WEEKLY ISSUE: Earnings and Washington Drama Take Center Stage
In this Week’s Issue:
- No Real Shock in AT&T’s (T) Earnings, However, Some of the Details Have Us Downgrading Dycom (DY) from a “Buy” to a “Hold”
- What We’re Expecting Later This Week in Earnings Reports from Amazon (AMZN), Alphabet (GOOGL) and Starbucks (SBUX)
- Developments in Our Positions in DIS, HACK, IFF, BETR
With the pace of corporate earnings picking up this week, we have a lot to cover so we’ll keep our opening comments rather brief.
You’ve likely noticed the strong rise to the market this week, following the initial round of French elections. That euphoria, however, could be short-lived as the market’s focus returns to earnings and the unfolding drama in Washington. While the earnings reports we’ve received thus far have been encouraging, in sifting between the headlines there are some reasons to be concerned and as we get the bulk of this week’s reports today and tomorrow, we suspect more concerns will bubble to the top.
On the political front, there is the risk of a federal government shutdown (low probability in our opinion), the renewed GOP effort on healthcare reform and now Trump’s tax proposal. To us, the combination of earnings and Washington happenings are likely to cause some renewed uncertainty in the market, which could lead to some giveback in its recent gains. Yes, we know new records were set in the Dow Jones Industrial Average and the Nasdaq Composite Index, but in our view that only means stretched market valuation are even more so. Given the findings of the Bank of American Merrill Lynch institutional money manager survey we shared in this week’s Monday Morning Kickoff that 83 percent find the stock market over-valued, we suspect that level has only ticked higher in the last few days.
We will continue to be prudent with the Tematica Select List and follow the latest thematic data points. Be sure to tune into the latest episode of the Cocktail Investing Podcast later this week, when we share a number of those data points.
Now let’s get to it…
No Real Shock in AT&T’s (T) Earnings, However, Some of the Details Have Us Downgrading Dycom (DY) from a “Buy” to a “Hold”
Last night Connected Society investment theme company AT&T (T) reported 1Q 2017 results that met bottom line expectations but missed on revenue for the quarter. With our underlying investment thesis intact — the transformation of the company into a mobile content player from simply a wireless services player — despite the wireless led revenue shortfall in the quarter, we will continue to watch AT&T shares with the intention of using weakness below $40 to round out our position size as the shares settle out from last night’s earnings report.
In looking into the details of what AT&T reported, we find that for the March quarter AT&T delivered earnings $0.74 per share on revenue of $39.4 billion vs. the expected $40.5 billion. The culprit in the revenue miss was a combination of lower new equipment sales (roughly 1 million fewer units vs. a year ago), a more challenging pricing environment and a loss of 191,000 postpaid subscribers — pretty much the same issues that plagued Verizon’s (VZ) Verizon Wireless business in the March quarter. The subscriber winner appears to have been T-Mobile USA (TMUS), but we offer our view that being a winner in an increasingly commoditized and price sensitive business is not really winning long-term.
In a somewhat surprising move, AT&T has decided it will no longer give full-year revenue guidance due to the unpredictability of the mobile handset market. Given the combination of the move to no longer subsidizing mobile phone purchases and a domestic wireless market that is more tied to the phone upgrade cycle than new subscriber growth, we are not shocked that forecasting wireless handset revenue has become increasingly difficult. Offsetting the 2.8 percent drop in AT&T’s revenue year over year, the company improved its consolidated margins by 80 basis points vs. year ago levels due to automation, digitization, and network virtualization. The company targets having 55 percent of its network functions virtualized by the end of 2017, which should offer incremental margin improvement opportunities over the coming quarters.
Our thesis on the T shares has centered on the pending transformation that will occur in the business model following the merger with Time Warner (TWX), which will shift the emphasis away from the increasingly commoditized mobile service business. Even ahead of the closing of that transaction, AT&T has taken steps to position itself within the content arena with the acquisition of DirectTV and the subsequent launch of DirecTV Now. On the earnings call, these were areas of focus with AT&T commenting that it continues to expect approval for Time Warner transaction and we’ve shared the environment toward it in Washington has warmed considerably since the 2016 presidential election. We continue to expect more details in terms of guidance and synergies to be had once the transaction closes late this year.
After what some would say was a slow start, DirecTV Now — the company’s s over-the-top service that offers a wide selection of live television, premium programming and On Demand content — continued to add customers in the quarter. AT&T is looking to get a little more aggressive in the second half of 2017 with DirectTV Now, particularly with wireless bundling and we’ve already started to see new TV ads with Mark Wahlberg touting the offering. With just five months under the belt, we expect AT&T to be patient with this business, especially since it is likely to be a direct beneficiary of the Time Warner’s content library in 2018.
The bottom line is while the revenue miss for the quarter was a disappointment, following Verizon’s results it was hardly a shock to the system. The revenue miss at both companies highlights the reasons for our owning the shares very much remain intact. As we said several months ago, with AT&T’s business poised to transform over the coming quarters, its shares are likely to be rangebound until we have some clarity and understanding on the synergies to be had. That same transformation means that investors are likely to look past near-term ups and downs in the wireless business. In our view, in hindsight, AT&T’s move to snare Time Warner shows the management team is rather forward-thinking and the same can be said for its leading wireless spectrum business as it looks to bring select 5G services to market in 2018.
AT&T’s focus on bringing 5G services to market are, of course, rather positive for our Dycom (DY) shares. During 1Q 2017, AT&T spent $6 billion on capital spending and reiterated its plans to invest $22 billion in full for 2017. With that expected spending level at Dycom’s largest customer unchanged to the upside, and following the additional 5 percent move in DY shares over the last few days, we now have just 6 percent upside to our $115 price target for Dycom.
To keep our Buy rating intact on DY shares from current levels, we’d need to see upside in the shares to more than $125; at the same time we recognize that given the 33 percent move in DY shares over the last three months, they could come under pressure should the market get a little rocky this earnings season. For those reasons, we’re downgrading DY shares to a Hold. We’ll continue to evaluate our price target as we other key customers update their 2017 capital spending plans and should we get wind of an accelerating 5G deployment timetable.
- Our price target on AT&T shares remains $45, and we intend to use near-term post-earnings weakness to add to this long-term holding.
- Our price target on Dycom (DY) shares remains $115 for now and given just percent upside to that target we are downgrading DY shares to a Hold from Buy.
What We’re Expecting Later This Week in Earnings Reports from Amazon (AMZN), Alphabet (GOOGL) and Starbucks (SBUX)
AT&T’s earnings report was just the start of what is to be a frenzied two weeks, as more than 2,000 companies report quarterly results and offer their latest outlook on what’s to come near-term. This week alone we have 40 percent of the S&P 500 reporting, and among that sea of results, we have three more Tematica Select List companies doing the same — Amazon (AMZN), Alphabet (GOOGL) and Starbucks (SBUX) — all after the market close tomorrow (Thursday, April 27).
Here’s what the market’s expecting and our pre-results commentary:
AMAZON (AMZN): Amazon shares have been a strong performer amid the escalating brick & mortar retail death spiral, climbing more than 20 percent thus far in 2017. That sharp move higher compared to just 6.7 percent for the S&P 500 likely means expectations are once again running high for Amazon even though consensus expectations call for EPS of $1.13 on revenue of $35.3 billion. We’ve seen this several times over the years and at times Amazon surprises Wall Street with its investment plans that tend to weigh on its outlook. As we saw last September, that mismatch tends to weigh on Amazon shares, offering a solid buying opportunity for long-term investors.
Amazon is a stock to own for the long-term given several powerful tailwinds that power its various businesses. While the right investment strategy is to use weakness to build one’s position, for subscribers who are underweight Amazon, we would suggest holding off right now from adding more shares until after the company reports.
- For now, our price target on AMZN remains $975.
Alphabet (GOOGL): Over the last week, Alphabet (GOOGL) shares have climbed more than 4 percent, bringing the year to date return to more than 12 percent. As we get ready for the company’s 1Q 2017 earnings report tomorrow, let’s remember the YouTube advertising snafu it had during the quarter, which could weigh on overall results. We would advise subscribers underweight GOOGL shares to be patient as we could see better prices late this week or early next. Longer-term, with the continued move in the Connected Society investment theme that bodes well for the core Search business as well as its own shopping portal efforts plus the launching streaming TV service, dubbed YouTube TV, the company still has several multi-year tailwinds behind it. On Alphabet’s earnings call, we’ll be listening for comments on returning capital to shareholders as well as signs the new regime remains focused on margins.
- Our price target on GOOGL shares remains $975, which offers 10 percent upside from current levels.
STARBUCKS (SBUX): Over the last week or so, Starbucks (SBUX) shares have broken out of the $54-$58 trading range they have been in over the last four months. Part of that move was due to an upgrade by the research arm of Stifel, which now sees upside to $67 for SBUX shares, which compares to our long-term price target of $74. Expectations call for Starbucks to deliver EPS of $0.45 on revenue of 45.41 billion for the March quarter and for the team to guide the current quarter to EPS between $0.52-$0.59 on revenue between $5.6-$6 billion.
They key for us will be the continued expansion overseas as well as an upgrade in the company’s food efforts, which to us are likely to be key areas of focus on the earnings call following the poor reception of its Unicorn Frappuccino. Coffee prices have abated over the last several months, which could help Starbucks project some additional margin lift in the coming quarters.
- We continue to rate SBUX shares a Buy at current levels.
Developments in Our Positions in DIS, HACK, IFF, BETR
The Walt Disney Co (DIS): This morning we’re hearing that Disney’s ESPN network could start issuing pink slips at its flagship cable sports channel today. Several reports suggest the layoffs may be more numerous than the expected, with some 70 employees ranging from anchors, reporters, analysts and online writers losing their jobs in coming weeks. We see this as the latest move by Disney to right the cost structure in a business that is finding its way among chord-cutters and Cash-Strapped Consumers seeking more cost friendly streaming services. Disney continues to explore such options, and we suspect more developments to be had on this in the coming quarters.
With the move in Disney shares in recent weeks, our positions are up 14 percent, with another 9 percent to go to our $125 price target. With a robust movie slate over the coming months that includes Guardians of the Galaxy 2 (May 5), Pirates of the Caribbean: Dead Men Tell No Tales (May 26), Cars 3 (June 16) and Spider-Man: Homecoming (July 7), we’re reviewing potential upside to our $125 price target for DIS.
PureFunds ISE Cyber Security ETF (HACK): This week we received two quick reminders over the downside to our increasingly Connected Society that fuels ourSafety & Security investing theme and bodes well for the PureFunds ISE Cyber Security ETF (HACK) shares on the Tematica Select List. First, last night at the very end of its earnings conference call Chipotle Mexican Grill (CMG) slipped in that it had detected “unauthorized activity” on a network that supports payment processing at its restaurants. Then this morning, French presidential candidate Emmmanuel Macron’s campaign team confirmed it had been the target of at least five advanced cyberattack operations since January.
- We continue to favor the HACK ETF as a diversified play on the ever-growing need for cyber security, which is just one aspect of our Safety & Security investing theme.
International Flavors & Fragrances (IFF): During PepsiCo’s (PEP) earnings call last night the company reported higher-than-expected quarterly revenue and profit as it benefits from demand for its healthier drinks and snacks and kept a tight leash on costs. The company has said it now gets about 45 percent of its net revenue from “guilt-free” products — beverages that have fewer than 70 calories per 12 ounces and snacks that have lower amounts of salt and saturated fat.
We see that as a very favorable sign for our International Flavors & Fragrances (IFF) shares, which are up more than 8 percent since we added them, which leaves some 4 percent to our $145 price target.
- Given the accelerating move by PepsiCo and others into health snacks and drinks, we are reviewing that $145 price target for IFF.
Amplify Snack Brands (BETR): As you are probably thinking, PepsiCo’s results mentioned earlier are very much in tune with our Food with Integrity investing theme as well as our decision to add Amplify Snack Brands (BETR) to the Tematica Select List last week. Over the last week, BETR shares slipped some 2 percent, but we’d remind subscribers that stocks under $10 can be volatile week to week. We continue to like Amplify’s expanding offering and footprint, and when the company reports its results we expect to hear more on those efforts.
- We continue to rate BETR shares a Buy with an $11 price target.
