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Category Archives: Guilty Pleasures

Weekly Issue: As earnings season continues, the market catches a positive breather

Weekly Issue: As earnings season continues, the market catches a positive breather

Key points in this issue:

  • As expected, more negative earnings revisions roll in
  • Verizon says “We’re heading into the 5G era”
  • Nokia gets several boosts ahead of its earnings report
  • USA Technologies gets an “interim” CFO

 

As expected, more negative earnings revisions roll in

In full, last week was one in which the domestic stock market indices were largely unchanged and we saw that reflected in many of our Thematic Leaders. Late Friday, a deal was reached to potentially only temporarily reopen the federal government should Congress fail to reach a deal on immigration. Given the subsequent bluster that we’ve seen from President Trump, it’s likely this deal could go either way. Perhaps, we’ll hear more on this during his next address, scheduled ahead of this weekend’s Super Bowl.

Yesterday, the Fed began its latest monetary policy meeting. It’s not expected to boost interest rates, but Fed watchers will be looking to see if there is any change to its plan to unwind its balance sheet. As the Fed’s meeting winds down, the next phase of US-China trade talks will be underway.

Last week I talked about the downward revisions to earnings expectations for the S&P 500 and warned that we were likely to see more of the same. So far this week, a number of high-profile earnings reports from the likes of Caterpillar (CAT), Whirlpool (WHR), Crane Co. (CR), AK Steel (AKS), 3M (MMM) and Pfizer (PFE) have revealed December-quarter misses and guidance for the near-term below consensus expectations. More of that same downward earnings pressure for the S&P 500 indeed. And yes, those misses and revisions reflect issues we have been discussing the last several months that are still playing out. At least for now, there doesn’t appear to be any significant reversal of those factors, which likely means those negative revisions are poised to continue over the next few weeks.

 

Tematica Investing

With the market essentially treading water over the last several days, so too did the Thematic Leaders.  Apple’s (AAPL) highly anticipated earnings report last night edged out consensus EPS expectations with guidance that was essentially in line. To be clear, the only reason the company’s EPS beat expectations was because of its lower tax rate year over year and the impact of its share buyback program. If we look at its operating profit year over year — our preferred metric here at Tematica — we find profits were down 11% year over year.

With today’s issue already running on the long side, we’ll dig deeper into that Apple report in a stand-alone post on TematicaResearch.com later today or tomorrow, but suffice it to say the market greeted the news from Apple with some relief that it wasn’t worse. That will drive the market higher today, but let’s remember we have several hundred companies yet to report and those along with the Fed’s comments later today and US-China trade comments later this week will determine where the stock market will go in the near-term.

As we wait for that sense of direction, I’ll continue to roll up my sleeves to fill the Guilty Pleasure void we have on the Thematic Leaders since we kicked Altria to the curb last week. Stay tuned!

 

Verizon says “We’re heading into the 5G era”

Yesterday and early this morning, both Verizon (VZ) and AT&T (T) reported their respective December quarter results and shared their outlook. Tucked inside those comments, there was a multitude of 5G related mentions, which perked our thematic ears up as it relates to our Disruptive Innovators investing theme.

As Verizon succinctly said, “…we’re heading to the 5G era and the beginning of what many see as the fourth industrial revolution.” No wonder it mentioned 5G 42 times during its earnings call yesterday and shared the majority of its $17-$18 billion in capital spending over the coming year will be spent on 5G. Verizon did stop short of sharing exactly when it would roll out its commercial 5G network, but did close out the earnings conference call with “…We’re going to see much more of 5G commercial, both mobility, and home during 2019.”

While we wait for AT&T’s 5G-related comments on its upcoming earnings conference call, odds are we will hear it spout favorably about 5G as well. Historically other mobile carriers have piled on once one has blazed the trail on technology, services or price. I strongly suspect 5G will fall into that camp as well, which means in the coming months we will begin to hear much more on the disruptive nature of 5G.

 

Nokia gets several boosts ahead of its earnings report

Friday morning one of Disruptive Innovator Leader Nokia’s (NOK) mobile network infrastructure competitors, Ericsson (ERIC), reported its December-quarter results. ERIC shares are trading up following the report, which showed the company’s revenue grew by 10% year over year due primarily to growth at its core Networks business. That strength was largely due to 5G activity in the North American market as mobile operators such as AT&T (T), Verizon (VZ) and others prepare to launch their 5G commercial networks later this year. And for anyone wondering how important 5G is to Ericsson, it was mentioned 26 times in the company’s earnings press release.

In short, I see Ericsson’s earnings report as extremely positive and confirming for our Nokia and 5G investment thesis.

One other item to mention is the growing consideration for the continued banning of Huawei mobile infrastructure equipment by countries around the world. Currently, those products and services are excluded in the U.S., but the U.K. and other countries in Europe are voicing concerns over Huawei as they look to confirm their national telecommunications infrastructure is secure.

Last week, one of the world’s largest mobile carriers, Vodafone (VOD) announced it would halt buying Huawei gear. BT Group, the British telecom giant, has plans to rip out part of Huawei’s existing network. Last year, Australia banned the use of equipment from Huawei and ZTE, another Chinese supplier of mobile infrastructure and smartphones.

In Monday’s New York Times, there was an article that speaks to the coming deployment of 5G networks both in the U.S. and around the globe, comparing the changes they will bring. Quoting Chris Lane, a telecom analyst with Sanford C. Bernstein in Hong Kong it says:

“This will be almost more important than electricity… Everything will be connected, and the central nervous system of these smart cities will be your 5G network.”

That sentiment certainly underscores why 5G technology is housed inside our Disruptive Innovators investing theme. One of the growing concerns following the arrest of two Huawei employees for espionage in Poland is cybersecurity. As the New York Times article points out:

“American and British officials had already grown concerned about Huawei’s abilities after cybersecurity experts, combing through the company’s source code to look for back doors, determined that Huawei could remotely access and control some networks from the company’s Shenzhen headquarters.”

From our perspective, this raises many questions when it comes to Huawei. As companies look to bring 5G networks to market, they are not inclined to wait for answers when other suppliers of 5G equipment stand at the ready, including Nokia.

Nokia will report its quarterly results this Thursday (Jan. 31) and as I write this, consensus expectations call for EPS of $0.14 on revenue of $7.6 billion. Given Ericsson’s quarterly results, I expect an upbeat report. Should that not come to pass, I’m inclined to be patient and hold the shares for some time as commercial 5G networks launches make their way around the globe. If the shares were to fall below our blended buy-in price of $5.55, I’d be inclined to once again scale into them.

  • Our long-term price target for NOK shares remains $8.50.

 

USA Technologies gets an “interim” CFO

Earlier this week, Digital Lifestyle company USA Technologies (USAT) announced it has appointed interim Chief Financial Officer (CFO) Glen Goold. According to LinkedIn, among Goold’s experience, he was CFO at private company Sutron Corp. from Nov 2012 to Feb 2018, an Associate Vice President at Carlyle Group from July 2005 to February 2012, and a Tax Manager at Ernst & Young between 1997-2005. We would say he has the background to be a solid CFO and should be able to clean up the accounting mess that was uncovered at USAT several months ago.

That said, we are intrigued by the “interim” aspect of Mr. Goold’s title — and to be frank, his lack of public company CFO experience. We suspect the “interim” title could fuel speculation that the company is cleaning itself up to be sold, something we touched on last week. As I have said before, we focus on fundamentals, not takeout speculation, but if a deal were to emerge, particularly at a favorable share price, we aren’t ones to fight it.

  • Our price target on USA Technologies (USAT) shares remains $10.

 

 

 

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.

 

 

As the Market Bounces Off Oversold Conditions, is this the Start of Another Bull Run?

As the Market Bounces Off Oversold Conditions, is this the Start of Another Bull Run?

Market Reversal

So far in 2019, we are seeing a reversal of the heavily oversold conditions from the end of 2018. Those stocks that were hit the hardest in 2018 are materially outperforming the broader market in 2019. For example, through the close on January 16, 62% of stocks in the Financial sector were above their 50-day moving average, the highest of any sector, versus 44% for the S&P 500 overall. To put that into perspective, Financials have not been the top performer for this metric in 273 trading days, the second-longest such streak since 2001 and only the fourth streak ever of more than 200 trading days. It isn’t just financials as the Energy sector, which was the worst performing sector in 2018, has the third highest percent of stocks above their 50-day in 2019.

While impressive looking, this shift doesn’t necessarily bode well for the Financial sector, nor for the broader market according to data compiled by Bespoke Investment Group.

 

Stock Performance After Streaks Ended

 

 

This recent outperformance by Financials in 2019 is particularly fascinating when I talk to my colleagues at various major financial institutions. Here are a few of the comments I’ve been hearing, paraphrased and without attribution for obvious reasons:

“This deal is way too small for you guys, but I wanted to let you know that our team is working on it.” –  (M&A consultant)

“Send it over.We are so late in the cycle that we are looking at damn near anything.” –  (Partner at one of the largest global private equity firms)

“What can we do to better serve your company? We are making a major push this year into better serving companies of this size.” –  (Partner at one of biggest investment banks to a very surprised member of the Board of Directors of a recently IPO’d company whose market cap would have normally left it well below the bank’s radar. After some investigation, many other board members for companies of a similar size in the sector have been getting the same phone calls from this bank.)

The big financial institutions are having to work their way downstream to find things to work on – that’s a major peak cycle indicator and does not bode well for margins. It also doesn’t bode well for the small and medium-sized institutions that will likely need to become more price competitive to win deals in this new more competitive playing field.

We have also seen some wild moves in a few of our favorites such as Thematic Leader Netflix (NFLX), which reported its earnings after the close on January 17th. Netflix sits at the intersection of our Digital Lifestyle and Disruptive Innovators investing themes and has seen its share price fall over 40% from the July 2018 all-time highs to bottom out on December 24th. Since then, as of market’s close on January 17, shares gained nearly 50% – in around all of 100 trading hours! While about 10% of that can be attributed to the recent price increase that will amount to about $2 or so per month for subscribers, there are greater forces at work for a move of such magnitude. No one can argue that either direction was based on fundamentals, but rather a market that is experiencing major changes.

One of the most important leading indicators as we start the Q4 earnings seasons was the miss by FedEx (FDX) and the negative guidance the company provided for the upcoming quarters. FedEx’s competitor United Parcel Service (UPS) is part of our Digital Lifestyle investing theme – how are all those online and mobile purchases going to get to you? Both FedEx and UPS are critical leading indicator because they touch all aspects of the economy and transportation services, in general, have been posting some weak numbers lately in terms of both jobs and latest price data.

In what could be reflective of both our Middle Class Squeeze investing theme, Vail Resorts (MTN) also gave a negative pre-announcement, stating that its pre-holiday period saw much lower volumes than anticipated despite good weather conditions and more open trains. The sour end of the year in the investment markets and the weakness we’ve seen in markets around the world may have led many decided to forgo some fun in the snow. We’ll be keeping a close eye on consumer spending patterns, particularly by income level in the months to come.

Investor Sentiment Slips

According to the American Association of Individual Investors, bearish investor sentiment peaked at 50.3% on December 26, right after the market bottomed. Bullish sentiment over the past month rose from 20.9% to 38.5% but then stalled this week, falling back to 33.5% as the markets reached resistance levels. Bullish sentiment is now back below the historic average but still well above the December lows. Bearish sentiment, on the other hand, is on the rise, up to 36.3% from last week’s 29.4%. This is just further indication that much of what we’ve seen so far in 2019 is a recovery from the earlier oversold conditions.

As we look at the unusual pace at which the major indices lost ground in the latter part of 2018 and the sharp reversal in recent weeks, I can’t help but think of one of the many aspects of our Aging of the Population investment theme. A large portion of the most powerful demographic of asset owners is either in or shortly moving into retirement. Many already had their retirement materially postponed by the losses incurred during the financial crisis. They are now 10+ years older, which means they have less time to recover from any losses and have not forgotten the damage done in the last market correction. I suspect that we are likely to see more unusual market movements in the years to come than we have since the Boomer generation entered into the asset gathering phase of life back in the 60s and 70s. Today this group has a shorter investment horizon and cannot afford the kinds of losses they could 20+ years ago.

The Shutdown and the Fed

Aside from a rebound against the oversold conditions, another dynamic that has the market in a more optimistic mood, at least for the near term, is the narrative that the government shutdown is good news for interest rates as it will likely keep the Federal Reserve on hold. Given that estimates are this shutdown will cost the economy roughly 0.5% of GDP per month, it would be reasonable for the Fed to stay its hand.

Inflation certainly isn’t putting pressure on the Fed. US Producer Prices fell -0.2% last month versus expectations for a -0.1% decline. The bigger surprise came from core ex-food and ex-energy index which fell -0.1% versus expectations for an increase of +0.2%. Keep in mind that core PPI declines less than 15% of the time, so this is meaningful and gives Powell and the rest of the FOMC ample cover to hold off on any hikes at the next meeting.

US import prices fell -1% month-over-month in December after a -1.9% decline in November, putting the year-over-year trend at -0.6%. That’s the first negative year-over-year print since August 2014. Yet another sign that inflation is rolling over.

 

Economy Flashing Warning Signs

Despite all the hoopla earlier this month over the December’s job’s report, this month’s Job Openings and Labor Turnover Survey (JOLTS) report showed that for the first time since the end of 2017 and just the 6thtime in this business cycle, hirings, job openings and voluntary quits fell while layoffs increased in November.

By digging further into the details of the Household survey as well we see that people holding onto more than one job rose +117k in December, accounting for over 80% of the total employment gain. On top of that, the number of unincorporated self-employed rose +126k. These two are things we normally see when times are tough, not when the economy is firing on all cylinders. Not to be a Negative Nancy or Debbie Downer here, but the prime-working-age (25-54) employment shrunk -11k in December on top of 48k the month before. This was before things started to get really scary for many workers with the government shutdown. Imagine how many more are now looking for a second job to make ends meet while they wait for those inside the beltway to work this mess out.

We also got a materially weak New York Empire Manufacturing survey report this week that saw New Orders decline for the second consecutive month and a sharp drop in the 6-month expectation index. The New York Federal Reserve’s recession risk model is now placing odds of a recession by the end of 2019 at over 21%, having more than doubled since this time last year and having reached the highest level in 10 years. Powell and his team at the Fed have plenty of reasons to hold off on hikes. I wouldn’t be surprised if their next move is actually to cut.

 

NY Fed Recession Probability

 

Risks, what risks, we don’t see no stinking risks

US economy isn’t as strong as the headlines would make you think. The political dialogue going back and forth while on the one hand entertaining in a reality TV I-cannot-believe-he/she-just-said-that kind of way isn’t so funny when we look at the severity of problems that need to be addressed – excessive debt loads, a bankrupt social security program, a mess of a healthcare sector – just to name a few. The market today isn’t pricing much of this in, and based on the year to date move in the major market indices, particularly not the potential economic damage the government shutdown if the situation worsens.

If we look outside the US, the market’s indifference is impressive. UK Prime Minister Theresa May’s Brexit plan suffered a blistering defeat in Parliament, the largest such defeat on record for over 100 years, leaving the entire Brexit question more uncertain than ever and it is scheduled to occur just over two months away. In the two days post the Brexit vote back in 2016 the Dow lost 870 points and the CBOE Volatility Index (VIX) rose 49%. This time around the equity markets were utterly disinterested and the VIX actually fell 3.5% – go figure. A messy Brexit has the potential to have a material impact on global trade and yet we basically just got a yawn from the stock market.

Over in Europe flat is the new up with Germany’s GDP expected to come in every so slightly positive and this is a nation that accounts for around one-third of all output in the euro area – with China a major customer. Overall, Eurozone imports and exports fell -2% in November.

The other major exporter, Japan, just saw its machinery orders fall -18.3% in December after falling -17% in November. Japan already had a negative GDP quarter in Q3 and the latest data we’ve seen on income and spending aren’t giving us much to be positive about for the nation.

The Trade War continues with some lip service on either side occasionally giving the markets brief moments to cheer on some potential (rather than actual) signs of progress. The overall global slowing coupled with the trade wars is having an effect. China’s exports for December were far worse than expected, -4.4% from year-ago levels vs expectations for +2%. Last week Reuters reported that China has lowered its GDP target for 2019 to a range of 6% to 6.5%, which is well below the 6.6% reported output gain widely expected last year which itself is the weakest figure since 1990. Retail sales growth has fallen to a 15-year low as auto sales contracted 4.1% in 2018, the first annual decline in 28 years. With a massive level of leverage in its economy, banking assets of $39.1 trillion as of Sept. 30, and nearly half of the $80.7 trillion 2017 world GDP, (according to the World Bank) waning economic growth could be a very big problem and not just for China. We’ll be watching this as it develops given our Rise of the New Middle-class and Living the Life investing themes.

The bottom line is we’ve been seeing the markets bounce off seriously oversold conditions after a breathtakingly rapid descent. The fundamentals both domestically and internationally are not giving us reason to think that this bounce is the start of another major bull run. With all the uncertainty out there, despite the market’s recent “feel good” attitude, we expect to see rising volatility in the months to come as these problems are not going to be easily sorted out.

 

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.

 

Weekly Issue: Investor anxiety continues

Weekly Issue: Investor anxiety continues

Key points inside this issue

  • As the investors grapple with anxiety over trade as well as the speed of economic and earnings growth, we’ll continue to hold ProShares Short S&P 500 (SH) shares.
  • Our price target on the shares of Guilty Pleasure Thematic Leader Del Frisco’s Restaurant Group (DFRG) remains $14.
  • Our price target on Middle-Class Squeeze Thematic Leader Costco Wholesale (COST) shares remains $250.
  • Our price target on Amazon (AMZN) shares remains $2,250

 

The stock market experienced another painful set of days in last week as it digested the latest set of economic data, and what it all means for the speed of the domestic and global economy. Investors also grappled with determining where the U.S. is with regard to the China trade war as well as the prospects for a deal by the end of March that would prevent the next round of tariffs on China from escalating.

There remain a number of unresolved issues between the U.S. and China, some of which have been long-standing in nature, which suggests a fix in the next 100+ days is somewhat questionable. This combination induced a fresh round of anxiety in the market, leading it to ultimately finish the week lower as the major indices sagged further quarter to date. In turn, that pushed all the major market indices into the red as of Friday’s close, most notably the small-cap heavy Russell 2000, which finished Friday down 5.7% year to date. For those keeping score, that equates to the Russell 2000 falling just under 15% quarter to date.

Last week we added downside protection to our holdings in the form of ProShares Short S&P 500 (SH) shares, and we’ll continue to hold them until signs of more stable footing for the overall market emerge. As we do this, I’ll continue to evaluate not only the thematic signals that are in and around us day-in, day-out, but also examine the potential opportunities on a risk to reward basis the market pain is creating.

 

Shares of Del Frisco’s get some activist attention

Late last week, our shares of Guilty Pleasure Thematic Leader Del Frisco’s Restaurant Group (DFRG) bucked the overall move lower in the domestic stock market following the revelation that activist hedge fund Engaged Capital has acquired a nearly 10% in the company with a plan to push the company to sell itself according to The Wall Street Journal. Given the sharp drop in DFRG shares thus far in 2018, down 52%, it’s not surprising to see this happen, and when we added the shares to our holdings, we shared the view that at some point it could be a takeout candidate as the restaurant industry continues to consolidate. In particular, Del Frisco’s presence in the higher end dining category and its efforts over the last few months to become a more focused company help explain the interest by Engaged.

In response, Del Frisco’s issued the following statement:

“Del Frisco’s is committed to maximizing long-term value for all shareholders. While we do not agree with certain characterizations of events or of our business and operations contained in the letter that we received from Engaged Capital, the Company values constructive input toward the goal of enhancing shareholder value. “

Compared to other Board responses this one is rather tame and suggests Del Frisco’s will indeed have a dialog with Engaged. Given the year to date performance in DFRG shares, odds are there are several on the Board that are frustrated either with the rate of change in the business or how that change is being viewed in the marketplace.

In terms of who might be interested in Del Frisco’s, we’ve seen a number of going private transactions in recent years led by private equity investors that re-tool a company’s strategy and execution or combine it with other entities. We’ve also seen several restaurant M&A transactions as well. Let’s remember too how on Del Frisco’s September quarter earnings conference call, the management team went out of its way to explain how the business performed during the last recession. That better than industry performance may add to the desirability of Del Frisco’s inside a platform, multi-branded restaurant company.

As much as we may agree with the logic behind Del Frisco’s being taken out, we’d remind subscribers that buying a company on takeout speculation can be dicey. In the case of Del Frisco’s, we continue to see a solid fundamental story. We are seeing deflation in food prices that bode well for Del Frisco’s margins and bottom line EPS. Over the last quarter we’ve seen prices in the protein complex – beef, pork, and chicken – move lower across the board. According to the United Nation’s Food and Agriculture Organisation’s (FAO) food price index, world food prices declined during the month of November to their lowest level in more than two years. We’re also seeing favorable restaurant spending per recent monthly Retail Sales reports, which should only improve amid year-end holiday dinners eaten by corporate diners and individuals.

We’ll continue to hold DFRG for the fundamentals, but we won’t fight any smart, strategic transaction that may emerge.

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

 

What to watch in the week ahead

As we move into the second week of the last month of the quarter, I’ll continue to examine the oncoming data to determine the vector and velocity of the domestic as well as global economy. Following Friday’s November Employment Report that saw weaker than expected job creation for the month, but year over year wage gains of 3.1% the Atlanta Fed continued to reduce its GDP forecast for the current quarter. That forecast now sits at 2.4%, down from 3.0% at the end of October.

With the sharp drove in oil prices has consumers feeling a little holiday cheer at the gas pump, odds are next week’s November inflation reports will be tame. The fact that world food prices per the Food and Agriculture Organization’s (FAO) food price index hit the lowest level since May 2016 also bodes well for a benign set of inflation data this week. Later in the week, we’ll get the November Retail Sales report, which should be very confirming for our holiday facing positions – Amazon (AMZN), United Parcel Service (UPS), McCormick & Co. (MKC) and Costco Wholesale (COST) – that given the kickoff of “seasons eatings” with Thanksgiving and the start of the holiday shopping season that clearly shifted to digital shopping.

That report will once again provide context for this shift as well as more than likely confirm yet again that Costco Wholesale (COST) continues to take consumer wallet share. Speaking of Costco, the company will report its quarterly results this  Thursday. Quarter to date, the company’s monthly same store sales reports are firm evidence it is winning consumer wallet share, and we expect it did so again in November, especially with its growing fresh foods business that keeps luring club members back. Aside from its top and bottom line results, I’ll be focused once again on its pace of new warehouse openings, a harbinger of the crucial membership fee income to be had in coming quarters.

  • Our price target on Middle-Class Squeeze Thematic Leader Costco Wholesale (COST) shares remains $250.

We’ll end the economic data stream this week with the November Industrial Production report. Given the sharp fall in heavy truck orders in November, I’ll be digging into this report with a particular eye for what it says about the domestic manufacturing economy.

As discussed above, this week Costco will report its results and joining it in that activity will be several other retailers such as Ascena Retail (ASNA), DWS (DWS), American Eagle (AEO) and Vera Bradley (VRA). Inside their comments and guidance, which will include the holiday shopping season, I’ll be assessing the degree to which they are embracing our Digital Lifestyle investing theme. We’ll also see Adobe Systems (ADBE) report its quarterly result and I’ll be digesting what it has to say about cloud adoption, pricing and prospects for 2019. As we know, that is a core driver of Amazon Web Services, one of the key profit and cash flow drivers at Amazon (AMZN).

  • Our price target on Amazon (AMZN) shares remains $2,250

 

Guilty Pleasures: the affordable treats that bring a moment of happiness

Guilty Pleasures: the affordable treats that bring a moment of happiness

 

There are several notions as to what constitutes a guilty pleasure. One definition is something one enjoys but would be embarrassed to have others know, while another is enjoying something even though it may not be held in high regard or may not be good for you. As one might expect there are a number of guilty pleasures to be had, ranging from certain films and TV programs (like the Bachelor, but we don’t judge), products ranging from tobacco, alcohol and marijuana to fast food, coffee and sugary treats as well as gambling and video games.

Some may label these as “vice” stocks, but that category tends to be limited to alcohol, gaming and tobacco and has a pejorative connotation vs. the little affordable treats and pleasures that bring a moment of enjoyment and happiness as well as much needed relief at certain times. By their nature, these guilty pleasures are ones that people will consume no matter the tone of the economic environment. In other words, they tend to be inelastic goods, and more often than not the companies behind them tend to be characterized as healthy cash flow generators and dividend payers.

These companies and brands differ from our Living the Life investing theme in that the pleasure derived is not a function of the premium price or image, but rather simply from the product or experience itself. Part of the joy of owning a Prada bag is having others see it whereas a guilty pleasure may be and often is, enjoyed in private.

In our view, Tematica’s Guilty Pleasure investing theme, like all of our other investing themes, cuts across several traditional Wall Street industry sectors, as the concept focuses on those companies that bring the kinds of products that consumers won’t do without, regardless of the economic climate. With that in mind, it should come as little surprise that the guilty pleasure group of stocks held up well during the last two recessions and performed even better on a relative basis when compared to several stock market indices. A 2009, report by Merrill Lynch that examined the performance of tobacco, alcohol, and casino stocks during all of the recessions since 1970 found that while the broad S&P 500 fell by 1.5% on average, guilty pleasure stocks rose on average 11%. During the great tech meltdown, the broad market fell 20% between June 2001 and June 2002, but during that time tobacco stocks gained 8% and gambling related stocks nearly 20%.

The inelastic nature of the products produced by these guilty pleasure companies has enabled them to weather price increases better than other products and services that are considered to be more of a commodity in nature. Perhaps the best example is in the tobacco industry. Consider that while the domestic tobacco business is in a decline as more people become aware of the health effects of smoking on their well-being and taxes are raised each year on cigarettes, price increases more than offset the decline in volume consumption by customers. Another example: despite the increasing concern over sugar as part of our diets, chocolate companies like Hershey Co., have been able to pass through price increases to offset any combination of higher raw material, fuel, utilities, and transportation costs.

When the price of key inputs of these guilty pleasure products, (such as commodities like coffee, beef, sugar, or cocoa) decline after a period of upward movement , the combination of lower input costs and prior price increases tends to deliver better margins, profit generation, EPS growth and cash flow. Think about it … when was the last time you saw the price of a beverage at Starbucks or the price for a package of Oreos decline? Demand for these products is such that rising costs are passed onto the consumer, but declining costs don’t result in much downward pricing pressure. Your wallet and your taste buds know what we’re talking about…

 

Altria: A Guilty Pleasure stock and a dividend dynamo as well

As mentioned above, tobacco is universally known to be harmful, yet people continue to smoke in one form or another. The US tobacco market saw a slight decline in volume sales and a slight increase in value sales in 2017 as Americans slowly continued to reduce their tobacco consumption, perhaps in part due to our Clean Living investment theme, while producers increased prices to maintain profits.

Big Tobacco has long been under threat from the steady decline of smoking, particularly in the developed world. But in recent years, the industry has been able to push through price increases to make up for falling volumes — boosting both their profits and stock prices. Those profits and cash flow have allowed tobacco companies to invest in smoking alternatives (e-cigarettes, vape pens and other devices) that deliver nicotine without as many of the harmful effects that come with lighting up as well as return capital to shareholders in the form of share repurchases and increasing dividends.

One such stock that falls into that grouping is Altria (MO), which is best known for cigarettes (primarily the Marlboro brand that has 43% market share in the US) and smokeless tobacco products (Copenhagen, Skoal, Red Seal, and Husky brands) and to a lesser extent wine under the brands Chateau Ste. Michelle, Columbia Crest, and 14 Hands. In the US, Altria has commanded 50%-51% of the cigarette market over the last year, and while primarily known for that product category, in cigars, the company has a 26% share with its large machine-made Black & Mild brand. In smokeless products, it has 55% share with the Copenhagen (32%) and Skoal (19%) brands.

Digging into Altria’s financials, roughly 85% of its revenue and profits are drawn from the smokeable products business, with smokeless accounting for 11% of sales and growing, and 14% of its operating profit. What that tells us is the smokeless products are a higher margin business for the company, thus a continued shift toward that product line bodes well for Altria’s profits and cashflow. Rounding out the revenue and profit mix at just under 4% and 1%, respectively, is the company’s wine business. What that business mix analysis tells us is even though we may hear some talk of the non-smokeable product potential, at least in the near-term, Altria is a smokeable product company.

That means we can expect additional tobacco taxes and further cigarette price hikes. As we’ve seen in the past, that should translate into rising profits, continued share buybacks and dividend increases. Current consensus estimates have Altria achieving EPS of $4.35 in 2019, up from $4.05 this year and $3.39 in 2017. Helping those EPS comparisons, during the June 2018 quarter, Altria repurchased 7.6 million shares at an average price of $57.65 and exiting that quarter, Altria had slightly more than $1 billion remaining in the current $2 billion share repurchase program. Management signaled it expects to complete that program by the end of the second quarter of 2019. As simple math shows us, shrinking share counts do wonders for EPS and their comparisons.

In terms of dividends, Altria recently announced it was boosting its quarterly dividend by 14% to $0.80 per share from the prior $0.70 per share – offering up a dividend yield of just over 5.4%. That marked the 53rd increase in the company’s dividend since 1968, which qualifies the company as a dividend dynamo company – one that increases its dividend year in, year out. That increase tends to lead to a step function higher in the share price overtime, something we’ve witnessed time and time again with Tematica Select List resident McCormick & Co. (MKC). With Altria, this latest dividend increase puts its annual 2018 dividend at $3.00, up from $2.00 in 2014.

If we look at other Guilty Pleasure stocks such as Hershey (HSY), Molson Coors (TAP), Constellation Brands (STZ) and your choice of a gaming company, the dividend yield range is 1.7% to 2.9%. If Altria shares traded in that dividend yield band, it would result in a share price well north of $100. Historically Altria shares have traded in the average dividend yield range of 3.74% to 4.8% over the last several years, which would suggest upside to $81 and downside to $63, which is well above the current share price.

Even after this latest quarterly dividend increase, Altria’s dividend payout remains close to 73% based on expected EPS of $4.35 in 2019 (vs. $3.39 in 2017) leaving ample room for additional dividend increases in the coming years. For example, if Altria kept its dividend payout ratio intact and achieved expected 2020 EPS of $4.70, it could mean a quarterly dividend of more than $0.85 per share. That would imply a potential annual dividend in the range of $3.30-$3.40, and further upside to be had in MO shares over the coming several quarters.

That’s a Guilty Pleasure company worth holding onto, especially if it manages to further transform its business from a tobacco centric one to something more evenly divided between smokeable and smokeless products. There is also the likely prospect of Altria entering the cannabis space as the legal status of marijuana continues to expand in the US. In many ways that move is a natural extension of its existing skill set – tobacco growth, processing, packaging and distribution – and it fits with the guilty pleasure framework of Altria’s business focus.

  • We are issuing a Buy on the shares of Altria (MO) and adding them to the Tematica Investing Select List with an $81 price target.

 

Companies riding the Guilty Pleasure Tailwind

  • ALTRIA (MO)
  • ANHEUSER-BUSCH (BUD)
  • BRITISH TOBACCO (BTI)
  • BROWN-FORMAN (BF.B
  • CAESAR’S ENTERTAINMENT (CZR)
  • CONSTELLATION BRANDS (STZ)
  • CRAFT BREW ALLIANCE (BREW)
  • DIAGEO PLC (DEO)
  • DOMINO’S (DPZ)
  • DUNKIN BRANDS (DNKN)
  • HERSHEY COMPANY (HSY)
  • L BRANDS (LB)
  • LAS VEGAS SANDS (LVS)
  • MCDONALD’S (MCD)
  • MELCO RESORTS AND ENTERTAINMENT (MLCO)
  • MGM RESORTS (MGM)
  • MOLSON COORS (TAP)
  • PEPSICO (PEP)
  • SHAKE SHACK (SHAK)
  • STARBUCKS (SBUX)

 

Weekly Issue: Black Friday, Tax Reform and Boosted Dividends in Time for the Holidays

Weekly Issue: Black Friday, Tax Reform and Boosted Dividends in Time for the Holidays

Black Friday Through Cyber Monday Provide Confirming Data Points for Amazon (AMZN) and UPS Positions

Earlier this week, we not only issued our Tematica Investing thoughts on the holiday shopping weekend, which was very confirming for our Connected Society investment theme thesis on both Amazon (AMZN) and United Parcel Service (UPS), it was also the topic of conversation between Tematica’ Chief Macro Strategist Lenore Hawkins and myself on this week’s earlier than usual Cocktail Investing Podcast. As a reminder, we see United Parcel Service as the sleeper second derivative play on the shift to digital shopping this holiday season and beyond.

Per data published by GBH Insights, on Black Friday alone, Amazon garnered close to half of all online sales, which set new record levels on Thanksgiving as well as Black Friday and Cyber Monday. As we learned yesterday, this year’s Cyber Monday was the biggest sales day for online and mobile ever in the US as online sales hit $6.59 billion, up 16.8% year over year. As Lenore and I discussed on the podcast, spending on mobile devices continued to take share from desktop and in-store spending during Thanksgiving and Black Friday, and that also happened on Cyber Monday as mobile sales broke a new record by reaching $2 billion.

Yesterday, Amazon issued a press release sharing it was the “’best-ever’ holiday shopping weekend for devices sold between Thanksgiving and Cyber Monday. After reviewing the data and prospects for Amazon’s business this holiday season as it benefits in part from its expanding private label brand business as well as the even greater than expected shift to digital commerce this holiday shopping season, we are boosting our price target on AMZN shares to $1,400 from $1,250. While some may focus on the implied P/E of 175x expected 2018 EPS of $7.98 for our new price target, it equates to a price to earnings growth (PEG) rate of roughly 1.0% as Amazon is set to grow its EPS by a compound annual growth rate of just over 184% over the 2015-2018 period. Even if 2018 expectations are a tad aggressive, after taking a more conservative 2018 view our new $1,400 price target equates to a PEG ratio between 1.1-1.3x, which we find more than acceptable from a risk to reward perspective.

  • We are boosting our price target on Amazon (AMZN) shares to $1,400 from $1,250.
  • Our price target on United Parcel Service (UPS) remains $130.

 

Market Moves Higher Ahead of Senate Vote on Tax Reform

The major market indices continued to move higher as the Senate Budget Committee approved the Senate’s tax plan yesterday, which brings it to an expected floor vote tomorrow. This inches the prospects for potential tax reform happening by the end of 2017 a bit higher, although while we remain optimistic we here at Tematica continue to see far greater odds of tax reform happening in 2018 as the House and Senate bills close their respective gap. While both bills cut taxes on businesses and individuals, they differ in the scope and timing of those cuts.

As enthusiasm has gained for tax reform, smaller cap stocks have rallied, as small-caps tend to have greater U.S. exposure in revenue and profit mix compared to bigger, multi-national stocks. The small-cap laden Russel 2000 is up more than 1% this week alone and has risen roughly 2.8% over the last month beating out the Dow Jones Industrial Average, the S&P 500 and even the Nasdaq Composite Index. That small-cap climb, combined with the influence of our thematic tailwinds led the USA Technologies (USAT), AXT Inc. (AXTI) and LSI Industries (LYTS) to rise even faster than the Russell. Over the last month, they’ve risen more than 30%, 18%, and 5% respectively and over the last few weeks, we’ve trimmed back USAT and AXTI shares, booking meaningful wins, while offsetting those gains by closing out positions that have been lagging.

As tax reform lumbers forward, we’ll continue to monitor developments and what they mean for both the market and the Tematica Investing Select List.

 

 

Dividend Dynamo Company McCormick Does it Again

Call me old-fashioned, but I love dividends and I love companies that have the ability to raise their dividends even more. When a company boosts its dividend, it tends to result in a step function move higher in its stock price. If it’s a serial dividend raiser, or as I like to call them a dividend dynamo company, we tend to get a hefty 1-2 combination punch of a step higher in the stock price as well as higher dividend payments. Boom!

We’ve got several such companies on the Tematica Investing Select List, and this week McCormick & Co. (MKC) once again boosted its quarterly dividend. This new 10% increase to $0.52 per share marks the 32nd consecutive year that McCormick has increased its quarterly dividend and offers us even greater comfort with our $110 price target. With regard to this new dividend, it is payable on January 16 to shareholders of record on December 29 – mark your calendars!

  • Our price target on McCormick & Co. (MKC) shares remains $110

 

What We’re Watching For Over the Coming Days

During the next several days, as we exit November a number of economic data points will start to roll in, as well as other key data points such as retailer monthly same-store sales figures. Amid the number of economic reports to be had, we’ll be parsing the October construction spending report and what it means for both non-residential construction activity and shares of LSI Industries (LYTS). The shares have been an “under the radar” mover on a week to week basis, but since adding the position to the Tematica Investing Select List in mid-September are up more than 5%. As August-September hurricane-related construction rebounds, we continue to see further upside ahead for LYTS shares.

  • Our price target on LSI Industries (LYTS) remains $10.

 

While we are understandably bearish on the vast majority of brick & mortar retailers, we remain upbeat with Costco Wholesale (COST) given its higher-margin membership fee income stream. Over the last several months, Costco’s monthly same-store sales reports have shown it is not suffering at the hands of Amazon at all, but rather in keeping with our Cash-Strapped Consumer investing theme, it continues to take consumer wallet share. As Costco shares it November data, we’ll be sure to break it down and assess what it means for our $190 price target.

  • Our price target on Costco Wholesale (COST) remains $190.

 

With Guilty Pleasure MGM Resorts (MGM) shares on the Select List, we’ll also be on the lookout for November gaming data pertaining to Nevada as well as Macau. As we mentioned recently, we are heading into one of the slower seasons for the Las Vegas strip and MGM continues to renovate several choice properties with expectations of reopening them in 1Q 2018. We’ll continue to be patient, and if the opportunity presents itself opportunistic as well given our $37 price target. On the housekeeping font, MGM’s next quarterly dividend of $0.11 per share should arrive in mid-December.

  • Our price target on MGM Resorts (MGM) shares remains $37.

 

 

A little bit of financial engineering underway at MGM Resorts

A little bit of financial engineering underway at MGM Resorts

While many eyes have been focused the build up to today’s Apple (AAPL) event, Guilty Pleasure company MGM Resorts (MGM) has made some interesting moves. Recently the company adopted a $1 billion stock repurchase plan and announced it will sell the real estate of its National Harbor property to MGM Growth Properties (MGP), a real estate investment trust (REIT) that focuses on destination entertainment and leisure resorts. That property sale is estimated at $1.19 billion and should provide ample firepower for the new stock buyback plan at MGM Resorts.

Two quick observations – first, we see this piece of financial engineering as bringing added flexibility to MGM Resorts, while also adding some extra capital to the balance sheet. Second, generally speaking, we like stock buyback programs as they tend to increase our comfort level with a company hitting EPS expectations provided the company actually executes its stock repurchase plan. This morning MGM Resorts flexed its new buyback program by sharing it plans to buy 10 million shares from Tracinda, private investment corporation owned by the late Kirk Kerkorian and a significant owner of MGM shares. The transaction, which is expected to close later this week will shrink the outstanding share count by roughly 2%. Following the transaction, Tracinda’s position will be reduced to 8.3% of MGM’s outstanding shares and MGM will have roughly $627 million in buyback power remaining under this new authorization.

We see this as a solid start on executing this new buyback program. Should the company eventually complete this program at or near the current share price, it would shrink the outstanding share count by another 19 million shares or just over 3%.

We’d note this engineering falls below the company’s operating line, and as beneficial as they may be to the bottom line, as investors we still have to focus on the fundamentals. Our next set of monthly gaming revenue updates from Nevada as well as Macau will tell us how both the Mayweather vs. McGregor bout and Typhoon Hato helped or hindered things in August.

 

  • Ahead of those next updates, our price target on MGM Resorts remains $37, which offers just under 14% upside from current levels factoring in the current dividend yield of 1.3%.

 

MGM Update: August Macau gaming revenue shrugs off Typhoon Hato

MGM Update: August Macau gaming revenue shrugs off Typhoon Hato

Early this morning the Macau Gaming Inspection and Coordination Bureau reported August gross gaming revenue rose 20.4% year over year, with a month over month dip of just over 1%. While this sequential dip may catch some off guard and could rattle the shares of gaming and resort companies operating in the Chinese city somewhat, as we head into the holiday weekend, let’s remember that as of late Houston was not the only city hit by a natural disaster. Earlier this month, Macau was hammered by the severe Typhoon Hato, which shuttered casinos and resorts for several days.

Adjusting our view for that, the year over year growth in Macau gaming revenue remained impressive in August as the city continues to woo tourists and gamblers, particular VIP gamblers. This was one of the key aspects for the addition of MGM Resorts (MGM) in June to the Tematica Select List as part of our Guilty Pleasure investment theme. With MGM slated to open another Macau based resort in 2018 — the MGM Cotai that will include a spa, theatre, and 1,500 hotel rooms — the company continues to expand its presence in this market. As a reminder, Macau is the only part of China where casino gambling is legal, and odds are China’s rising middle class (a key part of our Rise & Fall of the Middle Class investing theme) is embracing our Guilty Pleasure theme as are tourists to the region.

Being the data junkies we are here at Tematica, we’ll look to the next report on Macau gross gaming revenue due in early October to see how quickly the city shrugs off the effects of Hato. Before then, we’ll get the August Nevada Gaming Revenue Report and that should shed some details on the recent Mayweather-McGregor fight had on Las Vegas, even though it wasn’t a sold out event.

Finally, one quick reminder, on September 8 MGM shares go ex-dividend to reflect the next $0.11 per share dividend, which will be paid on September 15. While the current annualized dividend yield of 1.3% is not the largest, we see the recent decision to pay a quarterly dividend as more indicative of the company’s multi-year strategy.

  • For now, our price target on MGM Resorts (MGM) shares remains $37.
Mayweather vs McGregor not a sellout, but it’s the coming data that matters for MGM shares

Mayweather vs McGregor not a sellout, but it’s the coming data that matters for MGM shares

According to TV By The Numbers, roughly 3.2 million people tuned in to watch the Floyd Mayweather Jr. vs. Conor McGregor over the weekend. Those figures are preliminary in nature and are subject to change, but what’s not going to change is the simple fact that T-Mobile Arena in Las Vegas that housed the fight did not sell out. According to the official tally, 14,623 were in attendance vs. the 20,000-seat capacity according to ESPN’s Arash Markazi, making it a far cry from a sellout despite all the hubbub and hype.

While we look for final figures from the weekend’s fight and what it means for our MGM Resorts (MGM) shares, we’re also assessing the potential fallout from Typhoon Hato on the company’s Macau operations. Given the severity of Hatto (it triggered Hong Kong’s most severe typhoon 10 warning for only the third time in the past 20 years), we strongly suspect to see some aberrations in the August data when it is published. Ahead of those next Macau figures will be the July gaming revenue data for Las Vegas, which has been robust vs. a year ago, but is starting to bump up against stronger year over year comparison.

Given our $37 price target on MGM shares, which is a hair below the consensus price target of $37.50, we continue to evaluate scaling into the shares. Given the volatile market of late, we are also keeping close tabs on the shares from a technical perspective – should the shares cross the $29.50 level we’re inclined to cut losses and jettison the shares.

  • Our price target on MGM Resorts (MGM) shares remains $37.

Source: Mayweather vs McGregor didn’t sell out T-Mobile Arena | SI.com