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Category Archives: Digital Infrastructure

I’m Ringing in 2020 With This Smartphone-Powering Stock

I’m Ringing in 2020 With This Smartphone-Powering Stock

As 5G fires up across the nation and beyond, this chip-maker will likely be called on to let phones connect to new and old generations of networks.

As the smartphone market has matured, it has become increasingly tied to replacement demand.

Look at these statistics: As of December 2019, there are 5.175 billion unique mobile subscribers across the globe, according to the Global System for Mobile Communications, or GSM Association. As surprising as it may sound, the last big quarter for smartphone shipments was the fourth one in 2016. So, despite the seasonal pattern for stronger smartphone sales in the back half of the year, the 1.4 billion units shipped in 2018 was relatively unchanged year-over-year. Prospects for shipments in 2019 also point to modest growth year-over-year.  

As we move through 2020, mobile operators will light up their next generation 5G networks that will likely be…

Read more here 

Weekly Issue: Key Developments at Apple (AAPL) and AT&T (T)

Weekly Issue: Key Developments at Apple (AAPL) and AT&T (T)

Key points inside this issue:

  •  Apple’s 2019 iPhone event – more meh than wow
  •  GameStop – It’s only going to get worse
  •  Elliot Management gets active in AT&T, but its prefers Verizon?
  •  California approves a bill that changes how contract workers are treated
  • Volkswagen set to disrupt the electric vehicle market

I’m going to deviate from the usual format we’ve been using here at Tematica Investing this week to focus on some of what’s happening with Select List residents Apple (AAPL) and AT&T (T) this week as well as one or two other things. The reason is the developments at both companies have a few layers to them, and I wanted to take the space to discuss them in greater detail. Don’t worry, we’ll be back to our standard format next week and I should be sharing some thoughts on Farfetch (FTCH), which sits at the crossroads of our Living the Life, Middle Class Squeeze and Digital Lifestyle investing themes, and another company I’ve been scrutinizing with our thematic lens. 

 

Apple’s 2019 iPhone event – more meh than wow

Yesterday, Apple (AAPL) held its now annual iPhone-centric event, at which it unveiled its newest smartphone model as well as other “new”, or more to the point, upgraded hardware. In that regard, Apple did not disappoint, but the bottom line is the company delivered on expectations serving up new models of the iPhone, Apple Watch and iPad, but with only incremental technical advancements. 

Was there anything that is likely to make the average users, not the early adopter, upgrade today because they simply have to “have it”? 

Not in my view. 

What Apple did do with these latest devices and price cuts on older models that it will keep in play was round out price points in its active device portfolio. To me, that says CEO Tim Cook and his team got the message following the introduction of the iPhone XS and iPhone XS Max last year, each of which sported price tags of over $1,000. This year, a consumer can scoop up an iPhone 8 for as low as $499 or pay more than $1,000 for the new iPhone 11 Pro that sports a new camera system and some other incremental whizbangs. The same goes with Apple Watch – while Apple debuted a new Series 5 model yesterday, it is keeping the Series 3 in the lineup and dropped its price point to $199. That has the potential to wreak havoc on fitness trackers and other smartwatch businesses at companies like Garmin (GRMN) and Fitbit (FIT). 

Before moving on, I will point out the expanded product price points could make judging Apple’s product mix revenue from quarter to quarter more of a challenge, especially since Apple is now sharing information on these devices in a more limited fashion. This could mean Apple has a greater chance of surprising on revenue, both to the upside as well as the downside. Despite Apple’s progress in growing its Services business, as well its other non-iPhone businesses, iPhone still accounted for 48% of June 2019 quarterly revenue. 

Those weren’t the only two companies to feel the pinch of the Apple event. Another was Netflix (NFLX) as Apple joined Select List resident Walt Disney (DIS) in undercutting Netflix’s monthly subscription rate. In case you missed it, Disney’s starter package for its video streaming service came in at $6.99 per month. Apple undercut that with a $4.99 a month price point for its forthcoming AppleTV+ service, plus one year free with a new device purchase. To be fair, out of the gate Apple’s content library will be rather thin in comparison to Disney and Netflix, but it does have the balance sheet to grow its library in the coming quarters. 

Apple also announced that its game subscription service, Apple Arcade, will launch on September 19 with a $4.99 per month price point. Others, such as Microsoft (MSFT) and Alphabet (GOOGL) are targeting game subscription services as well, but with Apple’s install base of devices and the adoption of mobile gaming, Apple Arcade could surprise to the upside. 

To me, the combination of Apple Arcade and these other game services are another nail in the coffin for GameStop (GME). 

 

GameStop – It’s only going to get worse

I’ve been bearish on GameStop (GME) for some time, but even I didn’t think it could get this ugly, this fast. After the close last night, GameStop reported its latest quarter results that saw EPS miss expectations by $0.10 per share, a miss on revenues, guidance on its outlook below consensus, and a cut to its same-store comps guidance. The company also shared the core tenets of a new strategic plan. 

Nearly all of its speaks for itself except for the strategic plan. Those key tenets are:

  • Optimize the core business by improving efficiency and effectiveness across the organization, including cost restructuring, inventory management optimization, adding and growing high margin product categories, and rationalizing the global store base. 
  • Create the social and cultural hub of gaming across the GameStop platform by testing and improving existing core assets including the store experience, knowledgeable associates and the PowerUp Rewards loyalty program. 
  • Build digital capabilities, including the recent relaunch of GameStop.com.
  •  Transform vendor and partner relationships to unlock additional high-margin revenue streams and optimize the lifetime value of every customer.

Granted, this is a cursory review, but based on what I’ve seen I am utterly unconvinced that GameStop can turn this boat around. The company faces headwinds associated with our Digital Lifestyle investing theme that are only going to grow stronger as gaming services from Apple, Microsoft and Alphabet come to market and offer the ability to game anywhere, anytime. To me, it’s very much like the slow sinking ship that was Barnes & Noble (BKS) that tried several different strategies to bail water out. 

Did GameStop have its time in the sun? Sure it did, but so did Blockbuster Video and we all know how that ended. Odds are it will be Game Over for GameStop before too long.

Getting back to Apple, now we wait for September 20 when all the new iPhone models begin shipping. Wall Street get your spreadsheets ready!

 

Elliot Management gets active in AT&T, but its prefers Verizon?

Earlier this week, we learned that activist investor Elliot Management Corp. took a position in AT&T (T). At $3.2 billion, we can safely say it is a large position. Following that investment, Elliot sent a 24-page letter telling AT&T that it needed to change to bolster its share price. Elliot’s price target for T shares? $60. I’ll come back to that in a bit. 

Soon thereafter, many media outlets from The New York Times to The Wall Street Journal ran articles covering that 24-page letter, which at one point suggested AT&T be more like Verizon (VZ) and focus on building out its 5G network and cut costs. While I agree with Elliot that those should be focus points for AT&T, and that AT&T should benefit from its spectrum holdings as well as being the provider of the federally backed FirstNet communications system for emergency responders, I disagree with its criticism of the company’s media play. 

Plain and simple, people vote with their feet for quality content. We’ve seen this at the movie box office, TV ratings, and at streaming services like Netflix (NFLX) when it debuted House of Cards or Stranger Things, and Hulu with the Handmaiden’s Tale. I’ve long since argued that AT&T has taken a page out of others’ playbook and sought to surround its mobile business with content, and yes that mobile business is increasingly the platform of choice for consuming streaming video content. By effectively forming a proprietary content moat around its business, the company can shore up its competitive position and expand its business offering rather than having its mobile service compete largely on price. And this isn’t a new strategy – we saw Comcast (CMCSA) do it rather well when it swallowed NBC Universal to take on Walt Disney and others. 

Let’s also remember that following the acquisiton of Time Warner, AT&T is poised to follow Walt Disney, Apple and others into the streaming video service market next year. Unlike Apple, AT&T’s Warner Media brings a rich and growing content library but similar to Apple, AT&T has an existing service to which it can bundle its streaming service. AT&T may be arriving later to the party than Apple and Disney, but its effort should not be underestimated, nor should the impact of that business on how investors will come to think about valuing T shares. The recent valuation shift in Disney thanks to Disney+ is a great example and odds are we will see something similar at Apple before too long with Apple Arcade and AppleTV+. These changes will help inform us as to how that AT&T re-think could play out as it comes to straddle the line between being a Digital Infrastructure and Digital Lifestyle company.

Yes Verizon may have a leg up on AT&T when it comes to the current state of its 5G network, but as we heard from specialty contractor Dycom Industries (DY), it is seeing a significant uptick in 5G related construction and its top two customers are AT& T (23% of first half 2019 revenue) followed by Verizon (22%). But when these two companies along with Sprint (S), T-Mobile USA (TMUS) and other players have their 5G network buildout competed, how will Verizon ward off subscriber poachers that are offering compelling monthly rates? 

And for what it’s worth, I’m sure Elliot Management is loving the current dividend yield had with T shares. Granted its $60 price target implies a yield more like 3.4%, but I’d be happy to get that yield if it means a 60% pop in T shares. 

 

California approves a bill that changes how contract workers are treated

California has long been a trend setter, but if you’re an investor in Uber (UBER) or Lyft (LYFT) — two companies riding our Disruptive Innovators theme — that latest bout of trend setting could become a problem. Yesterday, California lawmakers have approved Assembly Bill 5, a bill that requires companies like Uber, Lyft and DoorDash to treat contract workers as employees. 

This is one of those times that our thematic lens is being tilted a tad to focus on a regulatory change that will entitle gig workers to protections like a minimum wage and unemployment benefits, which will drive costs at the companies higher. It’s being estimated that on-demand companies like Uber and the delivery service DoorDash will see their costs rise 20%-30% when they rely on employees rather than contractors. For Uber and Lyft, that likely means pushing out their respective timetables to profitability.

We’ll have to see if other states follow California’s lead and adopt a similar change. A coalition of labor groups is pushing similar legislation in New York, and bills in Washington State and Oregon could see renewed momentum. The more states that do, the larger the profit revisions to the downside to be had. 

 

Volkswagen set to disrupt the electric vehicle market

It was recently reported that Volkswagen (VWAGY) has hit a new milestone in reducing battery costs for its electric vehicles, as it now pays less than $100 per KWh for its batteries. Given the battery pack is the most expensive part of an electric vehicle, this has been thought to be a tipping point for mass adoption of electric vehicles. 

Soon after that report, Volkswagen rolled out the final version of its first affordable long-range electric car, the ID.3, at the 2019 Frankfurt Motor Show and is expected to be available in mid-2020.  By affordable, Volkswagen means “under €30,000” (about $33,180, currently) and the ID.3 will come in three variants that offer between roughly 205 and 340 miles of range. 

By all accounts, the ID.3 will be a vehicle to watch as it is the first one being built on the company’s new modular all-electric platform that is expected to be the basis for dozens more cars and SUVs in the coming years as Volkswagen Group’s pushed hard into electric vehicles. 

Many, including myself, have been waiting for the competitive landscape in the electric vehicle market to heat up considerably – it’s no secret that all the major auto OEMs are targeting the market. Between this fall in battery cost and the price point for Volkswagen’s ID.3, it appears that the change in the landscape is finally approaching and it’s likely to bring more competitive pressures for Clean Living company and Cleaner  Living Index constituent Tesla (TSLA). 

 

Weekly Issue: Watching the G20 for what the Fed may or may not do

Weekly Issue: Watching the G20 for what the Fed may or may not do


Key points inside this issue

  • The G20 meeting will set the stage for what the Fed does next
  • Earnings expectations have yet to follow GDP expectations lower
  • We are implementing a $340 stop loss on Digital Lifestyle Thematic Leader Netflix (NFLX).


Over the last few days several economic data points have reinforced the view that the domestic economy is slowing. Meanwhile, the continued back and forth on the trade front, between the U.S. and China as well as Mexico, has been playing out.

What has really captured investors’ focus, however, is the Federal Reserve and the comments earlier this week from Fed Chair Jerome Powell that the Fed is monitoring the fallout from trade issues and eyeing the speed of the economy. Powell said the Fed will “act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective.”

This has led to a pronounced shift in the market, from bad economic data is bad news for the market, to bad news for the economy and trade is good news for the Fed to take action and cut interest rates.

In other words, after the disappointing one-two punch of the IHS Markit US PMI and May ISM Manufacturing Index data, combined with the sharp uppercut that was the May ADP Employment Report, “hopium” has returned to the market.  

Over the weekend, we received signs the potential trade war with Mexico will be averted, though few details were shared. China is up next, per comments from U.S. Treasury Secretary Mnuchin, who warned Beijing of tariffs to come if it does not “move forward with the deal … on the terms we’ve done.”

“If China doesn’t want to move forward, then President Trump is perfectly happy to move forward with tariffs to re-balance the relationship,” Mnuchin said.

Near-term, we’re likely to see more “bad news is good news” for the stock market as evidenced by Friday’s market rally following the dismal May jobs report that fell well short of expectations. More economic bad news is being greeted as a positive right now by the market under the belief it will increase the likelihood of the Fed cutting rates sooner than expected.



While that data has indeed led to negative GDP expectation revisions for the current quarter as well as the upcoming one, this new dynamic moved the market higher last week and helped reverse the sharp fall in the market in May, when the major stock indices fell between 6.5% and 8.0%.

As I see it, while the Fed has recently done a good job of telegraphing its moves, the new risk is the market over-pricing a near-term rate cut.

The next Fed monetary policy meeting is less than two weeks away and already expectations for a rate cut exiting that two-day event have jumped to around 21% from less than 7% just over a month ago, according to the CME FedWatch Tool.

Let’s remember there are four more Fed monetary policy meetings — in July, September, October and December — and those give the Fed ample room to cut rates should the upcoming G20 Osaka Summit on June 28-29 fail to get U.S.-China trade talks back on track.

To me, this makes the next two weeks imperative to watch and to build our shopping list. If there is no trade progress coming out of the G20 meeting, it increases the potential for a July rate cut. If trade talks are back on track, we very well could see the Fed continue its current wait-and-see approach.

And what about that potential for over-pricing a rate cut into the market? Anyone who has seen the Peanuts cartoons knows what happens when Lucy yanks the football out from under Charlie Brown at the last minute as he goes to kick it. If you haven’t, we can assure you it never ends well, and the same is true for the stock market when its expectations aren’t fulfilled.

I talk much more about this on this week’s Thematic Signals podcast, which you can listen to here.



Earnings expectations have yet to follow GDP expectations lower

Here at Tematica our view is that one of the clear-cut risks we face in the current market environment is the over- pricing in of a Fed rate cut at a time when profit and EPS expectations are likely to be revised lower for the second half of 2019. When we see falling GDP expectations like those depicted in the two charts above, it stands to reason we will likely see, at a minimum and barring any substantial trade progress at the G20 summit, companies adopt a more cautious tone for the back half of the year in the coming weeks as we enter the June quarter earnings season. 

If that proves to be the case, we are likely to see negative revisions to EPS expectations for the second half of the year. Despite the slowing economic data and impact of tariffs, current expectations still call for an 11% increase in earnings for the S&P 500 in the second half of the year compared to the first half. Viewed a different way, those same expectations for the second half of 2019 call for mid-single digit growth on a year over year basis. To me, given the current backdrop there seems to be more downside risk to those expectations than upside surprise. 

Between now and then, we should be listening closely as management teams hit the investor conference circuit this week and next. This week alone brings the Stifel Inaugural Cross Sector Insight Conference 2019, Morgan Stanley U.S. Financials Conference 2019, JP Morgan European Automotive Conference 2019, UBS Asian Consumer, Gaming & Leisure Conference 2019, Deutsche Bank dbAccess 16th Global Consumer Conference 2019, Nasdaq 40th Investor Conference 2019 and the Goldman Sachs 40th Annual Global Healthcare Conference 2019, to name just a few. What we’ll be listening for is updated guidance as well as industry comments, including any tariff impact discussion.

In my view, the conferences and the information spilling out of them will reveal what we are likely to see and hear from various industry leaders in the upcoming June- quarter earnings season.


Tematica Investing

The June rebound in the stock market propped up a number of the Thematic Leaders, most notably Cleaner Living leader Chipotle Mexican Grill (CMG) and Safety & Security leader Axon Enterprises (AAXN). Digital Infrastructure Leader Dycom Industries continues to tread water on a year to date basis, but with 5G deployments accelerating I see a more vibrant landscape for it as well as Disruptive Innovator Leader Nokia (NOK). 

In recent weeks, we’ve gotten greater clarity and insight into forthcoming streaming video services from Apple (AAPL) and Disney (DIS), which are likely to make that market far more competitive than it has been to date. Disney’s rumored $6.99 per month starter price recently led Comcast (CMCSA) to not only abandon its own streaming initiative due in 2020 but to also sell its stake in Hulu to Disney. That to me is a potential game changer depending on how Disney folds Hulu’s streaming TV service into Disney+. 

One of our key tenants is to observe the shifting landscape, and with regard to streaming video we are seeing the beginning of such a shift. For that reason as well as the risk of a challenging June quarter earnings season in the coming weeks, we are implementing a $340 stop loss on Digital Lifestyle Thematic Leader Netflix (NFLX). That will lock in a profit of just over 27% for NFLX shares. 

Later this week, we’ll get the May Retail Sales report, which should once again showcase the accelerating shift to digital shopping. In my view, it’s just another positive data point to be had for Thematic King Amazon (AMZN)… as if all the UPS and other delivery vehicles aren’t enough proof.

 

Weekly Issue: As trade concerns escalate, investors brace for an expectations reset

Weekly Issue: As trade concerns escalate, investors brace for an expectations reset


Key points inside this issue

  • Safety & Security Thematic Leader is up big year to date, and new body camera and digital records products hitting later this year should accelerate the company’s transition. Our long-term price target on AAXN shares remains $90.
  • The April Retail Sales Report should offer confirmation for Thematic King Amazon (AMZN) as well as Middle-Class Squeeze Thematic Leader Costco Wholesale (COST). 


Given the wide swings in the market over the last few days that are tied back to the changing US-China trade talk landscape, I thought it prudent to share my latest thoughts even if it’s a day earlier than usual. 

As we discussed in the last issue of Tematica Investing, we knew that coming into last week, it was going to be a challenging one. Trade tensions kicked up to levels few were expecting 10 days ago and as the week progressed the tension and uncertainty crept even higher. We all know the stock market is no fan of uncertainty, but when paired with upsized tariffs from both the US and China that will present new economic and earnings headwinds, something that was not foreseen just a few weeks ago, investors will once again have to revisit their expectations for the economy and earnings. And yes, odds are those past and even more recent expectations will be revisited to the downside. 

What was originally thought to have been President Trump looking to squeeze some last- minute trade deal points out of the Chinese instead turned out to be more of a response to China’s attempt to do the same. This revealed the tenuous state of U.S./China trade talks. Last Friday morning, the U.S. had boosted tariffs to 25% from 10% on $200 billion worth of Chinese goods with President Trump tweeting there is “absolutely no need to rush” and that “China should not renegotiate deals with the U.S. at the last minute.” Even as the new tariffs and tweets arrived, trade negotiations continued Friday in Washington with no trade deal put in place, which dashed the hopes of some traders. Candidly, I didn’t expect a trade deal to emerge given what had transpired over the prior week. 

That hope-inspired rebound late Friday in the domestic stock market returned to renewed market pressure over the weekend and into this week as more questions over U.S.-China trade have emerged. As we started off this week, the trade angst between the U.S. and China has edged higher as China has responded to last week’s U.S. tariff bump by saying it would increase tariffs on $60 billion of U.S. goods to 25% from 10% beginning June 1st. Clearly, the latest round of tweets from President Trump won’t ease investor concern as to how the trade talks will move forward from here.

As the trade war rhetoric kicks up alongside tariffs, the next date to watch will be the G-20 economic summit in Japan next month. According to Trump economic adviser Larry Kudlow, there is a “strong possibility” Trump will meet Chinese President Xi and this morning President Trump confirmed that. 

The cherry or cherries on top of all of this is the growing worries over increasing tension with Iran, which is weighing on the market this morning, and yet another 2019 growth forecast cut by the EU that came complete with a fresh warning on Italy’s debt levels. Growth projections by the European Commission showed a mere 0.1% for GDP growth this year in Italy. The country has the second-largest debt pile in the EU and, according to the latest forecasts by the commission, the Italian debt-to-GDP ratio will hit 133% this year and rise to 135% in 2020. I point these out not to worry or spook you, but rather remind you there are other issues than just US-China trade that have to be factored into our thinking.

The natural market reaction to all of these concerns is to adopt a “risk off” attitude, which, as we’ve seen before, can ignite a storm of “fire first, ask questions later.” And as should be no surprise, that has fueled the sharp move lower in the major market indices. Over the last several days, the S&P 500, which as we know if the barometer used by most institutional and professional investors, fell 4.7% while the small-cap heavy Russell 2000 dropped 5.7%.

At times like this, it pays to do nothing. Hard to believe but as you’ve often heard few will step in to catch a falling knife and given the sharp declines, we also run the risk of a dead cat bounce in the market. We should be patient until the market finds its footing, which means parsing what comes next on the economic and earnings as well as trade front.  

I’ll continue to look for replacements for open Thematic Leader slots as well as other contenders poised to benefit from our pronounced thematic tailwinds. In the near-term, that will mean focusing on ones that also have a more U.S.-focused business model, a focus on inelastic and consumable products. Another avenue that investors are likely to revisit is dividend-paying companies, particularly those that fall into the Dividend Aristocrats category because they’ve consistently grown their dividends for the past 10 years. As I sift through the would-be contenders, I’ll be sure to look for those that intersect our investing themes and the aristocrats. 


Tematica Investing

As the stock market has come under pressure, a number of our Thematic Leaders, as well as companies on the Select List, have given back some of their year-to-date gains. One that has rallied and moved higher in spite of the market sell-off is Safety & Security Thematic Leader Axon Enterprises (AAXN) and are up some 48% year to date. That makes it the second-best performer on the Thematic Leaderboard year to date behind Clean Living company Chipotle Mexican Grill (CMG) that is up nearly 60% even after the market’s recent bout of indigestion.

Axon reported its March quarter earnings last week, which saw revenue grow 14% year over year as Axon continues to shift its business mix from Taser hardware to its Software & Sensor business that fall under the Axon Body and Axon Records businesses. During the company’s earnings conference call, the management team shared its next gen products will be available during the back half of the year. These include the Axon Body, its first camera with LTE live streaming, will launch during the September quarter and Axon Records, its first stand-alone software product. Records w will launch with a major city police department and it is already testing with a second major police department. As far as the new Axon Body product, I suspect the untethering of this camera could spur adoption much the way Apple’s (AAPL) Apple Watch saw a pronounced pick up when it added cellular connectivity to its third model. 

These new products, which leverage the intersection between our Digital Infrastructure investing theme and our Safety & Security one, should accelerate the transition to a higher margin, recurring revenue business in the coming quarters. In other words, Axon’s transformation is poised to continue and as that happens investors will be revisiting how they value the company’s business. More than likely that means further upside ahead for AAXN shares. 

  • Our price target on Safety & Security Thematic Leader Axon Enterprises (AAXN) remains $90.


Here comes the April Retail Sales Report

Later this week, we’ll get the April Retail Sales Report, which should benefit for the late Easter holiday this year. Up until the March report, this data stream was disappointing during December through February but even so from a thematic perspective the reports continued to reinforce our Digital Lifestyle and Middle-class Squeeze investing themes. 

When we look at the April data, I’ll be looking at both the sequential and year over year comparisons for Nonstore retailers, the government category for digital shopping and the category that best captures Thematic King Amazon (AMZN). I’ll also be looking at the general merchandise stores category with regard to Middle-Class Squeeze Thematic Leader Costco Wholesale (COST). Costco has already shared its April same-store sales, which rose 7.7% in the US despite having one less shopping day during the month compared to last year. Excluding the impact of gas prices and foreign exchange, Costco’s April sales were up 5.6% year over year. From my perspective, the is the latest data point that shows Costco continues to take consumer wallet share. 

With reported disposable income data inside the monthly Personal Income & Spending reports essentially flat for the last few months and Costco continuing to open new warehouse locations, which should spur its high margin membership revenue, I continue to see further upside ahead in COST shares. And yes, the same applies to Amazon shares as well.

  • Our $250 price target for Middle-class Squeeze Thematic Leader Costco Wholesale (COST) is under review.


This Week’s Issue: Hear those engines? It’s earnings season!

This Week’s Issue: Hear those engines? It’s earnings season!

Coming into this week 15% of the S&P 500 companies have reported and exiting it that percentage will jump to 45%. What the market and investors will be focusing on this week is what led to upside or downside surprises for the reported quarter and how is the current quarter shaping up relative to expectations. Remember, that during the March quarter we saw downward revisions in S&P 500 EPS expectations for the quarter such that the consensus called for EPS declines year over year. Currently, expectations for the current June quarter are up 10% sequentially but are flat year over year. 


If we get the data to show these March reports and prospects for the current quarter are better than expected or feared, we could see the 2019 view for S&P 500 earnings move higher vs. the meager 3.7% growth forecast to $167.95. If that happens, it will mark a change in view for 2019 expectations, which have been eroding over the last several months, and could drive the market higher. However, if we see a pickup in downward EPS cuts, we could see those 2019 S&P 500 consensus expectations come under pressure, which would make the stock market even more expensive following its year to date run of 16%. 

Now to sift through the onslaught of more than 680 companies reporting this week, which based on what we’re seeing this morning from Coca-Cola (KO), Lockheed Martin (LMT), Twitter (TWTR) and Pulte Group (PHM) suggest potential upside to be had. Tucked inside those results were positive data points for several of our investing themes:

Coca-Cola is feeling the tailwind of our Cleaner Living investing theme as sales of its flavored waters and sports drinks rose 6% year over year, significantly faster than the 1% growth posted by its carbonated drinks business. During the earnings conference call, CEO James Quincy shared that the management team is looking to make Coca-Cola a “total beverage company” by adding coffees, teas, smoothies and flavored waters to a portfolio that has traditionally offered aerated drinks.

Lockheed Martin Corp reported better-than-expected quarterly profit yesterday, benefitting from the Safety & Securitytailwind associated with President Donald Trump’s looser policies on foreign arms sales boosted demand for missiles and fighter jets.

Efforts to improve its advertising business model helped Twitter capture some of our Digital Lifestyletailwind as year over year monetizable daily user growth returned to double digits for the first time in several quarters. 

Verizon (VZ) beat quarterly expectations and on its earnings conference call 5G and its deployment in the coming quarters was a key topic during the question and answer session. Verizon will continue to build out its network and bring more 5G capable smartphones to market, which in my view continues to bode well for our Digital Infrastructureand Disruptive Innovators Thematic Leaders, Dycom (DY) and Nokia (NOK). Nokia will report its quarterly results later this week, and following Ericsson’s better than expected results that tied to strength in North America and 5G, Nokia could surprise on the upside as well.


Splitting the Housing and Retail Sales hairs

Late last week we received some conflicting economic data in the form of the March Retail Sales report and the March Housing Starts data. While retail sales for the month came in stronger than expected — a welcome sign following the last few months in which that data disappointed relative to expectations — March housing starts fell to their weakest point since 2017 despite a tick down in mortgage rates. Now let’s take a deeper dive into those two reports:

In looking at the March Retail Sales report, total retail rose 1.7% month over month (3.5% year over year) with broad-based sales strength and nice gains seen across discretionary spending categories. While we are quite pleased with the month’s data, subscribers know we tend to favor a longer-term perspective when it comes to identifying data trends. Consequently, as we are bracing for the March quarter earnings onslaught it makes sense to examine how retail sales in this year’s March quarter compared to the year-ago quarter. Here we go:

Leaders for the March 2019 quarter vs. March 2018 quarter:

  • Nonstore retailers up more than 11%, which bodes very well for Thematic King Amazon  (AMZN) and to a lesser extent our Alphabet (GOOGL). Let’s remember that those packages need to get to their intended destinations, which likely means positive things for United Parcel Service (UPS), and I’ll be checking that report, which is out later this week. 
  • Food services & drinking places rose 4.4%, which points to favorable data for Guilty Pleasure Thematic Leader Del Frisco’s Restaurant Group (DFRG). And yes, I continue to wait on more about its strategic review process. 
  • Health & personal care stores were up 4.6%.
  • Building material & garden suppliers and dealers increased by 4.7%.

Laggards for the March 2019 quarter vs. March 2018 quarter:

  • Sporting goods, hobby, musical instrument, & book stores were down 7.9 
  • Department Stores fell 3.8%, which comes as no surprise to me given the accelerating shift to digital shopping that is part of our Digital Lifestyle investing theme. 
  • Miscellaneous store retailers were down 3.8%

Turning to the March Housing Starts report, the aggregate starts data fell to the weakest level since 2017, but that decline includes both single-family and multifamily housing starts. Breaking down those two components, single-family starts were down 0.4% to 781,000, the slowest pace since September 2016, while permits decreased 1.1% to 808,000, the lowest since August 2017. Multifamily starts, which include apartments and condominiums, were unchanged month over month at 354,000, while those permits fell 2.7%. 

The March results may have been influenced to some degree by harsh weather in the Northeast, which contended with heavy snowfalls, and in the South as it dealt with record flooding along the Mississippi and Missouri rivers. Even so, the housing data were off despite a decline in the 30-year mortgage rate to roughly 4.15% this month from 4.86% last October, according to data from Marcrotrends. This decline likely signals that consumers are being priced out of the market as developers and home builders continue to struggle with building affordable properties amid rising labor and materials costs. We also must consider the state of the consumer, who is dealing with the impact of higher debt levels across credit cards, auto loans and student loans — a combination that is sapping disposable income and the ability to service mortgages on homes they may not be able to afford.

Generally speaking, most existing homeowners in the U.S. use the capital from selling their current homes to help fund the purchase of their next dwellings. This means we as investors should watch Existing Home Sales data as a precursor to new home sales and housing starts. Despite February’s better-than-expected sequential print, Existing Home Sales have been falling on a year-over-year basis since February 2018.

Per March Existing Home Sales report, which showed a 5.4% sequential drop vs. February and a similar decline vs. a year ago. For the March quarter, existing home sales fell 5.3%, which in our opinion does not augur well for a near-term pick up in the overall housing market, especially as the recent decline in mortgage rates has not jump started new mortgage applications.

Generally speaking, the housing market has two seasonally strong periods during the year, the spring and fall selling seasons, of which spring tends to be the stronger one. This year, it could be argued that harsh weather in various parts of the U.S. has resulted in the spring selling season getting off to a slow start. Leading up to it, we have seen a climb in the inventory of new homes listed for sale, according to Realtor.com. That’s the supply side of the equation, but the side we remain concerned about is demand.

As we get more data in the coming weeks, we’ll be better able to suss out if we are dealing with a weather related situation, a consumer affordability one or some combination of the two. If the data points to a consumer affordability one, we may consider Home Depot (HD), which is a company that cuts across our Middle Class Squeeze and Affordable Luxury investing themes. Through last night, however, HD shares are up some 28% year to date, and are sitting in over bought territory. Should we see a sizable pullback over the coming weeks as more earnings reports are had and digested, this could be one to revisit. 

Weekly Issue: A number of Thematic Leaders delivered outsized returns during Q1

Weekly Issue: A number of Thematic Leaders delivered outsized returns during Q1


Key points inside this issue

  • Despite a slowing global economy, the March quarter was a barn burner for stocks, but risks remain heading into the March quarter earnings season.
  • Our price target on Apple (AAPL) remains $225. 
  • Our price target on shares of Living the Life Thematic Leader Del Frisco’s Restaurant Group (DFRG) remains $14.
  • Our price target on Universal Display (OLED) shares of $150 is under review. 


Last week brought the March quarter to a close, and even though Friday’s personal income and spending data confirmed a slowing economy, it was the best quarter in nearly a decade for stocks. 

The bulk of the double-digit gains across all of the major domestic stock market indices — the Dow Jones Industrial Average, S&P 500, Nasdaq Composite Index, and the Russell 2000 — came early in the quarter due to positive expectations for U.S.-China trade talks, even as the market shrugged off the federal government shutdown. As the quarter wore on, data pointed to a slowing global economy, with more pronounced weakness in China, Japan and Europe, leaving the U.S. the best house on the slowing economic block. Even so, the domestic data point to a markedly slower U.S. economy compared to the second half of 2018, which in part reflects the anniversary of tax reform, but also consumers that increasingly appear to be hitting a spending wall.

Companies are also contending with higher wage costs, due in part to minimum wage hikes, as well as certain higher input costs. And of course, there is the current trade war with China that is also presenting a headwind, as is the slowing economies in Europe and Japan, especially given the year-over-year strength in the dollar, as you can see in the chart below.

In sum, we’ve seen a number of these headwinds result in reduced earnings expectations for the current quarter, and we’re now beginning to see companies once again trim back expectations. Last Thursday night DowDuPont Inc. (DWDP) slashed its sales and profits forecasts, joining the ranks of Infineon Technologies AG (IFX), Samsung Electronics Co., Ltd., Osram and others. This week, it was Walgreens Boots Alliance (WBA) that shared it had “the most difficult quarter we have had since the formation of Walgreens Boots Alliance.

On Monday we received a slew of economic data that included the March Manufacturing PMI data for China, Japan, the eurozone and the U.S. as well as the March ISM Manufacturing Index and February Retail Sales figures. There were bright spots inside this sea of data, most notably the March ISM Manufacturing Index that surprised modestly to the upside and showed a pickup in orders and employment.

That positive report was tempered by the IHS Markit Manufacturing PMI for the U.S., which showed a month-over-month decline in March and hit its lowest level since mid- 2017. As that report noted, “New order growth has fallen close to the lows seen in the 2016 slowdown, often linked to disappointing exports, tariffs and signs of increasing caution among customers.” This trend points to continued slow growth ahead for the domestic economy, though the latest data as a whole still leave the U.S. as the fastest-growing economy compared to China, Japan and the eurozone.

As for the February Retail Sales Report, it once again missed expectations, declining 0.2% month over month. This marks the third flat to down sequential comparison for this data set in the last four months. Viewing the data on a year-over-year basis, retail sales for the month rose 2.1%, which confirms a slower but still growing U.S. economy. While we don’t want to put too sunny of a view on it, the February year- over-year comparison was ahead of the 2.0% growth pace of the trailing three months. Still, there was no question the year-over-year rate of spending in February slowed compared to January.

While we don’t want to put too sunny of a view on it, the February year- over-year comparison was ahead of the 2.0% growth pace of the trailing three months. Still, there was no question the year-over-year rate of spending in February slowed compared to January.

In my view, this looks to be setting up a volatile earnings season, with earnings guidance that is likely to disappoint and lead to downward revisions for the June quarter as companies reset expectations. We will continue to be prudent, longer-term focused investors that take our cues from our 10 investing themes and the confirming signals to be had.


Tematica Investing

As we put the March quarter in the rear-view mirror, the market will continue to look for hope in a U.S.-China trade deal but given the factors outlined above, I see greater risk to the downside, generally speaking, than upside, as we begin the March-quarter earnings season. The stalwart among them was Clean Living Leader Chipotle Mexican Grill (CMG), as its shares rose more than 60% during the first three months of the year. Digital Lifestyle Leader Netflix (NFLX) as well as New Global Middle Class Leader, Alibaba (BABA), soared more than 30% during the quarter, and Thematic King Amazon (AMZN) climbed 20%. 

The quarter wasn’t without its challenges given declines experienced at Aging of the Population Leader AMN Healthcare (AMN), but as I am seeing with my 87 year old father, the need for elder care is pronounced and bodes well for nursing demand in the coming years. We will continue to hold AMN shares. Another laggard is Dycom Industries (DY), better known as the Digital Infrastructure Leader, which is positioned to benefit from the 5G and gigabit network buildout. We’re entering the seasonally strong time of the year for Dycom, which also brings us closer to initial 5G launches from AT&T (T), Verizon (VZ), T-Mobile USA (TMUS) and others. As with AMN shares, we will continue to hold DY shares as well. 

Now let’s dig into several Thematic Leaders and Select List positions that made news over the last week. 


Apple’s video and gaming efforts are interesting but not in the short-term

During the March quarter, Apple’s (AAPL) shares rebounded hard, rising just over 20%. Some of that climb was due to the excitement ahead of Apple’s services focused event last week, which candidly was largely as expected given prior news leaks. Leading up to the event we saw iPad, Mac and AirPod refreshes, but the event itself focused on Apple Card, Apple News+ and AppleTV+. The one surprise was the announcement of a streaming gaming service, which like AppleTV+ will debut later this year. 

As such while they are positives for the Services business, they will have little impact on the company’s bottom line near-term. That said, Canaccord Genuity upped its price target to $230 from $185 this week. The reality of the situation is that as much as we like content and Apple is looking to use it to make its devices and ecosystem even stickier with customers inside the Digital Lifestyle, in the near-term the primary driver of the company’s profits will continue to be the iPhone. 

  • Our price target on Apple (AAPL) remains $225. A key point to that target is the eventual upgrade cycle tied to 5G and the iPhone, which given our Dycom comments above, increasingly looks like it will happen in the second half of 2020.


Frustrated with Del Frisco’s Restaurant Group, but holding steady

If you’re growing frustrated with this Thematic Leader, you are not alone. During the March quarter, DFRG shares fell roughly 10%, but the inter quarter swing was far greater than that. What’s weighing on the shares is lack of news on the company’s strategic review process. Per some reports, the company could be cleaved into two parts to different buyers, which if true would explain the pronounced timetable.

From a fundamental perspective, while overall restaurant traffic and other metrics fell in February according to data published by TDN2K, the bulk of that decline was at fast casual restaurants, to which we have no exposure. Digging into the data, we find  fine dining was the best-performing industry segment during February for same-store sales growth. While I like such confirming data, as I noted above the DFRG share price will continue to be driven by any and all strategic review developments. This will continue to be our point of focus for now.

 Our plan is to hold DFRG as the takeout story evolves further, but as we have said previously, odds are we will use a deal- related pop in the stock to exit the position. 

  • Our price target on shares of Living the Life Thematic Leader Del Frisco’s Restaurant Group (DFRG) remains $14.


Universal Display should continue to shine

Universal Display (OLED) shares shined bright during the first quarter rising easily more than 50%. Yesterday, there were thesis confirming reports for the adoption of organic light emitting diode display that will drive demand for Universal’s chemical and IP licensing businesses. Those reports centered on Apple (AAPL) shifting its entire production of iPhones to organic light-emitting diode displays in 2020.

These same reports also suggest Apple will have three different- size iPhones, measuring 5.42 inches, 6.06 inches and 6.67 inches. While the varied iPhone sizing is new, we heard similar hints about the switch in display technology several months ago. We see this as follow up to that, which in our view increases the likelihood of this happening.

We’d also note the timing of these models and the display transition seem to coincide with the potential debut of a 5G iPhone. In light of the incremental RF chips the 5G model will contain, it makes sense that Apple would look to adopt this display technology for both space as well as power savings.

While we like seeing our investment thesis confirmed here, I’d note that not only have OLED shares climbed substantially over the last three months, but the transition to all organic light-emitting diode displays at Apple, and most likely others, is several quarters out. We will continue to be long- term investors in OLED shares. However, given market conditions and the upcoming earning season we could see OLED shares give some of its gains back in the near-term. We’ll continue to focus on the long-term opportunity not only in the smartphone market but in automotive and eventually the general illumination market. 

  • Our price target on Universal Display (OLED) shares of $150 is under review. 
Doubling Down on Digital Infrastructure Thematic Leader

Doubling Down on Digital Infrastructure Thematic Leader

Key point inside this issue

  • We are doubling down on Dycom (DY) shares on the Thematic Leader board and adjusting our price target to $80 from $100, which still offers significant upside from our new cost basis as the 5G and gigabit fiber buildout continues over the coming quarters.

We are coming at you earlier than usual this week in part to share my thoughts on all of the economic data we received late last week.

 

Last week’s data confirms the US economy is slowing

With two-thirds of the current quarter behind now in the books, the continued move higher in the markets has all the major indices up double-digits year to date, ranging from around 11.5-12.0%% for the Dow Jones Industrial Average and the S&P 500 to nearly 18% for the small-cap heavy Russell 2000. In recent weeks we have discussed my growing concerns that the market’s melt-up hinges primarily on U.S.-China trade deal prospects as earnings expectations for this year have been moving lower, dividend cuts have been growing and the global economy continues to slow. The U.S. continues to look like the best economic house on the block even though it, too, is slowing.

On Friday, a round of IHS Markit February PMI reports showed that three of the four global economic horsemen — Japan, China, and the eurozone — were in contraction territory for the month. New orders in Japan and China improved but fell in the eurozone, which likely means those economies will continue to slug it out in the near-term especially since export orders across all three regions fell month over month. December-quarter GDP was revealed to be 2.6% sequentially, which equates to a 3.1% improvement year over year but is down compared to the 3.5% GDP reading of the September quarter and 4.2% in the June one.  Slower growth to be sure, but still growing in the December quarter.

Before we break out the bubbly, though, the IHS Markit February U.S. Manufacturing PMI fell to its lowest reading in 18 months as rates of output and new order growth softened as did inflationary pressures. This data suggest the U.S. manufacturing sector is growing at its slowest rate in several quarters, as did the February ISM Manufacturing Index reading, which slipped month over month and missed expectations. Declines were seen almost across the board for that ISM index save for new export orders, which grew modestly month over month. The new order component of the February ISM Manufacturing Index dropped to 55.5 from 58.2 in January, but candidly this line item has been all over the place the last few months. The January figure rebounded nicely from 51.3 in December, which was down sharply from 61.8 in November. This zig-zag pattern likely reflects growing uncertainty in the manufacturing economy given the pace of the global economy and uncertainty on the trade front. Generally speaking though, falling orders translate into a slower production and this means carefully watching both the ISM and IHS Markit data over the coming months.

In sum, the manufacturing economy across the four key economies continued to slow in February. On a wider, more global scale, J.P. Morgan’s Global Manufacturing PMI fell to 50.6 in February, its lowest level since June 2016. Per J.P. Morgan’s findings, “the rate of expansion in new orders stayed close to the stagnation mark,” which suggests we are not likely to see a pronounced rebound in the near-term. We see this as allowing the Fed to keep its dovish view, and as we discuss below odds are it will be joined by the European Central Bank this week.

Other data out Friday included the December readings for Personal Income & Spending and the January take on Personal Income. The key takeaway was personal income fell for the first time in more than three years during January, easily coming in below the gains expected by economists. Those pieces of data not only help explain the recent December Retail Sales miss but alongside reports of consumer credit card debt topping $1 trillion and record delinquencies for auto and student loans, point to more tepid consumer spending ahead. As I’ve shared before, that is a headwind for the overall US economy but also a tailwind for those companies, like Middle-class Squeeze Thematic Leader Costco Wholesale (COST), that help consumers stretch the disposable income they do have.

We have talked quite a bit in recent Tematica Investing issues about revisions to S&P 500 2019 EPS estimates, which at last count stood at +4.7% year over year, down significantly from over +11% at the start of the December quarter. Given the rash of reports last week – more than 750 in total –  we will likely see that expected rate of growth tweaked a bit lower.

Putting it all together, we have a slowing U.S. and global economy, EPS cuts that are making the stock market incrementally more expensive as it has moved higher in recent weeks, and a growing number of dividend cuts. Clearly, the stock market has been melting up over the last several weeks on increasing hopes over a favorable trade deal with China, but last week we saw President Trump abruptly end the summit with North Korea’s Kim Jong Un with no joint agreement after Kim insisted all U.S. sanctions be lifted on his country. This action spooked the market, leading some to revisit the potential for a favorable trade deal between the U.S. and China.

Measuring the success of any trade agreement will hinge on the details. Should it fail to live up to expectations, which is a distinct possibility, we could very well see a “buy the rumor, sell the news” situation arise in the stock market. As I watch for these developments to unfold, given the mismatch in the stock market between earnings and dividends vs. the market’s move thus far in 2019 I will also be watching insider selling in general but also for those companies on the Thematic Leader Board as well as the Tematica Select List. While insiders can be sellers for a variety of reasons, should we see a pronounced and somewhat across the board pick up in such activity, it could be another warning sign.

 

What to Watch This Week

This week we will see a noticeable drop in the velocity of earnings reports, but we will still get a number of data points that investors and economists will use to triangulate the speed of the current quarter’s GDP relative to the 2.6% print for the December quarter. The consensus GDP forecast for the current quarter is for a slower economy at +2.0%, but we have started to see some economists trim their forecasts as more economic data rolls in. Because that data has fallen shy of expectations, it has led the Citibank Economic Surprise Index (CESI) to once again move into negative territory and the Atlanta Fed’s GDPNow current quarter forecast now sat at 0.3% as of Friday.

On the economic docket this week, we have December Construction Spending, ISM’s February Non-Manufacturing Index reading, the latest consumer credit figures and the February reports on job creation and unemployment from ADP (ADP) and the Bureau of Labor Statistics. With Home Depot (HD) reporting relatively mild December weather, any pronounced shortfall in December Construction Spending will likely serve to confirm the economy is on a slowing vector. Much like we did above with ISM’s February Manufacturing Index we’ll be looking into the Non-Manufacturing data to determine demand and inflation dynamics as well as the tone of the services economy.

On the jobs front, while we will be watching the numbers created, including any aberration owing to the recent federal government shutdown, it will be the wage and hours worked data that we’ll be focusing on. Wage data will show signs of any inflationary pressures, while hours worked will indicate how much labor slack there is in the economy. The consumer is in a tighter spot financially speaking, which was reflected in recent retail sales and personal spending data. Recognizing the role consumer spending plays in the overall speed of the U.S. economy, we will be scrutinizing the upcoming consumer credit data rather closely.

In addition to the hard data, we’ll also get the Fed’s latest Beige Book, which should provide a feel for how the regional economies are faring thus far in 2019. Speaking of central bankers, next Wednesday will bring the results of the next European Central Bank meeting. Given the data depicted in the February IHS Markit reports we discussed above, the probability is high the ECB will join the Fed in a more dovish tone.

While the velocity of earnings reports does indeed drop dramatically next week, there will still be several reports worth digging into, including Ross Stores (ROST), Kohl’s (KSS), Target (TGT), BJ’s Wholesale (BJ), and Middle-class Squeeze Thematic Leader Costco Wholesale (COST) will also issue their latest quarterly results. Those reports combined with the ones this week, including solid results from TJX Companies (TJX) last week should offer a more complete look at consumer spending, and where that spending is occurring. Given the discussion several paragraphs above, TJX’s results last week, and the monthly sales reports from Costco, odds are quite good that Costco should serve up yet another report showcasing consumer wallet share gains.

Outside of apparel and home, reports from United Natural Foods (UNFI) and National Beverage (FIZZ) should corroborate the accelerating shift toward food and beverages that are part of our Cleaner Living investing theme. In that vein, I’ll be intrigued to see what Tematica Select List resident International Flavors & Fragrances (IFF) has to say about the demand for its line of organic and natural solutions.

The same can be said with Kroger (KR) as well as its efforts to fend off Thematic King Amazon (AMZN) and Walmart (WMT). Tucked inside of Kroger’s comments, we will be curious to see what the company says about digital grocery shopping and delivery. On Kroger’s last earnings conference call, Chairman and CEO Rodney McMullen shared the following, “We are aggressively investing to build digital platforms because they give our customers the ability to have anything, anytime, anywhere from Kroger, and because they’re a catalyst to grow our business and improve margins in the future.” Now to see what progress has been achieved over the last 90 or so days and what Kroger has to say about the late-Friday report that Amazon will launch its own chain of supermarkets.

 

Tematica Investing

As you can see in the chart above, for the most part, our Thematic Leaders have been delivering solid performance. Shares of Costco Wholesale (COST) and Nokia (NOK) are notable laggards, but with Costco’s earnings report later this week which will also include its February same-store sales, I see the company’s business and the shares once again coming back into investor favor as it continues to win consumer wallet share. That was clearly evident in its December and January same-store sales reports. With Nokia, coming out of Mobile World Congress 2019 last week, we have confirmation that 5G is progressing, with more network launches coming and more devices coming as well in the coming quarters. We’ll continue to be patient with NOK shares.

 

Adding significantly to our position in Thematic Leader Dycom Industries

There are two positions on the leader board – Aging of the Population AMN Healthcare (AMN) and Digital Infrastructure Dycom Industries (DY) – that are in the red. The recent and sharp drop in Dycom shares follows the company’s disappointing quarterly report in which costs grew faster than 14.3% year over year increase in revenue, pressuring margins and the company’s bottom line. As we’ve come to expect this alongside the near-term continuation of those margin pressures, as you can see below, simply whacked DY shares last week, dropping them into oversold territory.

 

When we first discussed Dycom’s business, I pointed out the seasonal tendencies of its business, and that likely means some of the February winter weather brought some added disruptions as will the winter weather that is hitting parts of the country as you read this. Yet, we know that Dycom’s top customers – AT&T (T), Verizon (VZ), Comcast (CMCSA) and CenturyLink (CTL) are busy expanding the footprint of their connective networks. That’s especially true with the 5G buildout efforts at AT&T and Verizon, which on a combined basis accounted for 42% of Dycom’s January quarter revenue.

Above I shared that coming out of Mobile World Congress 2019, commercial 5G deployments are likely to be a 2020 event but as we know the networks, base stations, and backhaul capabilities will need to be installed ahead of those launches. To me, this strongly suggests that Dycom’s business will improve in the coming quarters, and as that happens, it’s bound to move down the cost curve as efficiencies and other aspects of higher utilization are had. For that reason, we are using last week’s 26% drop in DY shares to double our position size in DY shares on the Thematic Leader board. This will reduce our blended cost basis to roughly $64 from the prior $82. As we buy up the shares, I’m also resetting our price target on DY shares to $80, down from the prior $100, which offers significant upside from the current share price and our blended cost basis.

If you’re having second thoughts on this decision, think of it this way – doesn’t it seem rather strange that DY shares would fall by such a degree given the coming buildout that we know is going to occur over the coming quarters? If Dycom’s customers were some small, regional operators I would have some concerns, but that isn’t the case. These customers will build out those networks, and it means Dycom will be put to work in the coming quarters, generating revenue, profits, and cash flow along the way.

In last week’s Tematica Investing I dished on Warren Buffett’s latest letter to Berkshire Hathaway (BRK.A) shareholders. In thinking about Dycom, another Buffett-ism comes to mind – “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” Since this is a multi-quarter buildout for Dycom, we will need to be patient, but as we know for the famous encounter between the tortoise and the hare, slow and steady wins the race.

  • We are doubling down on Dycom (DY) shares on the Thematic Leader board and adjusting our price target to $80 from $100, which still offers significant upside from our new cost basis as the 5G and gigabit fiber buildout continues over the coming quarters.

 

As the pace of earnings slows, over the next few weeks I’ll not only be revisiting the recent 25% drop in Aging of the Population Thematic Leader AMN Healthcare to determine if we should make a similar move like the one we are doing with Dycom, but I’ll also be taking closer looks at wireless charging company Energous Corp. (WATT) and The Alkaline Water Company (WTER). Those two respectively fall under our Disruptive Innovators and Cleaner Living investing themes. Are they worthy of making it onto the Select List or bumping one of our Thematic Leaders? We’ll see…. And as I examine these two, I’m also pouring over some candidates to fill the Guilty Pleasure vacancy on the leader board.

 

 

WEEKLY ISSUE: Companies continue to serve up weaker guidance

WEEKLY ISSUE: Companies continue to serve up weaker guidance

Key points inside this issue

  • The outlook for earnings continues to wane even as the trade-related market melt-up continues.
  • Our price target on Amazon (AMZN) shares remains $2,250.
  • Our price target on Alphabet (GOOGL) shares remains$1,300.
  • Our price target on Costco Wholesale (COST) shares remains $250.
  • Our price target on Universal Display (OLED) shares remains $125.
  • Our price target on Nokia (NOK) shares remains $8.50

 

The outlook for earnings continues to wane even as the trade-related market melt-up continues

Domestic stocks continued to trend higher last week as the December-quarter issues that plagued them continued to be dialed back. Said another way, the expected concerns — the Fed, the economy, the government shutdown, geopolitical issues in the eurozone, and U.S.-China trade talks — haven’t been as bad as feared a few months ago.

In recent weeks, we have seen the Fed take a more dovish approach and last week’s data, which included benign inflation numbers and fresh concerns over the speed of the economy following the headline December Retail Sales Report and Friday’s manufacturing-led contraction in the January Industrial Production Index, reaffirm the central bank is likely to stand pat on interest rate hikes. We see both of those reports, however, feeding worries over increasing debt-laden consumers and a slowing U.S. economy. 

Granted, economic data from around the globe suggest the U.S. economy remains one of the more vibrant ones on a relative basis, which also helps explain both the melt-up in both the domestic stock market as well as the dollar. On Thursday we learned that economic growth in the eurozone was basically flat on a sequential basis in the December quarter, rising a meager 0.2%. Year-over-year growth stood at just 1.2% for the final quarter of 2018. This came after news that the eurozone economic powerhouse that is Germany had no growth itself in the fourth quarter after a contraction of 0.2% in the third quarter. Italy experienced its second consecutive quarter of economic contraction, putting it in a technical recession.

 

All of this put further downward pressure on the euro versus the U.S. dollar, which means dollar headwinds remain for multinational companies. And we still have another major headwind that is the lack of any Brexit deal. With three pro-EU Conservatives having resigned this morning from Prime Minister Theresa May’s party to join a new group in Parliament, there is no an even slimmer chance of Brexit deal being put in place ahead of next week.

So, what has been fueling the rebound in the stock market?

Among other factors, the deal to avoid another federal government shutdown, which was followed by the “national emergency” declaration that will potentially give President Trump access to roughly $8 billion to fund a border wall. We’ll see how this all plays out in the coming days, alongside the next step in U.S.-China trade talks that are being held this week in Washington. While “much work remains” on the working Memorandum of Understanding, trade discussions last week focused on several of the larger structural issues that we’ve been more concerned about — forced technology transfer, intellectual property rights, cyber theft, and currency.

Early this morning, it’s being reported that President Trump is softening on the March 1 phase in date for the next round of tariff increases, which is likely to give the market some additional trade optimism and see it move higher. We remain hopeful, but we expect there to be several additional steps to go that will set the stage for any final agreement that will likely be consummated at a meeting between Presidents Trump and Xi. And yes, the final details will matter and will determine if we get a “buy the rumor, sell the news” event.

Even as the trade war continues at least for now, we continue to see companies positioning themselves for the tailwinds associated with Living the Life and New Global Middle-class investing theme opportunities to be had in China. If you missed a recent Thematic Signal discussing how Hilton (HLT) is doing just that, you can find it here.

And then there are earnings

Over the last several weeks, we’ve been tracking and sharing the declining outlook for S&P 500 earnings for 2019. As we closed last week, roughly 80% of the S&P 500 companies had reported their quarterly earnings and issued outlooks. In aggregating the data, the new consensus calls for a 2.2% year-over-year decline in earnings for the current quarter, low single-digit earnings growth in the June and September quarters, and 9.1% growth in the December quarter. In full, the S&P 500 group of companies are now expected to grow their collective 2019 EPS by 5% to $169.53, which means that as those expectations have fallen over the last several months, the 2019 move in the market has made the stock market that much more expensive.

In my view, we are once again seeing a potentially optimistic perspective on earnings for the second half of the year. While a U.S.-China trade deal and infrastructure spending bill could very well lead to a better second half of 2019 from an earnings perspective, the unknown remains the vector and velocity of the rest of the global economy.  As discussed above, the US is looking like the best house on the economic block, but as I share below there are valid reasons to think that it too continues to slow.

 

Last week I touched on a Thematic Signal about the record level of auto loan delinquencies, and in the last few days, we’ve learned that student-loan delinquencies surged last year, hitting consecutive records of $166.3 billion in the September 2018 quarter and $166.4 billion in the December 2018 one. I’ve also noticed an uptick in credit-card delinquencies this past January as companies ranging from American Express (AXP) to JPMorgan (JPM) and other credit card issuers reported their monthly data. What I find really concerning is this record level of delinquencies is occurring even as the unemployment rate remains at multi-year lows, which suggests more consumers are seeing their disposable income pressured. While this isn’t a good sign for a consumer-led economy, it certainly confirms the tailwind associated with our Middle-class Squeeze investing theme.

 

Tematica Investing

 December Retail Sales shock some, confirm Costco and others

December Retail Sales have been published by the Commerce Department and to say the results were different than most were expecting is an understatement. And that’s even for those of us that were watching data of the kind I mentioned above.  Normally, holiday shopping tends to build as we close out the year, but according to the report, consumers pulled back in December as monthly retail sales fell 1.3% compared to November.

Yes, you read that right – they fell month over month, but as we know that is only one way to read the data. And while sequential comparisons are helpful, they do little to help us track year over year growth. From that perspective, retail sales in December 2018 rose 2.1% year over year with stronger gains registered at Clothing & Clothing Accessories Stores (+4.7%), Food Services & Drinking Places (+4.0%), Nonstore retailers (+3.7%) and Auto & other motor vehicles (+3.4%). That’s not to say there weren’t some sore spots in the report – there were, but there are also the ones that have been taking lumps for most of 2018. Sporting goods, hobby, musical instrument, & book stores fell 13% year over year in December, bringing the December quarter drop to 11% overall. Department Stores also took it on the chin in December as their retail sales fell 2.8% year over year. These declines are largely due to the accelerating shopping shift to digital from brick & mortar that are associated with our Digital Lifestyle investing theme.

Despite the headline weakness, I once again see the report as confirming for Thematic King Amazon (AMZN) and to a lesser extent Select List resident Alphabet (GOOGL) given its Google shopping engine. Not only is Amazon benefiting from the accelerating shift to digital commerce, but also from its own private label efforts, which span basic electronic accessories to furniture and apparel. It goes without saying that comparing the December Retail Sales report with Costco Wholesale’s (COST) monthly same-store sales reports shows Costco continues to win consumer wallet share.

 

As a reminder, Costco’s December same-store sales rose 7.5% in December (7.1% excluding gasoline prices and foreign exchange) and 6.6% in January (7.3%). And it remains on path opening new warehouse locations with 768 exiting January, up 3.0% year over year. That should continue to spur the company’s high margin membership fee income in the coming quarters. My suspicion is others are catching onto this given the 7% increase in COST shares thus far in 2019, the vast majority of which has come in the last week. We’ll continue to hold ‘em.

  • Our price target on Amazon (AMZN) shares remains $2,250.
  • Our price target on Alphabet (GOOGL) shares remains $1,300.
  • Our price target on Costco Wholesale (COST) shares remains $250.

 

Turning to this week’s data

This week’s shortened trading week brings several additional key pieces of economic data. And following the disappointing December Retail Sales report, these reports are bound to be closely scrutinized as the investment community looks to home in on the speed of the domestic economy. 

In addition to weekly mortgage applications, and oil and natural gas inventory data, tomorrow we’ll also get the December Durable Orders report and January Existing Home sales data. Given the drop-off in mortgage applications of late as well as weather issues, it’s hard to imagine a dramatic pick-up in the housing data since the end of 2018. Rounding out the economic data will be our first February look at the economy with the Philly Fed Index.

 Speaking of the Fed, today we’ll see the release of the Fed’s FOMC minutes from its January meeting. Considering the comments emanating from Fed heads lately as well as the lack of inflation in the January CPI and PPI data, there should be few surprises in terms of potential interest rate hikes in the near term. The looming question is the speed at which the Fed will normalize its balance sheet, which likely means that will be an area of focus as investors parse those minutes.

 

Here come Universal Display and Mobile World Congress 2019

As long as we’re looking at calendars, after Thursday’s market close Select List resident Universal Display (OLED) will report its quarterly results. To say the shares have found some legs in 2019 would be a bit of an understatement given their resurgence over the last several weeks.

 

We know Digital Lifestyle Select List company Apple (AAPL) has shared its plans to convert all of its iPhone models to organic light emitting diode displays by 2020, and that keeps us in the long-term game with OLED shares. Given the current tone of the smartphone market, however, we could see Universal Display serve up softer than expected guidance.

We’ll continue to hold OLED shares for the duration and look for signs that other device companies, including other smartphone vendors but other devices as well, are making the shift to organic light emitting diodes next week during Mobile World Congress 2019 (Feb. 25-28). The event is a premier one mobile industry as it tends to showcase new devices and technologies, and as you might imagine means a number of announcements. This means it’s not only one to watch for organic light emitting diode adoptions, but we are also likely to see much news on 5G virtual reality and augmented reality, key aspects of our Disruptive Innovators investing theme, as well. And with 5G in mind, we could very well hear of more 5G network launches as well, which means keeping my Nokia (NOK) and Digital Infrastructure ears open as well as my Digital Lifestyle ones.

  • Our price target on Universal Display (OLED) shares remains $125.
  • Our price target on Nokia (NOK) shares remains $8.50.

 

 

Weekly Issue: Earnings expectations take a dive

Weekly Issue: Earnings expectations take a dive

Key Points Inside This Issue

  • Earnings expectations for the first half of 2019 get revised lower
  • We are removing Altria (MO) shares from the Thematic Leaders.
  • Takeout speculation for USA Technologies (USAT)

 

 

Earnings expectations for the first half of 2019 get revised lower

Stocks surged last week, with all four major domestic stock market indices finishing up in low single digits compared to the prior week. This move was inspired by a number of factors, including a dovish-sounding Fed Beige Book report as more Fed districts have become less optimistic about the economy. Aside from the hard economic data, as we shared last week, rail company Genesee & Wyoming (GWR) reported traffic volumes for December that fell 4.8% year over year, and we saw sharp declines in the January reading for the Empire State Manufacturing Survey General Business Conditions Index.

This and the other data in the last several weeks led John Williams, president of the New York Federal Reserve and a voting member on the Federal Open Market Committee, to say in a speech Friday that the Federal Reserve should be cautious about hiking interest rates further after a year that saw four quarter-point increases. This reiterated the “data dependent” and patient view Fed Chair Powell exuded recently and signals a rate hike in the next few months is likely off the table.

Another powerful factor that led the market to finish the week on a high note was potentially positive progress on the U.S.-China trade front. On Thursday, The Wall Street Journal reported that Treasury Secretary Steven Mnuchin had floated the idea of easing tariffs on Chinese goods as the two countries continue to negotiate on trade. CNBC reported China offered a six-year increase in U.S. imports during recent trade talks and the potential deal could reduce the annual U.S. deficit to zero by 2024. These would be welcome developments ahead of the next round of trade talk in Washington on Jan. 30-31. Given the economic data emanating from China that shows declining factory sentiment, deflation and falling exports that have prompted China to add new stimulative measures for its economy, we are hopeful for more concrete and positive progress as we enter February.

There were also more developments on border security and the government shutdown, which still persists. This now longest government shutdown is increasingly expected to act as a headwind for the economy with some estimates putting the impact at 0.1-0.2% to GDP for each week of the shutdown. We will continue to watch the situation, potential discussions and any pending votes in Congress for what it means for the government shutdown as well as an incremental tailwind for our Safety & Security investing theme.

The government shutdown aside, potential progress on U.S.-China trade talks and more dovish talk by the Fed is helping the stock market grasp at that footing that we’ve been looking for. Granted it is tenuous at best, particularly on the trade front for any deal will hinge on the details. We are also still in the relatively early innings of the December-quarter earnings season, but this could very well help investors look through the growing list of companies that have served up disappointing earnings or guided below expectations. Notable misses last week were by JPMorgan Chase (JPM), BlackRock (BLK), Morgan Stanley (MS), JB Hunt Transport Services (JBHT), and Signet Jewelers (SIG), which was the latest victim of weak holiday sales.

But that was last week, and this shortened week for the market started off on a very different note. Given the growing signs of the slowing global economy, The International Monetary Fund (IMF) cuts its forecasts for world economic growth in 2019 to 3.5%, down from 3.7% forecast in October and 3.9% expected in July as it concedes the “global expansion has weakened.” While we here at home are focused on the potential impact of the government shutdown, the IMF’s forecast was  revised lower primarily due to Europe:

  • Germany’s growth forecast for 2019 was cut 0.6 percentage points due to weak consumption and industrial production data;
  • Italy was cut by 0.4 points due to weak domestic demand and high government borrowing costs,
  • and France was cut by 0.1 points due to the impact of ongoing street protests.

This view of slowing growth is making its way into the c-suite as evidenced by the latest edition of consulting firm PwC’s annual survey of CEOs. That findings of that survey of hundreds of corporate leaders showed 30% of respondents the hundreds of corporate leaders feel growth will decline this year. That’s a six-fold increase from a year earlier — when 57% were optimistic. That optimism was likely due to the impact of tax reform and as we know came before tariffs associated with the US-China trade war.

According to PwC, one of the clear messages from the new survey is “confidence is waning” amid rising trade tensions and protectionism. The survey found a 41-percentage point drop in CEOs choosing the U.S. as a top market for growth, and optimism among North American executives dropped the most sharply — from 63% to 37%. To me, that adds to the concern over corporate guidance to be issued during the current December quarter earnings season that I’ve been sharing over the last few weeks. Let’s remember too that we still have yet to see firm details emerge regarding Brexit and US-China trade talks, which are set for another round next week in DC.

As we’ve seen over the last several few weeks, a growing number of companies are issuing weaker than expected outlooks for the near-term. Over the last three months, this has led Wall Street to cut its earnings estimates for companies in the S&P 500 for the first half of 2019 to $81.73 from $85.56. That’s a hefty chop compared to the average trimming for the first half of the year earnings expectations that averaged 2.4% over the last 15 years.

The question we will continue to work toward answering as the current earnings season progresses is what are S&P 500 earnings looking like for 2019? That determination will shape what investors see as the appropriate market multiple based on the vector and velocity of the global economy and where we are in the business cycle. As those answers are determined, we here at Tematica will continue to look for companies that are poised to grow their earnings faster than the S&P 500, which historically has translated into a premium valuation relative to the market multiple. We aim to accomplish that identification process by leaning on our 10 investment themes and the signposts that are Thematic Signals.

 

Tematica Investing

To many a seasoned investor, we recognize that week to week stock prices can drift higher or lower, but it’s the longer trend in the share price that matters. Well, week over week we saw several of the Thematic Leaders move higher – AMN Healthcare (AMN), Chipotle Mexican Grill (CMG), Dycom (DY), Amazon (AMZN), and Axon Enterprises (AAXN) – while Netflix (NFLX), Del Frisco’s Restaurant Group (DFRG), Costco Wholesale (COST) and Alibaba (BABA) gave up some ground. Year to date, however, nearly all of the Thematic Leaders are in positive territory with quite a few outperforming the S&P 500 and its 5.0% gain so far this year.

The one underperforming leader is tobacco company Altria and that is leading us to…

 

Stubbing out Altria shares

In last week’s issue I shared that I was putting shares of Guilty Pleasure company Altria (MO) on watch, and today we are closing out that position and removing it from the Thematic Leaders. Despite the enviable dividend yield, the shares are down some 9% thus far in 2019, which has brought the return over the four months or so to -24%. I’m opting to cut bait on this position to limit losses. As I shared last week, questions are growing as to how Altria can generate sufficient returns on its significant investment in Juul Labs (JUUL) while its core tobacco business continues to come under increasing pressure and the cannabis legalization at the federal level has yet to emerge in the US.

As we bid adieu to Altria, I’ll be examining our thematic database for a new Guilty Pleasure Thematic Leader.

  • We are removing Altria (MO) shares from the Thematic Leaders.

 

Takeout speculation for USA Technologies

While all the major market indices gave back a portion of last week’s gains, shares of mobile payment company USA Technologies (USAT) that resides on the Tematica Select List bucked that trend to eke out a modest move higher. The reason for that relative outperformance was a note from Barrington Research that argues the best option for the company is for it to be sold. In other words, it is calling for either a larger mobile payment or payment company or perhaps private equity to acquire USA Technologies. The thought process in the Barrington note cites USA’s internal investigation as well as the ensuing credibility gap, both of which are amply reflected in the shares. Barrington puts the takeout price on USAT shares between $10-$15.

What do I think?

Last week we added the shares back on the prospects for the company to deliver its internal investigation findings and delayed 10-K filing, changes in key personnel that should help restore management credibility, and the positive fundamentals in the core mobile payments business. In our view, that risk-to-reward tradeoff justified adding the shares back to the portfolio with a revised price target of $10. That target is subject to revision based on what we learn when the company provides any and all financial restatements.

Would USA Technologies make for sense for a buyer?

Yes, it would particularly as current share price levels that would allow either a strategic or financial buyer to scoop the business up on the cheap. A larger entity would also look to address the credibility issues that have arisen but would also have greater resources to grow the business. That said, in our experience buying shares in a company because it MAY be acquired is tricky at best. We’ll continue to focus on the fundamentals, which in this case are benefitting from the positive tailwinds associated with mobile payment adoption that is part of our Digital Lifestyle and Digital Infrastructure investment themes.

And for what it’s worth, Amsterdam based Oakland Hill BV just boosted its ownership stake in USAT shares to 6.13%, up from 5.58% this past September. While I don’t know Oakland, my thought is they too see what we do in USAT shares at current levels.

 

 

Weekly Issue: Thematic M&A and Adding Back a Digital Infrastructure Position

Weekly Issue: Thematic M&A and Adding Back a Digital Infrastructure Position

Key points inside this issue

  • Despite the stock market’s year to date gains, concerns remain for December quarter earnings season
  • Thematic M&A was rampant in 2018
  • Our price targets on AMN Healthcare (AMN), Chipotle Mexican Grill (CMG) and Netflix (NFLX) remain $75, $550 and $500, respectively.
  • Putting shares of Guilty Pleasure thematic leader Altria (MO) on watch
  • We are issuing a Buy on and adding back shares of Digital Infrastructure company, USA Technologies (USAT), to the Tematica Select List with a price target of $10.

 

Despite the stock market’s year to date gains, concerns remain for December quarter earnings season

Over the last week, stocks continued to move higher placing all the major domestic stock market averages higher. Quite the turn from what we saw in much of the December quarter that evaporated all of 2018’s gains. Part of the rebound reflects the harsh beating that many stocks received as investors came to grips with the various factors that I’ve been discussing here over the last two months. The down and dirty summation of those factors is this: the global economy continues to slow and it is raising questions over not only GDP prospects for the coming year but also earnings.

Stoking those earnings growth concerns were negative pre-announcements from Apple (AAPL), Samsung, LG, Macy’s (M), Target (TGT) and Kohl’s (KSS) over the last two weeks. That combination points to slower smartphone demand, but I continue to see it picking up in the coming quarters as the Disruptive Innovation that is 5G ripples its way across our Digital Infrastructure and Digital Lifestyle investing themes.  This week we can add Delta Airlines (DAL), Dialog Semiconductor (DLGNF), Nordstrom (JWN), Electronics for Imaging (EFII), Sherwin Williams (SHW) and Ford Motor Company (F) to that list as well as earnings misses from Wells Fargo (WFC), BlackRock (BLK) and others. Not exactly a vote of confidence for the December quarter earnings season.

Adding fuel to the uncertainty, this morning rail company Genesee & Wyoming (GWR) reported traffic volumes for December fell 4.8% year over year. That piles on the limited data we are getting, which included the January reading for the Empire State Manufacturing Survey General Business Conditions Index that fell to 3.9 from 11.5 in December. That drop was led by a deceleration in new orders, inventories, and the number of employees. The survey’s six-month outlook also dropped, falling to 17.8 from 30.6 last month. These data points fit the view that there is a slowdown in manufacturing activity, which has piqued concerns about a broader slowdown in economic activity unfolding in 2019.

On top of that, yesterday Sen. Chuck Grassley said U.S. Trade Representative Robert Lighthizer saw little progress on “structural issues” in last week’s talks with China. These issues include intellectual property, stealing trade secrets, and putting pressure on corporations to share information with the Chinese government and industries. These issues are the very ones I was concerned about in terms of the trade negotiations. With China cutting its growth forecast some days ago to 6% from 6.5% and more data pointing to that economy cooling, there is likely room for the trade talks to include those issues, but my concern remains the ticking timeline until tariffs jump further. If that comes to pass, it would be another headwind to the global economy and corporate earnings for the coming quarters.

Given all of that, I remain concerned with the December quarter earnings season that will kick into gear next week and what it could do for the stock market’s recent rebound. We’ll continue to keep the long position in ProShares Short S&P 500 (SH) in play as we watch and listen to the thematic signals we see. One great thematic signal this week for our Guilty Pleasures investing theme is that Pizza Hut, owned by Yum Brands (YUM) is expanding beer delivery to 300 restaurants across seven states later this month. Amazing to think that only now Pizza Hut is realizing one of the great culinary pairings of Pizza and beer as it looks to offer customer one-stop shopping as well as capture that incremental revenue and profits. Odds are there will be some element of our Digital Lifestyle theme at play, given the push toward mobile orders we are seeing across the restaurant industry. Now to see what beer they offer… hopefully, it will be more than just the big brand beers like Budweiser.

Another signal that points to the bleeding over of our Digital Lifestyle, Disruptive Innovators and Aging of the Population themes is the partnering between Walgreens Boots Alliance (WBA) and Microsoft (MSFT). Over the next several years, the two will research and develop new methods of delivering healthcare services through digital devices, including virtually connecting people with Walgreens stores.

We at Tematica see thematic signals for our 10 investing themes practically everywhere… and that means we will continue using them to build and refine our investing mosaic in the days, weeks and months ahead. As we navigate the next few weeks, we may have a change or two on the Thematic Leaders and a few companies that make it onto the Contender List for when the stock market finds its footing.

 

Thematic M&A was rampant in 2018

Over the last two weeks, we here at Tematica have been reviewing the thematic database of more than 2,400 stocks that we’ve ranked based on their exposure to our 10 investment themes. That was no small project let me tell you, and it was a key initiative for 2018. In looking back over that body of work, I noticed more than a dozen companies that were in the database at the start of last year had been acquired during the second half of 2018. Here’s a short list of what I’m talking about:

As you can see, the acquisition activity was spread across a number of our themes and included both strategic and financial buyers. In each case, the buyer looked to fill a competitive hole be it a product, market or technology. That’s the classic finance take on it, but we know those buyers were looking to solidify their exposure to the thematic tailwinds that are powering their businesses or in some cases expose themselves to another one.

Are we likely to see more thematically based M&A in the coming months?

My view is yes, particularly as the global economy slows and companies look to deliver top and bottom line growth be it on an organic or acquired basis.

Adding back shares of Digital Infrastructure company USA Technologies

Today I am calling shares of mobile payments company, USA Technologies (USAT),  back onto the Tematica Select List following news earlier this week about the results of an internal investigation into its accounting practices. You may recall that last year, USAT shares were a high flyer for the Select List. However, upon learning that the USAT board would conduct an internal investigation into the accounting of certain of its present and past contractual arrangements and its financial reporting controls and would miss filing the company’s 10-K, we smartly jettisoned the shares near $10.25 last September.

We had been trimming the position at higher levels near $14 in the preceding months, but in light of those developments we “got out of Dodge”, so to speak, and did not stick around for the free fall to $3.44 by early December. While we continued to see growing adoption of mobile payments, especially at USAT’s core market of vending machines and unattended retail, we also saw the stock price pain associated with these investigations and potential financial restatements. “No thanks” was my thinking.

The company on Monday announced both the findings of its internal investigation and remedial actions to be implemented by the board. It also shared that it is working to file its 10-K as soon as possible and disclosed the departures of both its chief financial officer (CFO) and chief services officer (CSO). In tandem with those announcements, USAT also shared it is in negotiations for a new CFO.

In terms of the investigation and the planned responses, the company’s Audit Committee found that, for certain transactions, USAT had prematurely recognized revenue and, in some cases, the reported number of connections associated with the transactions under review. The committee went on to recommend the company enhance its internal controls and its compliance and legal functions; expand its public disclosures; and consider appropriate employment actions related to certain employees as well as splitting the roles of chairman and CEO.

These measures, along with the departure of the CFO and CSO, are not surprising, but they do put USAT on the path to restoring investor confidence in its reporting. While this investigation was happening the market for mobile payments continued to be on a tear as companies such as PepsiCo (PEP) inked a new five-year agreement with USAT.

Clearly, there is more work to be completed, and there is the risk that we are re-entering these shares on the early side. However, as we have seen in the past, as these clouds lift investors will focus on the tailwinds of the business, which in this case are centered on mobile payments and are improving. Therefore, we will resume ownership of USAT shares and look to scale on potential stock price weakness when the company formally restates its revenue and other key metrics. Better a bit early than too late is my thinking on this one.

Our previous price target on USAT shares was $16. However, we should prudently assume that several of the underlying financial metrics will be restated lower. Consequently, I’m taking a haircut relative to our prior target and putting out a new price target of $10. As the company releases its updated financials, I’ll look to fine-tune that price target as needed

  • We are issuing a Buy on and adding back shares of Digital Infrastructure company, USA Technologies (USAT), to the Tematica Select List with a price target of $10.

 

The Thematic Leaders

As the stock market moved higher week over week as of last night’s close, we saw several Thematic Leaders move higher. These included Aging of the Population leader AMN Healthcare (AMN), and Clean Living leader Chipotle Mexican Grill (CMG) as well as Thematic King Amazon (AMZN). The big winner, however, was Digital Lifestyle leader Netflix (NFLX), which yesterday announced it would boost prices for its monthly memberships by 13% to 18%. This marks the company’s biggest price increase and I suspect was well thought out by the management team, given the increasingly competitive playing field. That price increase should drive Wall Street’s revenue expectations higher and improve its ability to not only spend on proprietary content but also its ability to service its quarterly debt costs.

  • Our price targets on AMN Healthcare (AMN), Chipotle Mexican Grill (CMG) and Netflix (NFLX) remain $75, $550 and $500, respectively.

 

Putting Altria shares on watch

Even though we’re just a few weeks into 2019, shares of Guilty Pleasure leader Altria have been underperforming on both an absolute basis and a relative one compared to the S&P 500. Weighing the shares down are questions over its ability to recoup the $12.8 billion investment for a 35% stake, in e-vapor market leader Juul Labs (JUUL). While this is part of the company’s efforts to reposition itself, given prospects for continued declines in its core tobacco market, complicating things is the FDA’s move to stub out youth access to e-vapor and flavored cigarettes.

Odds are this will take several years to come about but it raises questions as to whether Altria is trading one shrinking market for another. Candidly, I would have preferred Altria take that $12.5 billion and spread it across several cannabis investments. I’ll continue to be patient for now with this thematic leader, however, I’ll be looking at several in the coming days that could offer a far better risk to return tradeoff.