons — including tough comparisons ahead, rising expenses, issues with Facebook’s video metrics, the post-election malaise for tech stocks and issues surrounding “fake news”.

We expect Facebook will successfully tackle the fake news issue — something that came to the forefront during the recent election cycle — as well as its video metrics problem based on the simple fact that advertising is a key revenue generator across its various platforms.

According to data from eMarketer, by the end of this year, U.S. digital ad spending will reach $72.09 billion, surpassing TV advertising spend ($71.29 billion) for the first time. This is not expected to be a blip, as digital advertising is forecasted to rise to $93 billion by 2018 vs. $74.5 billion for TV advertising.

Mobile and Video: Two key factors in that strength are critical areas for Facebook

Mobile ad spending is expected to grow 45 percent this year, reaching $45.95 billion, and by 2019 mobile ad spending is forecasted to account for more than one-third of total media spending. As we saw with the shift away from newspapers and magazines towards online and are once again seeing with the move to mobile, advertisers will go wherever the eyeballs are. Online video advertising won’t be a slouch either, as it grows to $10.3 billion this year, just over 14 percent of total digital spending, before taking additional share in 2017.

As this transition is underway, Facebook continues to roll out new products and services that should help it capture incremental advertising market share. We’ve already seen the company bring monetization efforts across Facebook and Instagram with great success, and similar monetization efforts coming to its Messenger app in the form of sponsored messages.

The company is also expanding its services to include live video messages on Instagram to compete with Snapchat and Twitter (TWTR), a free cross-platform video calling service for WhatsApp’s 1 billion users and a feature that would let page administrators create job postings and receive applications from candidates — a move that could pressure LinkedIn’s (LNKD) recruiting business, which recently agreed to be acquired by Microsoft Corp (MSFT). As these and other services become available, we suspect Facebook will look at new advertising and monetization models along the way.

Central to all of this is Facebook’s growing daily active user base (1.18 billion in the third quarter of 2016, up from 1.13 in 2Q 2016 and 1.0 billion in 3Q 2015), which is increasingly mobile in nature. Of the 1.18 billion users, roughly 15 percent are located in the U.S., 22 percent  in Europe, 31 percent  in Asia-Pacific and the balance in the company’s Rest of World category.

Now here is where it gets interesting 

Roughly half of Facebook’s revenue is generated in the U.S., with 16 to 22 percent derived from Europe and Asia-Pacific, each. What this tells us is that Facebook’s average revenue per user outside of the U.S. lags significantly compared to what it achieves in the U.S. To us, that is one of the key growth opportunities for Facebook, and in many ways mimics Amazon bringing its Prime offering to geographies outside the U.S. The great thing about Facebook targeting international revenue growth is that it is bound to be far less capital intensive than Amazon’s initiatives, and the strategy should be largely in sync with its mobile and video initiatives.

Progress by Facebook on its advertising/monetization strategies (especially video) and international revenue per user growth, and other opportunities that help grow its user base are behind the current revenue and EPS growth expectations, calling for continued revenue growth over the coming years. Consensus expectations have Facebook earning $4.12 per share this year, up from $2.28 per share in 2015. But the valuation story and bullish demeanor across the investment community for FB shares is really a 2017 to 2018 story. As Facebook continues to grow and improve its global monetization efforts, earnings expectations rise to $5.20 per share in 2017 and $6.55 per share in 2018.

Some quick math infers that over the 2015 to 2018 period, Facebook will grow its EPS to the tune of 42 percent on a compound annual growth rate basis. Even if we handicap those earnings expectations somewhat so that the compound annual growth rate is more like 25 percent to 30 percent, our $150 price target equates to a PEG ratio between 0.9 and 1.2 on 2017 EPS expectations, and a far more compelling 0.75 to 0.9 when looking at 2018.

To be fair, there are others with higher price targets for Facebook, like Goldman Sachs (GS) that  has published a $162 price target for the stock, but we’d prefer to see international advertising revenue growth in the coming quarters before getting a tad more aggressive in our valuation assumptions. As it is, Facebook’s recently announced $6 billion share repurchase that begins in 1Q 2017 has the potential to shrink the share count by around 2 percent near current share price levels, which should lend a helping hand when it comes to meeting those earnings expectations.

Bottomline on Facebook (FB)

• We are adding Facebook shares to the Tematica Select Investment List with a $150 price target, which offers 24 percent upside from current levels. 
• Because this is a new position, we are inclined to use any pullback near $105-$110 to scale into the position and improve our cost basis. 
• As such, we are holding off adding a protective stop loss recommendation at this time. 
• For subscribers looking for an ETF play for Facebook, we would suggest the First Trust Dow Jones Internet Index Fund (FDN).

Details Emerge on AT&T’s DirecTV Now Service and We Like It

Earlier this week Connected Society investment theme company AT&T (T) took the wraps off its much-discussed DirecTV Now video streaming service, which was first unveiled back in October. In many respects, it was a non-event event, given the prior unveiling. AT&T did, however, fill in a number of the missing pieces, including programming packages and the launch date.

With the previously missing details in hand, we have a better feel for the overall offering, which in our view should be rather attractive to potential cord-cutters that want to consume video where and when they want on whichever device they choose. This is something AT&T is counting on as it shores up its competitive offering (mobile, streaming) against Verizon (VZ), T-Mobile USA (TMUS) and Sprint (S), as well as potential mobile entrant Comcast (CMCSA) in an increasingly competitive mobile smartphone marketplace. In our view, this makes AT&T even more of a Connected Society company than before.

Over the coming months, investors such as ourselves will be watching DirecTV Now customer metrics to gauge not only the overall success of the services but what the potential impact could be on wireless capital spending in the coming quarters. Initial estimates call for AT&T to add 1.0 million subscribers in the first year, with others forecasting 3.0 million users by 2020. Helping spur initial demand, AT&T is making what appears to be a compelling promotional offering: 100 channels for $35/month, but only for a limited time (more on that below), which is likely to pull forward demand. This also means we’ll need to closely watch cancellations and churn metrics as well as new adds to gauge the true success of the offering.

We’ll watch these metrics with an eye to what it may mean for incremental network deployments to fill in capacity needs over the coming quarters as well as the next evolution in mobile technology that is 5G. As a quick reminder, 5G should not only offer far greater data speeds vs. 4G LTE networks but also bring improved network capacity as well. In our view, any such incremental deployments would bode well for our Dycom (DY) shares given that AT&T is its largest customer.

• Stepping back, the DirecTV Now service is but one step (granted, a medium-to-large one) in AT&T’s larger transformation. With the pending acquisition of Time Warner (TWX) still in motion — a transaction that we think will help transform AT&T into a connected content company, putting it in the same room as Disney (DIS) — we continue to have a $44 price target on T shares.

Here are the details that were shared at the DirecTV Now event this past Monday

DirecTV Now will debut on Wednesday, November 30, 2016, at prices ranging from $35 a month for over 60 channels to $70 for over 120 channels. The four programming packages include:

For a limited time, more than 100 channels will be available for $35 and anyone who signs up at this promotional price will be able to keep paying it until they cancel.

In addition to those packages, DirecTV Now users can also:

• Add premium services such as HBO and Cinemax for $5 per month.
• For $6 a month, viewers can also sign up for Fullscreen, a video service owned by Otter Media, a joint venture between AT&T and media company the Chernin Group. We’d note that AT&T is giving its wireless subscribers free access to Fullscreen for a year.
• AT&T is also rolling out FreeView, an ad-supported video service that gives viewers a taste of some on-demand DirecTV Now content for free.

Turning to the content, DirecTV Now will include content from Disney and ESPN, AMC Networks, Turner, Viacom, NBCUniversal, Fox, Discovery and Bloomberg, and continues to negotiate with CBS Corp. A better sense as to which channels are bundled into the different DirecTV Now packages can be seen in the below graphic.

Once the service goes live, potential users will be able to sign up for a 7-day free trial and download the app from either Apple’s (AAPL) App Store or Alphabet’s (GOOGL) Google Play. As previously announced, anyone who signs up for one month of prepaid access to DirecTV Now will receive a free Amazon (AMZN) Fire TV Stick with Alexa Voice Remote, while customers who pay for three months up front will get an Apple TV. Here’s a list of all the devices that will support DirecTV Now at launch:

• Amazon Fire TV and Fire TV Stick
• Android mobile devices and tablets
• iPhone, iPad and Apple TV
• Chromecast (Android at launch; iOS in 2017)
• Google Cast-enabled LeEco ecotvs and VIZIO SmartCast Displays
• Internet Explorer, Chrome and Safari web browsers

In 2017, the service is expected to expand to include Roku devices, Amazon Fire tablets and Samsung Smart TVs. From a device perspective, AT&T’s promotional activity could spur some upside unit demand this holiday season, but even so, those units are not likely to sway overall results at Amazon, Apple or Alphabet.

Even a new service such as this is bound to launch with some shortcomings and in this case, they include a total lack of a DVR feature, pausing of live video and access to local major networks like ABC, NBC and Fox outside of big cities. We expect new features and services over the coming months, much the way Amazon eventually allowed Amazon Prime subscribers to either stream or download video content for later viewing from its Prime Video service.

We’ll have more on DirecTV Now as Chris Versace is planning to beta the service as he contemplates removing not only the Verizon FiOS TV service to his home but becoming a true cord-cutter by axing his Verizon landline telephony service in exchange for increasing Internet speed and streaming services.

Mr. Versace could be running with scissors!

Still Bullish on Dycom (DY) Shares Following the Ground Hog Like Move Lower

Last Monday (Nov. 21) Dycom Industries (DY) reported better-than-expected bottom line results for its October quarter, but also offered several revisions to forward-looking expectations. Those revisions included the second cut to expected revenue from its Goodman acquisition and another customer, (which was not named but we suspect to be Google Fiber) that had “modified its plans” such that it would hit Dycom’s revenue over the coming quarters by $80 million.

The net effect of these two factors led Dycom’s backlog to fall to $5.2 billion at the end of October vs. $6 billion at the end of July. In after-market trading after the news, it was rather apparent Dycom shares were going to get hit and get hit hard when the market opened on Tuesday (Nov. 22), and that is exactly what happened. DY shares opened and fell to bottom at $70.60 in early market trading the next day.

All of that spun out of the company’s earnings press release as Dycom’s earnings conference got underway at 9 AM ET on Nov. 22. As usual, Dycom was rather forthcoming in breaking down its business during the quarter. Telco was 68.8 percent of revenue, cable 23 percent, facility locating 5.5 percent and electro and others 2.7 percent.

The key message was revenue from its top five customers — AT&T (T), CenturyLink (CTL), Comcast (CMCSA), Verizon (VZ), Windstream — which accounted for 75 percent of revenue in the quarter, rose 40 percent year over year. That does mean revenue contracted at other customers, which includes the revised expectation at Goodman as well as the now well- known issues at Google Fiber. We would note however during the quarter Dycom continued to win new mandates from its top customers

To put the impact of Google Fiber and Goodman into perspective, on a combined basis, they accounted for roughly 5 percent of expected revenue — not a small amount, but also not one that should drive a 20 percent pullback in the share price. Moreover, with multiyear capital spending plans to deploy gigabit fiber, expand cable footprints, enhance existing 4G LTE networks and deploy 5G ones being announced by key Dycom customers like CenturyLink, AT&T, and Comcast, we suspect the near-term is likely to be a bump in the road amid robust network spending over the next several years.

Added to all of this is the recent FCC approval by Verizon to take over XO Communications, which brings 20,000 route miles of intercity network crossing the U.S and Canada and 13,000 route miles of metro fiber to the company. For Verizon, the deal yields infrastructure for power future 5G gigabit wireless networks as well as incremental wireline expansion, both of which bode well for Dycom.

The bottom line is the move in DY shares last week was an over-reaction, given the size of the revenue adjustment and the longer-term opportunities to be had with its core customer base.

While it may be somewhat simplistic, over the coming quarters telecom and cable companies are going to expand existing networks and deploy new technologies to bring new revenue generation services to market. Perhaps the best example is AT&T’s DirectTV Now, which we covered above.

As we’ve seen in the past with new services like this as well as 3G and 4G networks, it all comes down to the quality and reliability of the network. Over the next few years, odds are some projects will speed up and others will get pushed back, but over the medium to longer-term, the buildout of those networks bodes very well for Dycom and its shares. There is also potential for incremental business with Google once it resumes its network buildout, be it with fiber or wireless technologies, which as we discussed in our initial piece on Dycom require wireline backhaul deployments.

During the conference call, we were reminded that Dycom has $100 million to repurchase shares under its current authorization, and the buyback window opens two days after earnings are released. We suspect the company will be putting that authorization to work near-term, and we would not be surprised to see another authorization emerge should Dycom exhaust the current one. Over the last 11 years, the company has bought back roughly 40 percent of the outstanding shares.

• We’ve seen EPS expectations lowered and subsequently price targets as well from more than $120 to in-line $100-$110 range, but we are also seeing DY shares defended, given its industry position and the expected network spending over the coming years. We certainly agree with the sentiment, but we too will trim our price target back to $105 from $115, which still offers substantial upside to be had over the coming quarters. 

McCormick Snaps Up An Italian Play

This week recently added McCormick & Co. (MKC) announced it was acquiring Florence, Italy-based Italian flavor manufacturer Enrico Giotti for $127 million in cash. Annual sales of the company’s beverage, sweet, savory and dairy flavor applications that include natural flavors, aromatic herbal extracts, and concentrated juices tally $56 million. That portfolio of products should be additive to McCormick’s Industrial food business and help expand its presence Europe.

This is a great example of the nip and tuck acquisitions that McCormick has been doing over the last several years as it strategically consolidates the fragmented flavor and spice industry. Granted the Enrico acquisition is not likely to move the McCormick needle dramatically, but over time it should be a solid contributor and McCormick leverages its products across its global platform.

• We continue to rate MKC shares a Buy with a $110 price target.

Tematica Select List Performance

Given the recent weakness in the share price, we are adding to our position in International Flavors & Fragrances (IFF) and setting a protective stop loss at $105.

Similarly, AT&T (T) shares have lagged the post-election move up in the market, and ahead of its Nov. 28 DirecTV Now event, we ’re scaling into the shares at current levels. As we do that, we’ll set a protective stop loss at $31 for T shares.

We are revisiting one of our favorite companies, extract, spice and marriage company McCormick & Co (MKC) with a Buy rating and a $110 price target. We will look to scale into the position should such an opportunity present itself in the mid-to-upper $80s. Because this is a new position, we are not issuing a recommended stop loss at this time.

From all of us here at Tematica, we wish a happy and flavorful Thanksgiving holiday. Send us your holiday shopping observations should you venture out on Black Friday, and be entered to win a free 1-year subscription to Tematica Investing — details inside.

We’re coming to you a tad earlier than usual this week, given the Thanksgiving holiday that historically has led to reduced trading volumes as Wall Street essentially takes a four day weekend before the final sprint to the end of the year.

Since the Wednesday after Election Day 2016, we ’ve seen a pronounced move higher in the domestic stock market, one that has favored growth as evidenced by the 10 percent move in the Russell 2000, compared to the 2.9 and 2.0 percent moves in the Dow Jones Industrial Average and the S&P 500 through last Friday, respectively. The Tematica Select Investment List has certainly benefitted with largest moves in Dycom Industries (DY), Universal Display (OLED), CalAmp (CAMP) and United Natural Foods (UNFI). As we wrote last week, despite those moves each of those remains a Buy at current levels as their respective thematic tailwinds — Connected Society, Disruptive Technologies and Foods with Integrity — remain intact.

As you know we tend to look at the world — both investing and the one we inhabit  — through our thematic lens, after all, it  ’s hard to outperform everyone when you think like everyone else. We are certainly aware of the sector-focused view used by most investors, and from time to time we have shared some interesting observations that crop up using that perspective. In the case of the post-election rally, the sector-based perspective shows the two real winners have been Financials and Industrials, which reflect expectations President-elect Trump’s will walk back financial regulations and rebuild the country’s crumbling infrastructure. If we had stuck with that outdated sector-based view, we would have missed the strong moves in the positions mentioned above as well as others — rest assured, we are not reverting to that herd strategy.

The other big mover over the last eight trading days has been the US dollar. As you can see in the chart to the right, the US dollar has reached its highest level in 13 years. The issue is that a strengthening dollar has negative implications for US companies that generate a significant part of their revenue from outside the US. This is nothing new as we encountered this throughout 2014 and into 2015 with company after company citing currency headwinds. Odds are this will be repeated in January and February when companies report 4Q 2016 results and offer their take on what’s to come in 2017. As we pointed out in this week’s Monday Morning Kickoff, consensus earnings expectations for the S&P 500 group of companies call for EPS growth of more than 12 percent in 2017 vs. 2016.

Would we love to see 12 percent EPS growth come to fruition?  

Absolutely!  But while our thematic lens does provide an alternative view of the landscape, it’s not an alternate reality, and as of now we question how those 500 companies will deliver that 12 percent growth based on the current global economic outlook. We’ll, of course, continue to watch the shifting landscape for signs that suggest that level of earnings growth could be possible — believe us, we hope we find them — but we’ll also be on the lookout for signs that pour cold water on those expectations.

Scaling into International Flavors & Fragrances & AT&T …

A few weeks ago, International Flavors & Fragrances (IFF) reported its September quarter results, which were hampered relative to expectations by product mix. During the quarter, IFF’s business mix was unfavorable as higher-margin businesses in both flavors (beverage) and fragrances (fine fragrances) were softer than expected, while volumes at lower-margin businesses — savory in flavors and fragrance ingredients — were better than expected.

As we mentioned previously, Coca-Cola (KO), PepsiCo (PEP) and other beverage manufacturers  are reformulating their offerings to reduce sugar content, but preserve flavor and taste. As these initiatives unfold, we see IFF’s mix swinging back, favoring higher-margin businesses in the coming quarters.

Our long-term view on IFF remains unchanged, as we see its near-oligopoly position in the flavors and fragrances industry benefiting from the Rise & Fall of the Middle-Class investment theme unfolding around the globe, as well as the growing consumer preference for natural and organic products that is leading IFF’s customers to reformat their products (an example of the Foods with Integrity theme).

As such, we are using the 11 percent fall off in IFF shares over the last three weeks to build out the position on the Tematica Select Investment List. As we do this, we’ll set a protective stop loss at $105.   

… and doing the same with AT&T 

Since the election results, AT&T (T) shares have lagged the overall market, climbing 1.5 percent compared to 2 percent for the S&P 500 — that’s despite the news that AT&T has bumped its annual dividend to $1.94 per share. At current levels, that equates to an enviable dividend yield of 4.9 percent — more than double the dividend yield of 2.1 percent for the S&P 500.

Last week, AT&T (T) shares climbed more than 2 percent as the Wall Street community warmed to the likely passage of the AT&T-Time Warner (TWX) merger. Details still need to be sorted out on the regulatory front, including the potential unloading of certain Time Warner TV channels and satellite dishes, which could eliminate a potential review by the FCC. We suspect AT&T is open to such options as it looks to transform its business to one that sits at the intersection of our Connected Society and Content is King investing themes.

On November 28, AT&T is holding an event in New York that will showcase its expected and much-discussed DirecTV Now streaming TV service. Some details have leaked already, including the $35 per month price point for 100 channels of content that includes HBO, Discovery, NBCUniversal, Turner, Viacom, Disney (including ESPN), AMC, Scripps, Starz, and more.

Because DirecTV Now will stream to wherever you are via your smartphone, tablet, or to your TV via a streaming device like Apple’s (AAPL) Apple TV or Amazon’s (AMZN) Fire Stick, AT&T expects this to be its “primary TV platform” by 2020. The big savings is tied up in the lack of required equipment, as it will utilize existing devices rather than hinge on a new set-top box. This cuts out all those monthly set-top box fees that we pay to companies like Verizon (VZ) and Comcast (CMCSA). To entice prospective customers, those who     commit to three months of the service will get a free Apple TV (worth $150), while those who pay for one month will receive an Amazon Fire TV Stick ($35).  That loud sound you are hearing is the millions of American’s cutting the proverbial cable chord in unison.

We expect more details to emerge at the event next Monday, and while reality could fall short of the hype at least on launch day, as we mentioned above, we see DirectTV Now jump-starting chord cutting. We here at Tematica are crunching the numbers ourselves to see if it warrants dumping the triple-play phone/internet/tv package, to a higher speed Internet-only package, with the DirectTV Now service running over the top of that internet connection and ditching the home phone altogether. The early numbers — and the fact that the only calls we receive at home are from telemarketers —suggest it could be a smart move.

We will continue to monitor Time Warner merger-related  developments, but ahead of next week’s media event, we are scaling into our AT&T (T) position at current levels. As we do this we are setting a protective stop loss of $31 on T shares.  We continue to have a Buy on T shares with a price target of $45.  

Bottomline on 
International Flavors & Fragrances (IFF) and AT&T (T)

• Using the 11 percent fall off in IFF shares to build out the position on the Tematica Select Investment List. As we do this, we’ll set a protective stop loss at $105.  
• Scaling into our AT&T (T) position at current levels. As we do this we are setting a protective stop loss of $31 on T shares.  We continue to have a Buy on T shares with a price target of $45.

Adding A Helping Flavor Of  Mccormick & Co. Shares

As we get ready for the holiday season — or as we like to say it here at Tematica “season’s eatings” — the one company that we can’t help but think of is the extract, spice and marinade as well as dividend dynamo company McCormick & Co. (MKC).

For those unfamiliarity with our “dividend dynamo” designation, it refers to a company with a pronounced track record of increasing its annual dividend. In the case of McCormick, it’s 2015 dividend increase marked its 30th and put its annual dividend at $1.72 per share run rate this year up from $0.66 per share in 2005.

Longtime subscribers will remember that we’ve owned shares of this company that sits at the intersection of our Cash-strapped Consumer and Rise & Fall of the Middle-Class investing themes before (August 2012 – September 2013 and January 2014 – January 2015) given the share price appreciation and steady dividend payments received.

Dividend income aside, these consistent year-over-year dividend increases tend to result in a step-like function higher in terms of the share price, even if the dividend yield metrics remain flat year over year. Historically, McCormick has announced its annual dividend increase in late November, but that is just one reason behind why we’re adding the shares.

The second reason for making the move on MKC now is the 15 percent pullback in the share price over the last several months. When we ’ve seen this before in late 2014 and 2014 it proved to be a smart time to buy the shares and warrants at a minimum further investigation, especially given the continued prospects for EPS growth to $4.45 per share in 2018, up from $3.48 per share in 2015. If those consensus expectations are hit it means McCormick will have nearly doubled its annual EPS from the $2.35 per share achieved in 2009, roughly a 6.5 percent compound annual earning growth rate over the 2009-2018 period.

Steady earnings growth has been a hallmark of McCormick and Co. due to its ability to augment its organic growth with strategic acquisitions, which have expanded both its product offering and its geographic footprint, primarily in the higher margin Consumer business. Historically, the Consumer segment accounts for approximately 60 percent of sales and 80 percent of operating income, and the industrial segment contributes roughly 40 percent of sales and 20 percent of operating income. From our perspective, this means the Consumer business is the one that drives the vast majority of profits, earnings and therefore the stock price.

It’s that consumer-facing business that most are familiar with given the  McCormick®, Lawry’s®, Stubb’s®, Club House®, Zatarain’s®, Thai Kitchen® and Simply Asia® brands. Approximately half of the Consumer segment is spices, herbs and seasonings and for those products, the company is the category leader in what is a rather fragmented industry. For example, in the US alone, there are more than more than 250 other brands of spices, herbs and seasonings with many having less than 3 percent market share. This suggests there are ample nip and tuck acquisition opportunities to be had by McCormick.
Recent acquisitions include:

• March 2015 — Brand Aromatics, a privately held company and a supplier of natural savory flavors, marinades, and broth and stock concentrates to the packaged food industry.
• May 2015 — Drogheria & Alimentari, a privately held company based in Italy, and a leader of that country’s spice and seasoning category that supplies both branded and private label products to consumers.
• August 2015 — One World Foods, Inc., owner of the Stubb’s brand of barbecue products, a privately held company located in Austin, Texas. Stubb’s is the leading premium barbecue sauce brand in the US. In addition to sauces, Stubb’s products include marinades, rubs and skillet sauces.
• April 2016 — Botanical Food Company, owner of the Gourmet Garden brand of packaged herbs, a privately held company based in Australia. Gourmet Garden is a global market leader in chilled convenient packaged herbs.

In our view, McCormick is certainly one, of it not the industry consolidator of choice, given its global footprint and enviable Consumer customer base that spans    grocery, mass merchandise, warehouse clubs, discount and drug stores, and e-commerce retailers. Odds are, whether you ’ve been at a Kroger (KR), Whole Foods (WFM), Wegman’s, Ralph’s, Stop & Shop, Harris Teeter, Safeway, Piggly Wiggly or some other grocery chain, you’ve bought or at least seen some of McCormick’s Consumer products.

The big question we hear about the McCormick customer base is if Wal-Mart (WMT) is a customer? It’s a great question given Wal-Mart’s position in the overall grocery industry, and yes Wal-mart is a customer. In fact, Wal-mart has been the largest customer for McCormick’s Consumer business, accounting for 11-12 percent of sales over the last several years. And for those wondering if you can order McCormick products through Amazon (AMZN), the answer is yes.

While we tend to focus on McCormick’s Consumer business benefitting from our Rise & Fall of the Middle-Class and Cash-strapped Consumer investing themes, it’s also receiving a hefty tailwind from our Food with Integrity investing theme as well, as people focus on healthier food choices, which often favor natural ingredients and eating at home. The current bout of food deflation has spurred a return to consumers eating at home, and we ’ve heard this from Kroger, Costco and others over the last few months.

We’ve also witnessed the falling restaurant traffic and sales trends over the last several months in the Miller Pulse Restaurant Survey data published by the Nation’s Restaurant News. One of the key reasons for this weakness is the “wide price gap between grocers and restaurants remains a major factor in this year’s depressed same-store sales at restaurant chains.” While this is likely weighing on McCormick’s lower margin Industrial business, this shift is extremely positive for McCormick as consumers increasingly look for not only healthier but more flavorful meals.

With that mention, let’s take a look at McCormick’s Industrial business, which provides a wide range of products,  including seasoning blends, spices and herbs, condiments, coating systems and compound flavors. The key customer for this business is PepsiCo (PEP),which accounted for roughly 11 percent of sales over the last few years. Much like the Consumer business, McCormick’s Industrial business is benefitting from its customer base focusing on meeting growing consumer demand for organic flavors, non-GMO products, and “on-trend” flavors, as well as  healthier snacking foods. We’ve mentioned this as a positive for International Flavors & Fragrances (IFF) and the same holds for McCormick’s business as well.

Several years ago, MKC management targeted expanding the company ’s presence in the emerging markets to capitalize on rising disposable incomes. This has led to continued growth in the non-US business, which has come to account for 40-45 percent of sales depending on the quarter. What this means is, aside from the overall business dynamics that tend to focus on shifting consumer preferences and the benefits associated with rising incomes in the emerging markets, we have to be mindful of US dollar strength and the impact of foreign currency translation. Much as we do with Costco Wholesale (COST), we’ll focus on metrics adjusted for currency in order to better gauge volume demand.

We are issuing a Buy on MKC shares with a $110 price target, which offers upside of just over 21 percent before factoring in the company’s dividend yield that has ranged between 1.8 to 2.2 percent on a consistent basis over the last few years.  Based on a “ high” dividend yield that coincides with annual stock price lows over the last few years, we see potential downside in the shares to $83, roughly 9 percent below the current share price.

With $600 million left on the company’s current share repurchase authorization, we suspect the likelihood of seeing the shares fall to that level on a sustained basis to be rather low. Year to date, McCormick has generated $322 million on operating cash flow, which should help fund that repurchase program as well as another divided boost in our view.

Bottomline on 
McCormick & Co. (MKC) 

Given that likelihood combined with several thematic tailwinds at the company’s back and the simple fact that we are in the sweet spot of the core Consumer business at a time when more people are opting to eat at home, we are adding MKC shares to the Tematica Select Stock & ETF List. 

We will look to scale into the position should such an opportunity present itself in the mid-to-upper $80s. 

Because this is a new position, we are not issuing a recommended stop loss at this time. 

An ETF Option for MKC Exposure 

For subscribers looking for an ETF with meaningful exposure to MKC shares, the PowerShares DWA Consumer Staples Momentum Portfolio (PSL) has the greatest exposure at 3.6 percent of its assets. That position puts MKC share behind Altria Group (MO), Church & Dwight (CHD), Reynolds America (RAI) and several other positions.

To us, that stake falls short of really influencing the ETF as the top six holdings account for more than 25 percent of PSL’s assets. As such, we are not adding PSL shares to the Tematica Select Investment List.

In a perfect world, we would have an ETF that contained both MKC and IFF shares, but alas at least for now there isn’t one.

Win a chance to extend your subscription

From all of us here at Tematica, we wish a happy and flavorful Thanksgiving holiday. If you’re inclined to venture forth during Black Friday, be sure to let us know what you’re seeing out there. What stores are heavy with traffic? Which shopping bags are you seeing? We’ll be making our own store and mall walks, but we’d love to hear from you. So much so that, we’re having our first Tematica contest.

All subscribers that email in their holiday shopping observations to customerservice@tematicaresearch.com will be eligible to win a free 1-year addition to their Tematica Investing subscription.

Send us an email with the details of what you’re seeing — the packed stores as well as the empty ones — along with a photo or two and we’ll choose one lucky winner at random.

Our tip, follow the money and bags.

It’s been quite a week for the US stock market 

The Dow Jones Industrial Average climbed nearly 5.8 percent over the last week, placing it firmly in overbought territory. Both the Nasdaq Composite Index and the S&P 500, our preferred benchmark for the domestic stock market, rose roughly 4.5 percent.

While those two indices remain out of overbought status, the small-cap heavy Russell 2000 Index is overbought after having climbed just under 9 percent over the last five days. Those are quite pronounced moves in a rather short period of time, and the likelihood the market gives some of those gains back is better than 50/50.

In the Tematica Investment Select List, we saw several positions move substantially higher over the last week, including Universal Display (OLED),  United Natural Foods (UNFI), and Dycom Industries (DY) as well as nice rebounds in CalAmp (CAMP) and AMN Healthcare (AMN). We continue to see further upside ahead for each of those positions given the strength of their respective thematic tailwinds — Disruptive Technologies, Food with Integrity, Connected Society and Aging of the Population — but in some cases, we’re revisiting the notion of adding protective stop losses. That thought reflects the likelihood the overall market could cool off and move lower (worst case) or trade sideways (better, but less likely).

The pronounced upward moves in those positions over the last week were mitigated by further softness in International Flavors & Fragrance (IFF), which we chalk up to investor concern over a President-elect Trump sparked trade war, and declines at both Amazon (AMZN) and Alphabet (GOOGL). As you’ll see below, the outlook for AMZN and GOOGL shares remain bright as there is no slowdown in sight for the drivers of our Connected Society investing theme.

Heading into Holiday Sales, October Retail Sales Bode Well for Amazon and Alphabet

Yesterday we received the October Retail Sales Report, which saw the headline Retail Sales figure as well as the Retail Sales Ex-Auto come in better than expected for the month.

Reported Retail Sales for October registered a gain of 0.8 percent, beating expectations for a 0.6 percent improvement, while Retail Sales Ex-Auto for October rose 0.8 percent, outpacing expectations for 0.5 percent. Compared to October 2015, retail strength was registered at Nonstore Retailers (+12.9 percent), Health & Personal Care Stores (+8.3 percent), Building Material & Garden (+6.5 percent), which outpaced overall Retail Sales gains of +4.3 percent (+4.0 percent if we exclude autos). The two categories that continued to post year over year declines in sales were Department Stores (-7.3 percent) and Electronics & Appliance Stores (-4 percent).

Our take on the above — and juxtaposing the performance of Nonstore Retail vs. Department Stores and Electronics & Appliances — is it’s another data point for the accelerating shift toward digital commerce at the expense of brick & mortar. If we look at the trailing 3-month period that is August 2016-October 2016 vs. the August 2015-October 2015 period we see NonStore Retail Sales rose more than 12 percent year-over-year vs. declines of 6.7 percent and 4.3 percent for Department Stores and Electronics & Appliances, respectively.

We see this as not only confirming for our Connected Society investing theme, but also the Amazon (AMZN) and Alphabet (GOOGL) shares that are on the Tematica Investing Select List. Whiles the shares of both companies have gotten a little banged up since the Election Day 2016, we see these companies as prime beneficiaries from not only the shift to digital commerce, but also digital content consumption and streaming services and to a lesser extent our Cashless Consumption investing theme.

With no slowdown in sight for those thematic drivers, we continue to rate AMZN and GOOGL shares a Buy with a price target of $975 for both stocks.

An ETF to Target the Connected Society Thematic

Over the last several weeks, we’ve been reaching out to subscribers and we’ve heard from more than a few that they would like ETF options as well as individual stock picks. We’re happy to oblige, provided we can suss out the right ETF, which in our view means it’s benefitting from the same thematic tailwind and has enough upside to be had that allows us to get behind the shares. Our subscriber conversations also led to something else that we’ll share with you in a few paragraphs.

In this instance, the ETF that we are adding to the Tematica Investing Select List is PowerShares NASDAQ Internet Portfolio ETF (PNQI), which closed last night at $83.14. For an ETF that invests in companies like Amazon, Alphabet, and Facebook (FB) as well as Baidu (BIDU) and Priceline (PCLN) among its top holdings, it’s well off its 52-week high.

Much like AMZN, GOOGL and FB shares, PNQI shares have come under pressure over the last week, but the thematic tailwind behind its core holdings — the Connected Society — remains intact.

See PNQI Top 10 Holdings

Bottomline on
POWERSHARES NASDAQ INTERNET ETF (PNQI) 

• We are adding PNQI shares to the Select List with a price target of $90. 
• Because this is a new position, we’re inclined to use additional weakness in the shares to build out our position size. 

A Quick Word on Costco Wholesale (COST)

As expected the October Retail Sales Report showed a -0.7 percent decline in General Merchandise Stores, which compares to the 4 percent sales increase Costco reported for October. We continue to see Costco taking consumer wallet share this holiday season with its high margin membership revenue improving as it opens additional warehouse locations and benefits from renewed credit card marketing efforts.

We continue to rate COST shares a Buy with a $170 price target. 

After canvassing several ETFs, there are few that have any meaningful exposure to COST shares — the largest is Consumer Staples Select Sector SPDR Fund (XLP) at 3.87 percent of assets. While some may consider that enough to “give it a go” we find such a recommendation rather contrived, and we’ve seen too many folks make those kinds of recommendations and rarely seen them work out well. We’ll pass on that “opportunity.

This brings us to the other revelation from our subscriber conversations. 

In addition to the thematic lens through which we view the investing world as well as the larger world around us, they like new stock ideas. Especially ones that aren’t exactly mainstream ones like current holdings United Natural Foods (UNFI), Dycom Industries (DY) and CalAmp Corp. (CAMP), as well as past positions in American Water Works (AWK), USA Technologies (USAT), Pilgrim’s Pride (PPC) and Measurement Specialties.

We hear you and from here on out, we will be sharing two new stocks per month with subscribers, and more detailed portfolio updates once per month. Should there be a big move in position during the week, rest assured we’ll address it as well as what we’ll be doing about it. In breaking down each of the two new stocks per month, each will have at least one of our thematic tailwinds at its back, however, depending on the upside in the stock price and other factors the shares could wind up on the Select List to take an immediate position or the Contender List where we’ll continue to watch for the right time to make a move. We’ll kick this off next week.

The Restaurant-Grocery Inflation Gap Is Driving A Pick Up In Restaurant Bankruptcies

We’ve long said that thematic data points can be easily observed in the world around us in our day to day lives. Some are more obvious, and others need to be noodled on, but those data points are there and we are not only looking for them but listening to what they have to tell us as well. Here’s an example:

For its September 2016 quarter, Sonic Corp. (SONC), the largest chain of drive-in restaurants in the US, reported its same-store sales decreased 2.0 percent year over year, with a 1.8 percent same-store sales decrease at franchise drive-ins and a decrease of 3.0 percent at company drive-ins.

Similar year on year declines have been reported at Red Robin Gourmet Burgers (RRGB), which experienced a 3.6 percent fall in same store comp sales year over and Chipotle Mexican Grill (CMG), which continues to be impacted by its E.Coli crisis several quarters ago. Despite that lingering crisis impact, Chipotle’s 3Q 2016 monthly comps were as follows:

• July down 23.8 percent
• August down 21.7 percent
• September down 20.1 percent

Despite the kick-off of the new National Football League season, even Buffalo Wild Wings (BWLD) reported a 1.8 percent drop in same-store sales for the September quarter.

Pulling the lens back, we find that these year-over-year declines are far more pervasive than at just these three companies. Per Black Box Intelligence, same-store restaurant sales were negative for the fourth consecutive month in September, with a drop of 1.1 percent. All told, for 3Q 2016 at -1.0 percent same-store sales growth and -3.4 percent in traffic, was the weakest quarter since the second quarter of 2010.

Casual-dining traffic has fallen for each of the past 14 months, according to data from the MillerPulse index. And it has fallen at least 2.3 percent in each of the past five.

The question is why restaurants are taking it so hard on the chin during a time of lower unemployment and modestly better wages… at least according to the official government statistics?

The answer can be found in the restaurant-grocery inflation gap. Over the past year, restaurant prices have increased 2.4 percent, according to federal data, while grocery prices have fallen 2.2 percent on average. There are far greater price declines found in the grocery store, like those for meat, which have fallen 6.3 percent over the last year.

“The gaps are widest it’s been in the last 15 years. But the environment is somewhat anomalous in that food deflation is not coinciding with the recession or at least not a consumer recession. In the immediate term, our view is that this deflation is impacting consumer buying patterns and channel preferences, but it’s also heightening the depth and frequency of competitive activity as well as consumer sensitivity to discounting. And this persistent upward pressure on labor costs, in our view, will continue to make this environment that much more difficult to manage in the near-term… We need to cycle through the next six months of commodity deflation and difficult comparisons.”

J. Clifford Hudson, Sonic Corp (SONC)
October 24, 2016

“Wage for sure, right, I think we’re operating in an environment Jeff where wage inflation is the reality, it’s the biggest source of inflation in our industry, it’s certainly the biggest source of inflation in our P&L and it’s unprecedented. Again, I think if we had 5 percent food cost inflation, everyone would be kind of really flipping out, but 5 percent labor inflation is significant.”

– Michael J. Bufano, Panera Bread Co. (PNRA)
October 26, 2016

The cold hard reality that restaurants are dealing with is despite lower input costs, higher labor and benefit costs, are resulting in higher prices that has consumers voting with their feet to eat more at home to take advantage of lower food prices.

Why is this important?

Thus far in 2016, more than 8 restaurant chains repressing a dozen chains have filed for bankruptcy including — Logan’s Roadhouse, Fox & Hound, Champps, Bailey’s, Old Country Buffet, HomeTown Buffet, Ryan’s, Johnny Carino’s, Quaker Steak & Lube, Zio’s Italian Kitchen, Black-eyed Pea, Cosí, and Don Pablo’s Mexican Kitchen among others.

This wave of bankruptcies is largely due to a decline in sales at restaurant chains that is particularly harmful to companies that are already walking a balance-sheet tightrope. These bankruptcies have led to job losses in the domestic economy, and with the odds high that more bankruptcies are likely to be had, it means more job losses. According to the National Restaurant Association (NRA), the restaurant industry employs 14.4 million people in the US and is expected to create another 1.7 million jobs by 2026. Perhaps the National Restaurant Association may need to recast those figures as we head into 2017.

The Thematic Bottom Line

We continue to receive data points that reveal continued weakening of restaurant traffic as consumers take advantage of food price deflation to return to grocery stores and eating in. This bodes well for United Natural Natural Food’s (UNFI) expanding footprint as consumers continue to shift toward natural, organic and similar products.

Even after climbing more than 16 percent over the last week, we continue to rate UNFI shares a Buy and our price target remains $65. 

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Markets are in tumult today because the degree of confidence in estimating the difference between candidate Trump and President Trump is larger than for any other presidential candidate in modern history.

You would have to have been stuck under a very large rock if you’re just getting the news that Candidate Donald Trump has become President-Elect Trump.

Late into the night, as the pundits analyzed and poured over election results that showed Trump pulling ahead of Secretary Clinton, we quickly saw domestic futures fall, the Mexican peso drop and international markets crumble on the realization that Trump was poised to upset polls and other expectations to win the 2016 election. At one point in the wee early hours of the morning, when it became clear that Clinton would have to sweep all seven outstanding states to get to the 270 electoral votes, Dow Jones Futures were down more than 800 points with the S&P 500 futures off more than 4.5 percent.

Since that point, as Hillary Clinton conceded the election, President-elect Trump gave an acceptance speech that included: “We have a great economic plan. We will double our growth and have the strongest economy anywhere in the world. At the same time, we will get along with all other nations willing to get along with us. We will be. We will have great relationships. We expect to have great, great relationships.”

Those comments combined with his conciliatory tone towards his Hillary Clinton, commenting on how the United States owes her a debt of gratitude, and his request that those who did not support him now offer him their advice, helped calm the market as Dow Futures “recovered” to be down “just” 345 points around 7:30 AM with S&P futures down 2 percent and Nasdaq futures down 2.4 percent.

As I shared with Larry King on RT’s election coverage last night, the market had expected Secretary Clinton to win the election and the aftermarket sell-off last night and still this morning reflects the uncertainty over exactly what a Trump White House will mean on a number of fronts. Pretty much, “Holy cow! Trump did it. Now what?”

Looking at the electoral map, one has to think that after 10 years of stagnant jobs, wages and economic growth amid crushing debt, Americans decided to take a chance on the outsider . . . try something different.

In all fairness, this is also a return to the norm we’ve seen in American elections whereby a president who terms-out is replaced by the opposing party’s candidate and that opposing candidate often gets more House and Senate seats. Despite all the commentary to the contrary, American still appears to swing back and forth across the center.

As we all know the stock market and the economy abhor uncertainty, and at least for now the Trump win is going to raise more questions than provide answers concerning policy, trade, healthcare reform, tax rates and the like. Like a deer in the headlights that is unsure if that approaching car will swerve or not, so too is the market looking to see just how much Candidate Trump and President Trump differ.

Whenever the market is faced with such an unknown, and this is a fairly big one that will chart the course over the next four years, it defaults to shoot first and ask questions later. More often than not, and with hindsight being 20/20, turmoil such as this tends to result in a buying opportunity, especially for patient investors. We saw this following the Brexit vote, which was also very much unexpected.

What this calls for is calmer heads, and that’s exactly what we aim to be this morning and over the coming weeks as more details emerge from President-elect Trump on what his policies will be, who will fill out his cabinet, and just what his relationship will be with the Federal Reserve, given his attacks on Chairwoman Janet Yellen. As those details emerge, odds are the market will start to recover. This should give us some opportunity to scale into well-positioned companies, as well as add new ones at better prices than we’ve seen over the last several weeks.
Will it be smooth sailing? Not likely.

Until Trump spells out his policies in detail and even then, there is bound to be some indigestion. That will require some patience. Markets are in tumult today because the degree of confidence in estimating the difference between candidate Trump and President Trump is larger than for any other presidential candidate in modern history. The markets reaction hasn’t been because the consensus view is that Trump will be bad for the economy and for stocks, but rather because uncertainty mean companies postpone investments until they have a clearer view into the future.

With that, let us take a look at the likely impact of candidate Trump.

• Pharmaceutical stocks will breathe a sigh of relief after the shellacking they have taken under candidate Clinton and Sanders. Overnight shares of Mylan (MYL) and Pfizer (PFE), two of the largest drugmakers in the US rose more than 6 percent in pre-market trading. Even overseas drug companies such asGlaxoSmithKline (GSK) and Sanofi (SNY) were up around 3 percent on the news of a Trump victory.
• Hospital stocks will likely get hit, as the combination of a Trump presidency and a full Republican sweep of Congress means the Affordable Care Act has little chance of survival. This will likely be bullish for pharma, but bearish for hospitals.
• In pre-market trading gunmakers Sturm Ruger & Company (RGR) rose 5.6 percent and Smith and Wesson (SWHC) gained just under 7 percent.
• The Mexican Peso fell to record lows, suffering its worst fall since the Tequila Crisis of 1994. The jury is still out on that wall.
• Non-American industrial/manufacturing companies are getting hit hard as are global transports such as shipping giant AP Moller-Maersk based on candidate Trump’s promise for protectionist policy-making. Auto manufacturers such as Daimler (DDAIY), BMW (BMWYY), Volkswagen (VLKAY), Toyota (TM) and Mazda (MZDAF) were down between 3 percent and 9 percent earlier this morning.
• Global banking is taking a hit as well. Given the US accounts for around one-quarter of world GDP, a move towards protectionist policies could further dampen already weak global trade, which would further weaken a weak global economy, putting further strain on banks that are struggling to cope with the level of non-performing loans.
• Oil companies are likely to have a much friendlier White House and Congress, but with today’s depressed prices, that isn’t likely to have a major impact immediately as the price of oil isn’t exactly supply-constrained at the moment.
• Green energy stocks like SunPower Corp. (SPWR) are likely to take some hits as a Trump presidency is not nearly as green-friendly as candidate Clinton.
• Defense-sector companies, such as Lockheed Martin (LMT) and Northrop Grumman (NOC), will likely see a serious boost as candidate Trump campaigned for 90,000 new soldiers and 75 new ships.
• Infrastructure spending is likely to get a boost from fiscal stimulus, which is a tailwind for companies such as Caterpillar (CAT), Terex Corp. (TEX) and Granite Construction (GVA), but the impact on those companies’ bottom line isn’t exactly straightforward when we combine that impact with the potential for trade wars given candidate Trump’s protectionist promises.
• Emerging markets, which are all near recent highs, will likely take hits if candidate Trump was representative of President Trump’s protectionist policies.
• Gold and the safety trades are likely to do well as investors flee risk assets until the dust settles and we get a better grasp on just who President Trump will be.

Finally, if President Trump is anything like candidate Trump when it comes to speak first, clarify later, increased volatility is here for the duration.
One of the questions that is bound to jump into the limelight is what does the Trump win mean for the likelihood the Fed raises interest rates come December? 

While the Fed signaled in its October FOMC statement that it would likely raise rates come December, the October Employment Report missed the mark and raised some doubts. With Trump yet to provide line by line, point by point policies, we suspect the Fed will take a pass once again come December, pushing the potential rate hike timetable out to its March 14-15, 2017 meeting. That meeting is well after Inauguration Day  (Jan. 20, 2017) and leaves a window for President Trump to share his plans. Up until last night, the market had been pricing in a December rate hike, and the realization this is likely to be once again pushed back is likely to be met with welcome arms from investors.

Now to roll up our sleeves and get back to work.

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Getting Ready for Walt Disney Earnings on Thursday

As earnings season starts to slow, we still have a few laggards to report their quarterly earnings. One of those is Content is King thematic player The Walt Disney Company (DIS) and it will be doing so tomorrow (Thursday, November 10) after the market close. Consensus expectations are for Disney to deliver EPS of $1.16 on revenue of $13.5 billion for the September quarter and EPS of $1.61 on revenue of $15.75 billion for the December quarter.

Over the last several weeks, the stock has been relatively catalyst free, but that changed this past weekend when Marvel’s Dr. Strange put a whammy on the box office as the #1 film. On the earnings conference call, we expect a review and update from Disney management on its film slate for the coming quarters, which feature a number of Marvel, Pixar and Lucasfilm properties.

In the company’s earnings report, we expect ESPN to once again be a hot topic given reports that declines in subscriber numbers have picked up. Odds are Disney will counter with its participation in DirecTV Now and Hulu’s soon-to-be-launched streaming TV service, both of which are expected to include ESPN.

Even after accounting for continued ESPN-related issues vs. the company’s rich slate of films on tap in the coming months that will drive its other business units, we find the current discount on the shares to be excessive. Last night the shares closed at 15.6xexpected 2017 EPS of $6.04, which is well below its three- and five-year average multiples of 19x to 20x. Wall Street would have to cut its 2017 outlook to something like $4.85 per share for the current share price to trade in line with historic multiples, and the odds of that are rather low given the strength of Disney’s non-ESPN businesses.

Given the lack of movement in expectations for the September and December quarters over the last few weeks, we suspect analysts covering the stock are likely to revisit their forecasts to update their ESPN-related assumptions, which is likely to pressure DIS shares. Should this be the case, it’s likely we could see institutional investors return to the stock ahead of the holiday season, which includes the release of the new animated film Moana, just ahead of the next installation in the Star Wars franchise Rogue One.

We are inclined to be patient with Disney as we consider it THE Content Is Kingcompany, with its international efforts propelled by rising disposable incomes and a brand-conscious rising middle class. We also see Disney making the right investments (streaming media and turning studio content into park rides, attractions, and high margin licensed products) to drive revenue and profits.

Ahead of Thursday’s earning call, our price target on DIS shares remains $115.

AMN Healthcare Services (AMN) Aging of the Population

Amid a ticker symbol change snafu last week (See last week’ issue for details), AMN reported better- than-expected September-quarter earnings due to the continuing fundamental strength in demand for nurses and other health-care professionals. AMN shares came under pressure following company guidance for an increase in interest expense due to its recent debt offering (we’re not sure how analysts who cover the shares missed this) and the expiration of R&D tax credits that will drive the company’s tax rate higher.

As the market digests the re-jiggering of EPS estimates and trimming of price targets, AMN management will be at the SunTrust Financial Technology, Business & Government Services Conference on Thursday (Nov. 10) and the Stifel Healthcare Conference next week (Nov. 16). We expect the team will talk about the long-term prospects and favorable dynamics driving AMN’s business.

By 2020 the U.S. will require 1.6 million more direct-care workers than in 2010, which equates to a 48 percent increase for nursing, home-health and personal-care aides over the decade. This shortage is expected to get worse near term, as the 78 million aging baby boomers (roughly 24 percent of the domestic population) will require increasingly more health-care services.

In response to the re-cut in earnings expectations, we are trimming our price target to $43 from $47, but that still offers more than enough upside to keep a Buy on the shares. With the Trump win, healthcare related stocks are bound to get hit, as such we would recommend subscriber wait at least a day or two before using near-term weakness for long-term gains. 

Costco Wholesale (COST) Cash-strapped Consumer

Despite reporting last week better-than-expected net sales and same-store sales for October, Costco shares traded off modestly over the last several days. From our perspective, the pullback has put COST back in oversold territory and offers subscribers that are underweight in the shares a buying opportunity — we would be taking advantage of this opportunity ourselves if we were not already overweight relative to the overall portfolio.

The last time the stock was at these levels was last May, which turned out to be a solid buying opportunity as the company continued to take consumer wallet share.

As we head into the holiday shopping season, we see that continuing as Costco benefits from a growing number of warehouse locations. As we’ve pointed out to subscribers previously, Costco opened two new locations in October and is poised to add several others before the end of the year. In our view, these additional units bode well for membership growth and high-margin fees as well as retail sales growth.

Bolstering those fees, last month Costco increased annual membership fees by about 10 percent in three Asia locations — Taiwan, Korea and Japan — as well as in Mexico and the U.K. We see Costco gaining share in the shopping-heavy second half of the year, with potential benefits from co-branded Costco card marketing. Also, any domestic membership price hike in the coming months would aid margins in 2017.

Based on the potential upside to our $170 price target, we continue to have a Buy on COST shares.

Dycom Industries (DY) Connected Society

This earnings season there have been a number of positive data points for Dycom Industries (DY), which has come from rising network capital spending at mobile carriers and cable providers. Its top four customers, which account for 64 percent of revenue, grew their combined 3Q 2016 capex by 9 percent sequentially, which was better than consensus expectations that had called for a sequential dip.

Another leading indicator, Corning (GLW), witnessed strong demand in the fiber to the home market in North America and expects this positive trend to continue. While capital spending and related deployments can be lumpy, we see the ongoing shift toward the digital lifestyle straining network capacity, forcing incremental spending on existing networks and the deployment of newer, higher-speed ones.

On the housekeeping front, later this month (Nov. 23) Dycom will hold its annual shareholders meeting. We’ll be sure to mark our calendars amid what is likely to be the usual Thanksgiving chaos.

We rate DY shares a Buy with a $115 price target.

United Natural Foods (UNFI) Food with Integrity

Last week, Whole Foods Market (WFM), a key United Natural Foods (UNFI)customer, reported it’s September-quarter results. For its September quarter, Whole Foods’ revenue of $3.5 billion was in line with expectations, despite same-store comps coming in down 2.6 percent versus the comparable quarter, on consensus of a 2.1 percent drop.

We attribute the discrepancy to Whole Foods experiencing less price deflation due to the contract nature of its organic/natural products like fish and other proteins, as well as eggs, which have seen sharp price declines over the last several months. Given the nature of UNFI’s meat and cheese products, we see this as a positive.

On the follow-up earnings conference call, the Whole Foods management team shared the following:

“if you look across the quintile data for the baskets, every single basket was moving up. And so what that says is that there’s some real stability here. And particularly in the $100 basket, it’s showing some nice growth.”

While some subscribers are likely to think that backs up Whole Foods’s nickname of “Whole Paycheck,” it tells us that underlying demand for natural and organic products remains firm — another positive for UNFI.

The larger issue for Whole Foods, in our view, remains the increasingly competitive landscape. The management team called this out on the earnings call:

“…you not only have strong conventional supermarkets like Kroger (KR) and H-E-B and Wegmans, but you’ve also now got more of the discount natural food operators, like Sprouts Farmers Market (SAFM) and Fresh Thyme and Lucky’s, and they’re all growing. And then you’ve got more delivery fresh stuff like Amazon (AMZN), and then you’ve got these meal-kit operators like Blue Apron and HelloFresh and Plated.”

We see this as confirmation of the shifting consumer preference to natural, organic and other lifestyle products. With shelf space at a premium, grocery stores are only likely to stock those items that it knows consumers prefer. And those alternatives to WFM, like Blue Apron and HelloFresh? Those are potential customers for UNFI, as is Amazon as it continues to expand its Amazon Fresh home grocery delivery service.

We’ve tried that latest service from Amazon, and we have to say we are impressed, not only with the prices but with the quality of the fruit and produce.

In our view, these are simply more positives for UNFI shares. We continue to rate the shares a Buy with a $65 price target.

Universal Display (OLED) Disruptive Technology

Shares of this organic light emitting diode (OLEDs) chemical and licensing company rose 7.4 percent last week, putting our position back into positive territory. Two factors were behind the upward movement last week. First, Universal Display’s (OLED)September-quarter earnings were solid on the bottom line and better than expected on the top line. As we shared in our post-earnings comments, the key takeaway from the earnings call is the continued ramp in industry OLEDs capacity as the technology gains share in existing applications, such as TVs and smartphones, and new ones emerge, like wearables, virtual and augmented reality applications and automotive lighting.

The bottom line is the quarter, much like the back half of 2016, was an expected one of transition. When we added OLED shares to the portfolio, we noted industry capacity was constrained, with existing players such as Samsung and LG as well as newer entrants adding organic light-emitting diode capacity to meet demand from the smartphone market as well as new applications that include OLED TVs, wearables, virtual reality and augmented reality, and for emerging opportunities including automotive OLED display and lighting.

While that last opportunity — automotive OLED display and lighting — is rather small today compared to demand for smarthones (OLED’s largest end market today), research firm UBI forecasts the global OLED lighting panel market is expected to rise from $114 million this year to $1.6 billion by 2020. Factor in other applications as well as new ones, including side displays to the PC market akin to Apple’s (AAPL) new Touch Bar, and it explains the confirmed plans from Samsung and LG to expand their OLED capacity. It also helps explain Taiwan’s Ministry of Economic Affairs announcing it would support the development of OLED technology in that country, pledging $3 billion of government capital in the process. At the end of September, Sharp announced its plans to invest $570 million in two OLED pilot production lines, which are expected to start operation in the second quarter of 2018.

Stepping back, this is very similar to the light-emitting diode (LED) backlighting and lighting revolution, except we are in the early innings of OLED technology replacing LED and other lighting. As the LED revolution occurred, industry capacity grew ahead of new applications coming to market, and we see that transpiring in the OLED market.

Second, Gabelli & Co. bumped up its rating on OLED shares to “Buy” from “Hold” with a $68 price target, with rationale that largely reflects our own investment thesis (iPhone’s potential adoption of OLED display; a large increase in the global OLED display capacity building in 2017 and 2018; and a mobile device market shift from LCD to OLED displays).

Any move by Apple to utilize that display technology would be a positive for its overall adoption. Other signposts we’ll be watching include OLED equipment order activity at Applied Materials (AMAT), Aixtron (AIXG) and Veeco Instruments (VECO) as well as new product announcements and OLED applications from consumer electronics companies ahead of the holiday shopping season and after at events such as CES 2017.

Our price target on OLED shares is $68, which offers potential upside of more than 20 percent.

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