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Costco vs Amazon? We see opportunity for both

Costco vs Amazon? We see opportunity for both

 

In this Week’s Issue:

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

 

 

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

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

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

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

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

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

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

 

 

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

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

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

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

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

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

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

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

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

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

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

 

 

Investor Short-Sightedness Triggers UNFI Stop-Loss

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

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

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

 

 

Checking in on Dycom Shares

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

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

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

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

 

 

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

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

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

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

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

 

 

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

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

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

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

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

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

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

 

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

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

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

 

Food with Integrity Theme Seen in Retail Sales Report As Well

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

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

 

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

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

In this Week’s Issue:

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

 

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

 

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

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

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

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

 

 

Putting UNFI and AT&T Under the Microscope

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

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

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

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

 

 

Nuance Communications – Big Deals for this Disruptive Technology Player

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

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

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

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

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

 

AXT Inc.  – More Than Riding the Smartphone Wave

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

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

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

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

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

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

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

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

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

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

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

The Bottom Line in AXT Inc (AXTI):

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

 

Washington’s Attack on Online Advertising Revenues Disguised as Tax Reform

Washington’s Attack on Online Advertising Revenues Disguised as Tax Reform

When we look at the creative destruction associated with our Connected Society investing theme, on the positive side we see new technologies transforming how people communicate, transact, shop and consume content. That change in how people consume TV, movies, music, books, and newspapers has led to a sea change in where companies are spending their advertising dollars given the consumer’s growing preference for mobile consumption on smartphones, tablets and even laptops over fixed location consumption in the home. This has spurred cord cutters and arguably is one of the reasons why AT&T (T) is looking to merge with Time Warner (TWX).

Data from eMarketer puts digital media advertising at $129.2 billion in 2021, up from $83 billion this year with big gains from over the air radio as well as TV advertising. As a result, eMarketer sees, “TV’s share of total spend will decline from 35.2% in 2017 to 30.8% by 2021.”

That shift in advertising dollars to digital and mobile platforms away from radio, print and increasingly TV has created a windfall for companies like Facebook (FB) and Alphabet (GOOGL) as companies re-allocate their advertising dollars. With our Connected Society investing theme expanding from smartphones and tablets into other markets like the Connected Car and Connected Home, odds are companies will look to advertising related business models to help keep service costs down. We’ve seen this already at Content is King contenders Pandora (P) as well as Spotify, both of which use advertising to allow free, but limited streaming music to listeners. Outside the digital lifestyle, other companies have embraced this practice such as movie theater companies like Regal Cinema Group (RGC) that use pre-movie advertising on the big screen to help defray costs.

As we point out, however, in Cocktail Investing, investors need to keep tabs on developments in Washington for they can potentially be disruptive to business models and that could lead to revisions to both revenue and earnings expectations. Case in point, current Ways and Means Committee Chairman Kevin Brady recently acknowledged that there “may be a need” to look at some of the revenue raisers to complete his 2017 tax reform proposal. One item was revisiting the idea to convert advertising from being a fully deductible business expense – as it has been for over a century – to just half deductible, with the rest being amortized over the course of a decade.

The sounds you just heard was jaws dropping at the thought that this might happen and what it could mean to revenue and earnings expectations for Facebook, Alphabet, Twitter (TWTR), Snap (SNAP), Disney (DIS), CBS (CBS), The New York Times (NYT) and all the other companies for which advertising is a key part of their business model.

Other jaws dropping were those had by economists remembering the 2014 IHS study that showed the country’s $297 billion in advertising spending generated $5.5 trillion in sales, or 16% of the nation’s total economic activity, and created 20 million jobs, roughly 14% of total US employment at the time. Those same economists are likely doing some quick math as to what the added headwind would be to an economy that grew less than 1 percent in 1Q 2017 and how it would impact future job creation should an advertising tax be initiated. It’s hard to imagine such an initiative going over well with a president that is looking to streamline and simplify the tax code, especially when one of his key campaign promises was to lower tax rates.

As we talked on the last several Cocktail Investing Podcasts, there are several headwinds that will restrain the speed of the domestic economy – the demographic shift and subsequent change in spending associated with our Aging of the Population investing theme and the wide skill set disparity noted in the monthly JOLTs report that bodes well for our Tooling & Retooling investment theme are just two examples. Our view is incremental taxes like those that could be placed on advertising would be a net contributor to the downside of our Economic Acceleration/Deceleration investing theme.

That’s how we see it, but investors in some of the high-flying stocks that have driven the Nasdaq Composite Index more than 17 percent higher year to date should ponder what this could mean to not only the market, but the shares of Facebook, Alphabet, and others. In our experience, one of the quickest ways to torpedo a stock price is big earnings revisions to the downside. With the S&P 500 trading at more than 18x expected 2017 earnings, a skittish market faced with a summer slowdown and pushed out presidential policies could be looking for an excuse to move lower and taking the wind out of this aspect of the technology sails could be it.

Macy’s Margins Harbinger of What’s to Come as Amazon Flexes Its Apparel Muscles

Macy’s Margins Harbinger of What’s to Come as Amazon Flexes Its Apparel Muscles

 

Yesterday Macy’s (M) warned that its gross margins are likely to come under pressure in the balance of 2017, which in our view serves as a reminder of the more than challenging retail environment that is a direct fallout of our Connected Society and Cash-Strapped Consumer investing themes. With many households living paycheck to paycheck, consumers want the best price possible and the Connected Society makes price comparison easier than ever, leaving retailers with less and less pricing power while at the same time minimum wage hikes shrink margins even further.

We’ve had other reminders in the last few days of the profound impact of these themes, including Sears (SHLD) closing an additional 72 locations on top of the 180 it announced earlier this year. In sum, these closures will shrink the Sears footprint to roughly 1,200 locations compared to 2,073 five years ago. One-time high flying Affordable Luxury investment theme retailer Michael Kors (KORS) not only recently shared it would shut 125 full-price locations over the next two years, but it guided same-store comps and revenues lower for the coming quarters due to decreased mall traffic and increased promotional activity.

These are just the latest in a series of data points that confirm the current bout of “retail-megaddon” has legs into the all-important holiday-filled second half of the year. Those same data points also confirm our short position thesis in Simon Property Group (SPG). Over the last few years, we’ve seen shoppers increasingly switch to digital commerce, with both online and mobile shopping, at the expense of brick & mortar retailers. While many will rightfully jump to Amazon and its Prime service that has compressed delivery time to customer significantly, other retailers ranging from Nike (NKE) to Under Armour (UA), Williams Sonoma (WSM) and Nordstrom (JWN) are embracing the direct to consumer (DTC) model — some with more success than others.

 

Yet Another Thematic Tailwind for Amazon

We expect to see a continued shift in retailers from brick & mortar to digital, much like we’ve seen at Macy’s and others, but here’s the thing that is likely to hit apparel retailers – Amazon flexing its muscles as it moves into apparel. Even though Amazon has cancelled its Style Code Live show, which served to tout products for shoppers to buy on Amazon, in 2016 it registered the most apparel sales of any online retailer in the US for the 18–34 demographic with more than double the market share of second place Nordstrom.

Clearly, Amazon is looking to leverage the reasons cited by shoppers for switching to Amazon – Prime, convenience, customer service, and reviews – and earlier this year it launched several private label apparel brands with products in men’s accessories, women’s dresses, and handbags followed by its own line of lingerie in April. The company’s latest effort to goose its apparel position can be found in its latest Alexa powered device, the Echo Look, which is, “a gadget with a built-in camera that is being marketed as a way to photograph, organize and get recommendations on outfits.” As part of its recommendation services, no doubt the Echo Look will recommend not only brands that can be bought on Amazon, but more than likely it will include its private label products as well.

To us, the question is not will Amazon succeed in apparel, but rather, is it tracking ahead of expectations? Research firm Cowen & Co. shared its expectations for Amazon apparel sales to account for 8.2 percent of the domestic apparel market this year, up from 6.6 percent in 2016, and 16.2 percent by 2021. To help put some context in and around those percentages, apparel is one of the biggest US retail categories with estimates sizing it up as high as $300 billion. Each market share point gain by Amazon equates to an additional $3 billion in annual revenue for the company — yes, that’s billion with a b.

And while that $ 3 billion in revenue equates to 1.5 to 1.8 percent of expected 2017-2018 revenue for Amazon, it also equates to:

  • 12 percent of Macy’s (M) total expected revenue this year
  • Roughly half of what Wall Street expects Dillard’s (DDS) to generate in revenue this year
  • More revenue than Bon-Ton Stores (BONT) is forecasted to collect this entire year across is 270 stores and 25 million square feet.

Again, that’s each market share point, and Cowen’s forecast calls for Amazon to gain more than 1.5 percentage points in 2017 alone. To paraphrase one time presidential candidate Ross Perot, that giant sucking sound you are hearing is brick & mortar retailers going down the drain.

Back to the topic at hand, the bottom line is Amazon’s apparel market share gains, revenues and profits as part of our Connected Society and Cash-Strapped Consumer investing themes will only exacerbate retail-meggadon, likely leading to even more vacant retail space in malls across the U.S. Spurring this along is a consumer that is increasingly strapped with high and likely raising debt levels combined with little in the way of wage gains. This one-two combination of our Cash-strapped Consumer and Connected Society investing themes paints a not so pleasant picture of fewer retailers and empty storefronts with potentially more people unemployed.

Lastly, as retailers go down the drain, our thematic lens also looks to what could also be washed down with it. We’re talking about the large chain restaurants that tend to favor retail centers, the likes of Darden Restaurants (DRI), Brinker International (EAT) and Bravo Brio Restaurant Group (BBRG) just to name a couple. How those groups pivot to attract diners when malls are increasingly closing or are near empty will be critical as they attempt to avoid “restaurant-mageddon”. Haven’t heard that one yet? We’re already starting to see the Thematic Signals point to it as lunchtime meals have plunged and restaurant sales are showing signs of peaking.

The good news is, we all have to eat, and several restaurant chains are turning to mobile ordering (good news for our Cashless Consumption theme) and new, more healthy menu options that is part of our Foods with Integrity theme. But that’s all for another story, literally.

 

 

Apple’s WWDC17: An event lacking vision from a company without a visionary

Apple’s WWDC17: An event lacking vision from a company without a visionary

Yesterday, Apple (AAPL) held its annual World Wide Developer Conference (WWDC) at which CEO Tim Cook showcased a number of announcements. While we tend to be Apple devotees when it comes to the hardware and its ease of use, in taking a few steps back, our view is this year’s WWDC is it was one largely filled with refinements and incremental additions. Not entirely surprising, given the fact that Apple is now led by an expert operations manager, Tim Cook, and not a visionary like Steve Jobs. As we see it, Apple will either need to bring in some visionary expertise, or perhaps, and more likely, use it’s war chest of $250 billion to buy some vision in the form of acquisitions, but that’s another story.

We have not been buyers of Apple shares as of late — despite being avid fans, if not a lover of its products — given the transition-like nature of the product cycle that keeps Apple arguably reliant on the iPhone. Instead, for subscribers to our Tematica Research premium service, we’ve recognized the Apple-related opportunity from a different perspective – one that intersects with our tendency to “Buy the Bullets, Not the Guns” and several of our investing themes — Connected Society, Content is King, Cashless Consumption and Disruptive Technologies – with great success along the way. Examples include Universal Display (OLED), Nuance Communications (NUAN) and Applied Materials (AMAT), which are up more than 127 percent, 23 percent and 28 percent, respectively since being added to the Tematica Select List.

In our view, Apple is in a tough spot after setting the bar so high for so long. It too now has to compete with how it once wowed audiences and consumers as it updates existing products and tries to find its footing with new ones. Given its size, install base and the fact that its products are for the most part so simple to use, Apple isn’t likely to go the way of Kodak or Xerox anytime soon.

Getting back to the conference, on the smaller side, there were announcements like Amazon’s (AMZN) Prime Video coming to Apple TV and the upgrades to its Mac line. The real interest was in what the latest release of its mobile operating system iOS 11 brings, with a surprise in that this next iteration is likely to make the iPad a device to be embraced for both business as well as personal use. Perhaps the best worst kept secret heading into the event was Apple’s move into the connected speaker market, and yes Apple did take the wraps off HomePod, which looks to be Apple’s second if not a third potential hub in the home. The first two hubs being the iPhone and Apple TV, both of which connect with Apple’s HomeKit.

 

 

Interestingly, Apple is leading HomePod with music first and as a connected device with Siri second. Perhaps this is because if you’ve ever asked Siri the same questions as you might ask Amazon Alexa, one tends to realize that Siri isn’t the sharpest knife in the drawer, as it lacks the backing of Amazon’s Amazon Web Services and artificial intelligence. This strategy is also likely aiming to spur subscriptions to Apple’s Apple Music service; we can’t tell you how many times Apple shared it offers more than 40 million songs during the keynote presentations. Will this be a viable competitor to Sonos’s smart speakers when it comes to sound quality? Could the HomePod spur Amazon or Alphabet to acquire Sonos? Time will answer both of those questions.

Apple did tout Siri Intelligence several times during yesterday’s presentations, but this appears to be an area of continued investment as Apple catches up to Amazon and Google rather than leapfrogging them in the process and redefining the category. With Amazon’s strategy to make Alexa compatible with autos, the likes of Ford (F) and Volkswagen, as well as consumer appliance companies such as Whirlpool (WHR), it looks like the old OS war between Microsoft and Apple could be played out again in the voice digital assistant space. This raises several questions in our minds – Will Apple license Siri for use outside of Apple products? Will Amazon have the same issues Microsoft had with Windows and device compatibility? Fodder for thought and what it may mean for the future of these interfaces.

Yes, there was some cool new Apple stuff, like the Do Not Disturb While Driving feature, the ability to drag and drop with iOS 11, which in our view was sorely missing for the iPad and Apple’s foray into Virtual Reality (VR). But again, the head turning “wow” factor just wasn’t there. Even with HomePod, it will be interesting to see how it stacks up against Amazon’s Echo products as well as Alphabet’s (GOOGL) Google Home in the coming months. One would have to think these companies are prepping newer models, perhaps with better sound capabilities, ahead of the year-end holiday season.

The problem as we see it is Apple is trapped inside a near yearly refresh rate that makes it challenging to deliver breakthrough features each and every year. Even the new iOS name, iOS 11, is uninspiring.

Who has a blowout birthday when they turn 11?

Even the naming conventions for the new macOS and iMac were iterative in nature with Craig Federighi, Apple’s senior vice president of Software Engineering, getting a good nature laugh along the way.

Now with the WWDC keynote behind us, the next event to watch for Apple will be the unveiling of the much-discussed iPhone 8 model later this year. While Apple did sneak peek a few products yesterday, we heard nothing about the next iPhone model and as the news cycle turns away from WWDC we expect investor speculation to run rampant when it comes to this device later this summer. With 66 percent of Apple’s sales coming from the iPhone over the last two quarters, it’s the one product that Apple has to get right. Odds are it will, and that device will keep Apple as one of the key players in our Connected Society investing theme as its other initiatives – Virtual Reality, Apple Pay, Apple Watch and Apple TV – feel the lift of our Disruptive Technology, Cashless Consumption, Fountain of Youth and Content is King themes.

As these tailwinds blow, our Tematica Select List will surely continue to reap the benefits.

Amazon spends 2.5x more on content than HBO

Amazon spends 2.5x more on content than HBO

We nearly passed right over this article on Business Insider because it didn’t seem all that newsworthy to us — the ins and outs of how Amazon is producing its video content.  But then near the bottom came some very interesting figure:

Global dominationJPMorgan has estimated that Amazon will spend $4.5 billion on video in 2017. While this would still sit below Netflix’s $6 billion content budget for 2017, it would mean a big step up for Amazon. For reference, HBO spent around $2 billion on programming in 2016, and while Time Warner CEO Jeff Bewkes said that budget would rise a bit this year, he characterized the 2017 HBO programming budget as a “couple of billion dollars” in December.

Amazon spending more than twice what HBO is spending on programming says a lot about where Amazon things the market is and the power of original content to its Amazon Prime offering.

 

Source: How Amazon makes TV, according to Jill Soloway of ‘Transparent’ – Business Insider

 

 

May Data From ADP and Challenger Offer Confirmation for Several Tematica Select List Positions

May Data From ADP and Challenger Offer Confirmation for Several Tematica Select List Positions

This morning we received the Challenger Job Cuts Report as well as ADP’s view on May job creation for the private sector. While ADP’s take that 253,000 jobs were created during the month, a nice boost from April and more in line with 1Q 2017 levels, we were reminded that all is not peachy keen with Challenger’s May findings. That report showed just under 52,000 jobs were cut during the month, a large step up from 36,600 in April, with the bulk of the increase due unsurprisingly to retail and auto companies.

As Challenger noted in the report, nearly 40% of the May layoffs were due to Ford (F), but the balance was wide across the retail landscape with big cuts at Macy’s (M), The Limited, Sears (SHLD), JC Penney (JCP) and Lowe’s (LOW) as well as others like Hhgregg and Wet Seal that have announced bankruptcy. In total, retailers continued to announce the most job cuts this year with just under 56,000 for the first five months of 2017. With yesterday’s news that Michael Kors (KORS) will shut 100 full-price retail locations over the next two years, we continue to see more pain ahead at the mall and fewer retail jobs to be had.

Sticking with the Challenger report, one of the items that jumped out to us was the call out that,

“Grocery stores are no longer immune from online shopping. Meal delivery services and Amazon are competing with traditional grocers, and Amazon announced it is opening its first ever brick-and mortar store in Seattle. Amazon Go, which mixes online technology and the in-store experience, is something to keep an eye on since it may potentially change the grocery store shopping experience considerably, “

 

In our view, this means the creative destruction that has plagued print media and retail brought on by Amazon (AMZN) is set to disrupt yet another industry, and it’s one of the reasons we’ve opted out of both grocery and retail stocks. The likely question on subscriber minds is what does this mean for our Amplify Snack Brands (BETR) position? In our view, we see little threat to Amplify’s business; if anything we see it’s mix of shipments skewing more toward online over time. Not a bad thing from a cost perspective. We’d also note that United Natural Foods (UNFI) is a partner with Amazon as well.

  • Our price target on Amazon (AMZN) remains $1,100 and offers more than 10% upside from current levels.
  • Amplify Snack Brands (BETR) has an $11 price target and is a Buy at current levels.
  • Our target on United Natual Foods (UNFI) is $65, and the recent pullback over the last six weeks enhances the long-term upside to be had.

We’d also note comments from Chipotle Mexican Grill (CMG) that its recent cybersecurity attack hit most Chipotle restaurants allowing hackers to steal credit card information from customers. In a recent blog post, Chipotle copped to the fact the malware that it was hit with infected cash registers, capturing information stored on the magnetic strip on credit cards. Chipotle said that “track data” sometimes includes the cardholder’s name, card number, expiration date and internal verification code. We see this as another reminder of the down side of what we call both our increasingly connected society and the shift toward cashless consumption. It also serves as a reminder of the long-tail demand associated with cyber security, and a nice confirmation point for the position PureFunds ISE Cyber Security ETF (HACK) shares on the Tematica Select List.

  • Our price target on PureFunds ISE Cyber Security ETF (HACK) shares remains $35.

 

While revenues for Esports aren’t “there” yet, males 18-34 sure are, and we know what that means

While revenues for Esports aren’t “there” yet, males 18-34 sure are, and we know what that means

Over the past few years, esports have taken the gaming world by storm. Although China accounts for 57% of worldwide esports viewership, according to IHS Markit, the market in Europe has gained a lot of attention recently for its rapid growth.In the run-up to this week’s Wargaming.net 2017 World of Tanks Grand Finals in Moscow, one of the event’s sponsors, PayPal, commissioned SuperData Research to investigate the esports marketplace in 12 countries in Europe. The May 2017 study found that revenues derived from esports in the region totaled $301 million in 2016, and are expected to reach nearly $346 million in 2018.

Full Article: Esports Revenues in Europe to Reach $346 Million in 2018 – eMarketer

 

We’ve all heard about the demise of traditional broadcast media and the loss of the coveted 18-24 age demographic by advertisers being the main culprit dwindling TV advertising revenues.  Of course, those following our Connected Society and Content is King themes know, it’s certainly not because that age group is spending LESS time in front of screens.  They’re just in front of different screens, or in some cases, the same screen just not watching traditional programming.

A year or so ago we wrote about Madison Square Garden being sold out for an eSports event (it certainly wasn’t for a Knicks NBA Finals game).  And then in April we shared how the University of Utah had created an e-Sports “varsity” program — essentially an intercollegiate gaming program.

As we all know, where the eyeballs are is where the advertisers will head. And once the ad dollars pour in we’ll see rapid expansion of the genre.

 

Facebook following Amazon’s playbook — creating original content

Facebook following Amazon’s playbook — creating original content

Facebook has signed deals with millennial-focused news and entertainment creators Vox Media, BuzzFeed, ATTN, Group Nine Media and others to make shows for its upcoming video service, which will feature long and short-form content with ad breaks, according to several sources familiar with the situation.Facebook is planning two tiers of video entertainment: scripted shows with episodes lasting 20 to 30 minutes, which it will own; and shorter scripted and unscripted shows with episodes lasting about 5 to 10 minutes, which Facebook will not own, according to the sources.

Source: Facebook paying up to $250,000 for its own TV shows – Business Insider

 

With all of the screens at our disposal and eyeballs are pulled in more and more directions, it’s the content producers that are winning — the underlying component of Tematica’s Content is King investment theme. Amazon being the most notable non-traditional content producer in the space, Facebook is now following the same playbook by jumping into the original content space to keep the audience on page for longer. The difficulty of course for the competition is that Facebook isn’t necessarily getting into this game to generate revenue, but rather as a defensive measure to keep the advertising dollars flowing.