Menu
WEEKLY ISSUE: As April starts off more like March than January and February, we tighten up several price targets

WEEKLY ISSUE: As April starts off more like March than January and February, we tighten up several price targets

We have entered 2Q 2017 and with all of two days under our belt, it looks like April is at least starting off more like March than January or February. As we discussed in this week’s Monday Morning Kickoff, we are in what we call No Man’s Land — that time period after the quarter close and before companies start reporting their earnings. It tends to be a time of reduced trading volume, something we’ve seen at both NYSE and Nasdaq listed stocks, as investors wait for tell-tale signs of what’s to come. Another way to phrase it is to say they are waiting for the first signs of what is likely to come.

 

Retailer Woes Means Even Stronger Tailwinds for Amazon

In the last few weeks of March, we had less than stellar results from LuluLemon (LULU), Nike  (NKE), FedEx (FDX) and several other companies. While Urban Outfitters (URBN) won’t report its quarterly results for a while, on Monday night it shared that thus far during the quarter, its comparable retail segment net sales are “mid-single digit negative” vs. up 1 percent in the year ago quarter. Last night, Saks owner Hudson Bay (TSE) shared that overall consolidated sales fell more than 1 percent year over year. More signs that traditional retail remains a challenging environment due in part to Connected Society investing theme company Amazon (AMZN).

Amazon shares, have been on a tear over the last three months, climbing more than 19.8 percent vs. 3.9 percent for the S&P 500. Along the way, the shares have set several new highs, including a fresh intraday high yesterday at $908.54 before closing at $906.83 and firmly in overbought territory. As we head into earnings season, we remember that despite the continued tailwinds that are pushing Amazon’s businesses — the shift to digital consumption and the cloud — Amazon continues to invest heavily in its business. The risk is that from time to time the company’s investment plans tend to be larger than those expected by Wall Street, and when confronted with that realization investors shed shares.

We’ve seen that several times in recent years, and given our view that first-quarter earnings season is likely to bring a return of volatility to the market, we’re going to get a little more cautious on AMZN shares.

  • With an additional 7.5 percent to our $975 price target, we are reducing our rating on AMNZ shares to a Hold from Buy. 
  • We would look to revisit our rating below $850 or on signs that potential upside to our price target is closer to $1,050. 

 

AT&T Gets the FirstNet Nod and That’s Also Good for Dycom

As expected, it was announced AT&T won a lucrative contract to build and manage a nationwide public safety network for America’s police, firefighters, and emergency medical services. Dubbed FirstNet, it will cover all 50 states, five U.S. territories, and the District of Columbia, including coverage for rural and tribal lands. Besides basic voice and Internet service, AT&T expects the network to be used for applications “providing near real- time information on traffic conditions to determine the fastest route to an emergency.”

This win also bodes well for specialty contractor Dycom (DY) that counts AT&T as its largest customer. As Dycom’s other key customers that include Verizon (VZ) and Comcast (CMCSA), deploy both next-generation solutions as well as add incremental capacity to existing networks, we continue to see blue skies ahead for DY shares on the Tematica Select List.

Circling back to the key item of 2017 for AT&T shares — the pending merger with Time Warner (TWX) — chatter in and around DC seems to suggest that President Trump has softened his opposition to the combination of the two companies. We’d note this follows the recent approval of the pending acquisition by the European Commission.

  • As more clarity on the merger between AT&T and Time Warner develops, we are likely to revisit our $44 price target. All things being equal, we are likely to add to our position below $40
  • Our price target on DY shares remains $115.

 

Easter and Spring Break Bode Well For Disney

As we enter peak Spring Break travel season, which bodes well for Disney’s (DIS) parks business, particularly Disney World and its other Florida attractions, we remind subscribers that the company recently announced it was boosting ticket prices, which we may cringe at as consumers, but love as shareholders. Combined with leveraging its Frozen and Star Wars content at the parks over the coming years, we see Disney providing new reasons to revisit these destinations.

Looking beyond the April travel season and continued performance of Beauty and the Beast at the box office, the next catalyst we see for the shares will be several box-office films being released by Disney — 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 have just over 10 percent to our $125 price target for DIS shares.

 

Housekeeping Items

First, if you missed our comments on either Alphabet (GOOGL) or McCormick & Co. (MKC) shares that we posted yesterday, you can find them here and here, respectively.

Second, later this week on TematicaResearch.com we’ll share our thoughts on the purported acquisition of Panera Bread (PNRA) by Guilty Pleasure investment theme company Starbucks (SBUX) as well as our take on the rash of economic data to come later this week.

Third, be sure to the website later in the week for the latest edition of the Cocktail Investing Podcast as well as archived episodes.

Finally, in observance of the upcoming Easter holiday, US stock markets will be closed on Friday, April 14. With the aforementioned spring break in full swing next week, we too here at Tematica will be taking a respite as we get ready to gear into 1Q 2017 earnings the following week.

Odds are we won’t be able to keep ourselves from posting some commentary throughout the week on TematicaResearch.com, but your next regularly scheduled Tematica Investing issue will be on Wednesday, April 19.

 

Revisiting Position Ratings as the Stock Market Grinds Higher

Revisiting Position Ratings as the Stock Market Grinds Higher

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is below; however downloading the full issue provides detailed performance tables and charts.Click here to download.

Since our last issue, the stock market continued to move higher on the news that President Trump will soon be sharing his tax overhaul plan and Fed Chairwoman’s Yellen’s congressional testimony yesterday. We review Yellen’s comments below in greater detail, but the point is the Fed, in aggregate, sees enough oomph in the economy to keep its stated goal of up to three rate increase this year in the mix. Candidly, we didn’t expect Yellen to deviate from the script given the next Fed meeting is still several weeks away, and far more data will be had ahead of it.

With the market climbing, we had a number of strong performers on the Tematica Select List, including recently added Disruptive Technology company Nuance Communications (NUAN) and  Safety & Security play PureFunds ISE Cyber Security ETF (HACK). Both of those remain Buys at current levels. Several other positions are closing in fast on their respective price targets. Last week we trimmed back the position in Costco Wholesale (COST) and reduced it to a Hold from Buy. We’d note that’s a true Hold, not to be interpreted in the herd mindset as a loose Sell recommendation. We continue to see Costco benefitting from our Cash-strapped Consumer theme and its plan to open additional warehouse clubs, which boosts higher margin membership fee income.

Similarly, this morning we are reducing our ratings on both Universal Display (OLED) and PowerShares NASDAQ Internet Portfolio ETF (PNQI) from Buy to Hold. Both have enviable runs, the former as more talk of Apple’s next iPhone iteration heats up and the potential of OLED screen and the latter given the moves we’ve enjoyed in our Facebook (FB) and Alphabet (GOOGL) shares. As we adjust these ratings, we’re also going to layer in stop losses as well:

  • We will set the OLED stop loss at $60, which ensures a gain of at least 13 percent.
  • And set a stop loss at $88 for PNQI shares, which ensures a 5 percent gain.

Positions that we’ll be watching closely as they move closer to our price targets include AMN Healthcare (AMN), Facebook FB), Alphabet (GOOGL) and Disney (DIS) shares.

 

What’s all the Yellin’ About Yellen?

As we mentioned above, yesterday Fed Chairwoman Janet Yellen began her two day session in front of Congress for her semiannual testimony on monetary policy. Last night Tematica Chief Investment Officer, Chris Versace, joined CGTN’s Global Business to discuss the testimony, which was very much a non-surprise given the Fed Chair is not likely to tip the Fed’s policy hand in between meetings, particularly when we have ample economic data ahead and we’ve yet to get the particulars on several Trump policies. In her prepared speech to the Senate Banking Committee yesterday, Yellen said the central bank can continue to raise interest rates slowly although it would be “unwise” to wait too long. Pretty much more of the same if you ask us.

Over the last few months, the pace of manufacturing activity has picked up as evidenced by the monthly ISM manufacturing data and manufacturing PMI metrics from Markit Economics. And while it has us thinking another hike is in the cards, we agree with Yellen that with little meat on the Trump policy bone as yet, the Fed might hold out until more specifics are shared before boosting rates. This also means much more economic data to factor into their economic group-think. Odds are this means a rate hike is more likely at the May FOMC meeting than at the March one.

Today Yellen takes the stage in front of the House Financial Services Committee, and while it’s a bit mean to say we do tend to get a hearty chuckle out of watching some of those folks ask questions they don’t really understand. That good fun aside, we don’t expect Yellen to deviate from the Fed script anytime soon.

Updates, Updates, Updates

Over the last few days, there were several noteworthy items for a few of our Tematica Select List holdings. The following is a roundup of those developments.

The Walt Disney Co. (DIS)    Content is King

Disney raised admission prices for U.S. theme parks, by as much as $5 for certain one-day tickets at the Magic Kingdom theme park in Orlando and Disneyland. The cost of a regular ticket at the Magic Kingdom, effective yesterday, is now $115, while the same at Disneyland is now $110. The $124 peak price at Magic Kingdom, which includes many summer days and holidays, is unchanged.

As a consumer, we may cringe at the Disney’s ticket prices, but there is no denying its parks remain a key attraction, and new exhibits/rides, such as Frozen and eventually Star Wars, will only serve to keep people coming. From an investor perspective, price increases like these tend to drive margin expansion and profits, and that’s something we certainly like.

  • Our price target on Disney remains $125, and we continue to rate DIS shares a Buy. 

 

AT&T (T)  Connected Society

AT&T competitor Verizon (VZ) announced it was returning to unlimited data plans, in part to combat Sprint (S) and T-Mobile USA (TMUS). Typically, there tends to be a herd mentality when such programs are introduced, which means we’ll be watching to see if AT&T joins the fray — and if so, how the company tiers its product offering.

Also with AT&T, when asked about the pending merger with Time Warner (TWX), CEO Randall Stephenson said, “We still think we’ll be closed by the end of the year.” That matches recent comments from Time Warner, and likely means AT&T shares will be somewhat rangebound until the proposed merger clears its review by the Department of Justice. Time Warner shareholders will meet today to decide on the company’s proposed $86B merger with AT&T — a “yes” vote is expected.

  • We continue to rate T shares a Hold, with a $45 price target. All things being equal, we’d look to revisit our rating on the shares below $40.
Amazon (AMZN)    Connected Society

As it relates to our position in Amazon, over the weekend there was news that FedEx (FDX) has launched FedEx Fulfillment, a logistic network for small and medium businesses. Given the accelerating shift to digital commerce (one of our key investment pillars for AMZN shares), it comes as little surprise that FedEx would seek to replicate Amazon’s Fulfilled By Amazon (FBA) business. For FBA transactions, Amazon receives a portion of each sale, but could, at the same time, be competing with the vendor.

The differentiator, in our view, is Amazon’s Prime service, which offers “free” two-day delivery for the shopper, and a growing list of items/services. Given the overall shift to digital commerce, odds are this rising tide will lift several boats, but to us, the real question is how vendors will offset shipping costs paid by shoppers. If they stick it to shoppers, this effort by FedEx could be more sizzle than steak.

 

AMN Healthcare (AMN)    Aging of the Population

The December JOLTS report showed yet another month-over-month increase in health-care and social assistance jobs, which led to a 12 percent increase in December 2016 compared to December 2015. Meanwhile, hiring levels in December remained relatively unchanged, up only 2.1 percent year over year.

In our view, this confirms the difficulty in finding quality staff, which bodes well for AMN’s business. Longer term, by 2020, the U.S. is expected to need 1.6 million more direct-care workers than in 2010, which equates to a 48 percent increase for nursing, home-health and personal-care aides over the decade, due primarily to the aging of 78 million baby boomers.

Our intent remains to nibble on AMN shares closer to $35 to build out the position at better prices. AMN will report its quarterly earnings tomorrow (Feb. 16) and consensus expectations call for EPS of $0.54 and revenue of $476.4 million.

  • We have a $47 price target on AMN and at current levels, that leaves 21 percent upside; as such we will look to revisit the rating and the price target after the company’s earnings announcement.

 

Dycom Industries (DY)  Connected Society

Our shares of this Connected Society infrastructure play rose more than 2 percent since last week following the news that CenturyLink’s (CTL) 2017 capital spending will be $2.6 billion vs. $3.0 billion in 2016. While overall spending is ticking down, on its earnings call CenturyLink management shared that its “broadband investments for 2017 are expected to actually be a little higher than 2016 levels.” Combined with 2017 capital spending plans for AT&T, Verizon, and Comcast, it looks like total capital spending on broadband and wireless will be up modestly year over year with a greater portion of spending on network capacity and new technologies (5G, Gigabit fiber).

We continue to see Dycom as a prime beneficiary of that wireless and wireline capital spending. We are going to sit tight and be patient with the position given our view that, worst case, it’s only a matter of time for next-generation network technologies to be deployed.

  • We rate Dycom shares a Buy with a $115 price target.

 

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

After today’s market close, IFF will report its December quarter earnings. Consensus expectations have the company delivering EPS of $1.16 on revenue of $752.3 million. As we’ve shared previously, flavor and fragrance competitor results set a sound footing for IFF’s quarterly earnings that will be reported this week (Feb. 15).

We remind subscribers that given IFF’s international exposure, currency is likely to weigh on its December-quarter results as well as its near-term outlook. But, as we have said before, we see that largely reflected in the share price over the last few months.

  • We continue to see ample upside to our $145 price target over the coming quarters fueled by rising disposable income, particularly in the emerging markets, but also from the shift in consumer preferences to natural/organic flavors.

 

Nuance Communications (NUAN)  Disruptive Technology

Following solid December-quarter earnings last week, shares of this voice technology company rose more than 6 percent over the last several days, bringing our return in the shares to roughly 9 percent. In our view, the performance in the most recent quarter shows that despite all the headway we are hearing about Amazon’s (AMZN) Alexa voice digital assistant and similar offerings from Alphabet (GOOGL), there is ample opportunity in this expanding voice technology market for Nuance and its offerings to the health-care, mobile/auto, enterprise and imaging markets.

During the conference call Nuance shared that while there has been growing interest in voice interface technology in the last few years, the arrival of Amazon and Alphabet products has accelerated the pace of investment across several Nuance customer verticals. These opportunities along with Nuance’s expanding solution set, which includes artificial intelligence and analytics, bodes well for the company’s competitive position in the coming quarters.

Longer term, Tractica forecasts total voice digital assistant revenue will grow from $1.6 billion in 2015 to $15.8 billion in 2021. That is also likely to put Nuance on the M&A contender list for those larger entities that need to expand their voice technology capabilities.

  • Our price target on the shares remains $21 and our rating a Buy. All things being equal, the line at which we will revisit that rating is around $19

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is above; however downloading the full issue provides detailed performance tables and charts. Click here to download.

As the market scales new heights, we review our current holdings

As the market scales new heights, we review our current holdings

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is below; however downloading the full issue provides detailed performance tables and charts.Click here to download.

Over the last few days, we’ve been attending the Inside ETF conference in warm and sunny Hollywood, FL. While we were focused on the latest developments in the ETF space, we’ve kept one eye on the markets and the renewed climb in the stock market, with the DOW tipping over the 20,000 mark for the first time in history just this morning.

With yesterday’s close both the tech-heavy Nasdaq composite index and the S&P 500 powered to new all-time highs amid news that President Trump is already getting down to business, the domestic manufacturing economy perked up further in January and the continued mixed bag of December quarter earnings.

As we shared in this week’s Monday Morning Kickoff, this is the first full week of the year that teems with both data and earnings, with the latter escalating as the week goes on and on into next week. Toward the end of the week, we get the first print on 4Q 2016 GDP and we close it out with the start of Chinese New Year. As that holiday begins, we’ll be looking for confirming points for our Affordable Luxury, as well as Rise & Fall of the Middle-Class themes.

This week we have four positions on the Tematica Select List reporting – Cash-strapped Consumer company McCormick & Co. (MKC), Connected Society player AT&T (T), Guilty Pleasure company Starbucks (SBUX) and Alphabet (GOOGL), which resides in our Asset-lite Business Model investing theme. This morning McCormick reported is 4Q 2016 results, and despite the impact of currency, which was expected given the company’s geographic mix, we found the results rather favorable and the same can be said for the outlook over the next year – more on that below.

After today’s market close, AT&T will share its full results for the December quarter. Last week the company pre-announced several metrics for its December quarter, but yesterday Verizon’s (VZ) results fell short of Wall Street expectations. As part of our monthly position review below, we’ve laid out some of those metrics as well as shared reporting dates for those companies that have made their reporting dates known. That’s right, today is the last Wednesday in January and it’s time to take stock (pun intended) of the positions on the Tematica Select List.

This week’s issue is jammed packed, with updates on the 15 of the holdings in the Tematica Select List along with our current ratings and guidance on each position. Given the length, we recommend you download the full issue by either clicking on the download button below or simply clicking here.

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is above; however downloading the full issue provides detailed performance tables and charts. Click here to download.

A Wait-and-See Approach as Trump Inauguration and Earnings Cocktail Unfolds

A Wait-and-See Approach as Trump Inauguration and Earnings Cocktail Unfolds

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is below; however downloading the full issue provides detailed performance tables and charts.Click here to download.

As you sit down and digest this latest issue of Tematica Investing, you’ll notice it’s a tad shorter than the usual 6-10 pages that we fill to the brim. On the one hand, we’re inclined to say “you’re welcome,” but the reality is with the market rangebound over the last 20 plus days, the presidential inauguration about to take-over the news cycle, the velocity of earnings reports about to pick up, and Eurozone drama likely to re-emerge in the coming days, we’ve opted to see how things unfold over the next several days before making any new moves with the Tematica Select List.

That said, the thematic tailwinds are still blowing for a number of our positions with a “Buy” rating, including: Facebook (FB), Nuance Technologies (NUAN), McCormick & Co. (MKC), Dycom Industries (DY), Universal Display (OLED), CalAmp Corp. (CAMP), United Natural Foods (UNFI), Starbucks (SBUX) and International Flavors & Fragrances (IFF).

With the market move over the last several weeks, we’d recommend subscribers continue to hold their positions in AT&T (T), Costco Wholesale (COST), Disney (DIS), Alphabet (GOOGL) and Amazon (AMZN), but wait for a pullback before adding any more capital to those positions. For new subscribers that means we’d recommend you watch from the sidelines for now on those positions.

 

Is the Trump Rally Over as Investors Keep the Markets Range Bound Since the New Year?

Since last week’s Tematica Investing, we’ve seen the overall stock market little changed, with the Dow Jones Industrial Average down slightly, the S&P 500 essentially flat and the Nasdaq Composite Index up a tick.

range-bound index

We’ve had a number of favorable moves on the Tematica Select List, with Facebook (FB) climbing more than 2 percent and Amazon (AMZN) up more than 1.5 percent with favorable moves in International Flavors & Fragrances (IFF), AT&T (T), Costco Wholesale (COST) and Universal Display (OLED) were had. Several Tematica Select List positions moved relative sideways during the week, like Alphabet (GOOGL) and Nuance Communications (NUAN), but we see that as treading water ahead of the earnings report deluge.

As the market braces for the deluge of fourth quarter earnings announcements, we continue to find confirming data for our active positions. Case in point, reports that smartphone vendors are concerned Apple (AAPL) could “monopolize OLED supply capacity for this year’s iPhone 8,” and are looking to secure organic light emitting diode capacity fits with our thesis and bodes well for our Universal Display (OLED) shares.

Another, even though we just added Disruptive Technology theme company Nuance Communications (NUAN) to the Tematica Select List last week, we continue to hear about new voice-enabled applications like the one from Adobe Systems (ADBE) called “intelligent digital assistant photo editing” that is more simply put a voice-controlled photo editor. We have to admit, we are rather excited for that one assuming it helps reduce the trial and error effort to touch up photos and get rid of all those red eyes.

As we mentioned above, we are preparing to drink from a firehose-like deluge of earnings announcements this week and the next few. As evidenced by what we’ve seen thus far from JPMorgan Chase (JPM), Bank of America (BAC), PNC Bank (PNC), United Continental (UAL), WD40 (WDFC), CSX (CSX) and Gigamon (GIMO) it’s going to be a rather mixed bag of reports over the coming weeks. Once again we’re seeing earnings misses relative to expectations lead to falling stock prices. Not a bad thing considering how far and how fast the stock market has jumped since early November, especially if you’ve been a prudent investor like we have been these past several weeks. During that time we added Rise & Fall of the Middle Class McCormick & Co. (MKC), Facebook (FB) as our latest Connected Society play and last week Nuance Communications (NUAN) given its disruptive voice technology.

While we could point out that all three have moved nicely higher, especially Facebook, which certainly has us feeling pretty good, it’s the opportunity to circle back to the ones that got away that has us rather excited this earnings season. It’s not that we want bad news, but rather the opportunity to buy well positioned, thematically driven businesses at better prices. That’s how we added Facebook shares to the Tematica Select List — we knew the company was a key player in our Connected Society investing theme, but we waited until we had a compelling risk-to-reward tradeoff in the share price.

This reminds us of one of “Uncle” Warren Buffet’s most used sayings, “Price is what you pay. Value is what you get.”

We suspect there will be far more value to be had in the stock market over the next few weeks compared to the last several as December quarter earnings kicks into gear. As we’ve shared in the last several issues of The Monday Morning Kickoff, expectations have been running high, but recently more investors have been scratching their heads as they put the economic reality puzzle pieces together and reassess what is “expected.” Making this even more challenging is we have the Volatility Index near its lowest levels in over a year. Looking at the chart below, the words “reversion to the mean” ring in our head.

What this tells us is should the news turn to something less than expected, we are bound to see a far more bumpy time in the market than the smooth sailing we’ve seen since early November.

 

President-elect Trump’s Tweets and Interviews Suggest a Bumpy Ride 

Unless you live under a rock or are stuck under a very large piece of furniture with no access to a TV or the internet (yes, the internet has become so ubiquitous that it now lowercase), you know this week also marks the presidential inauguration, which will dominate headlines over the next few days. While we will watch the events of the week and listen to the speeches and confirmation hearings for clues as to what’s to come from the new Trump administration, we won’t be shedding a tear as we move past the event and onto the work that needs to be done.

As that happens, we also hope that President Trump rethinks his Twitter (TWTR) usage, but not necessarily for the same reasons as the media. While we like the push to bring jobs back to the US and put a more effective healthcare program in place, as investors we are not fans of the policy-by-bullhorn we have seen.

What makes this even more challenging is we have yet to receive a holistic view on what President-elect Trump’s policies will be, and this “keep them guessing” approach of one-off pronouncements may be good for his intended deal making, it’s added a layer of uncertainty for the stock market, and as we know the market doesn’t like uncertainty.


As we’ve seen from president-elect Trump’s tweets and interviews, his words have the potential to be very disruptive to the investment playing field:

  • Earlier this month, close to $25 billion was shaved off the value of the S&P 500’s top nine pharmaceutical companies in a matter of minutes, following President-elect accusing them of “getting away with murder.”
  • Last week following a newspaper interview with President-elect Trump in which he warned he would impose a border tax of 35 percent on vehicles imported from abroad to the US market, German carmaker stocks sold off sharply.
  • The US dollar slumped to a seven-week low against Japan’s yen late Tuesday, and continued to trade lower against a slew of currencies early this morning after President-elect Trump said that the buck was “too strong”. In an article in The Wall Street Journal, Mr. Trump said the strength of the US dollar against China’s yuan “is killing us.”

 

Amidst All This Uncertainty, We’re Taking a Wait and See Approach 

We’ve encountered many disruptions in the past and odds are these current events won’t be last. Over the last few years, we’ve seen earnings season become a greater source of stock price volatility — miss EPS expectations by a penny, and we now see share prices fall 10-20 percent, far greater than the single digits selloffs that had been the norm. These tend to be short-term disruptions that give way to market forces, which means that as we continue to focus on thematic fundamentals, we’ll be vigilant for opportunities presented by wide swings in stock prices.

With this in mind, we’re holding off making any moves with the Tematica Select List this week as we instead digest company comments regarding the tone of the economy, impact of the dollar on their business outlook and of course the strength of our thematic tailwinds.

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is above; however downloading the full issue provides detailed performance tables and charts. Click here to download.

Making a Nuanced Move With The Tematica Select Investment List

Making a Nuanced Move With The Tematica Select Investment List

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is below; however downloading the full issue provides detailed performance tables and charts.Click here to download.

Over the last week, while many have been watching the Dow Jones Industrial Average flirt with 20,000, the Nasdaq Composite Index continued to climb higher. That led our Connected Society investment theme positions in Facebook (FB), Alphabet (GOOGL) and Amazon (AMZN) higher over the last week.

  • Even so, we still have ample room to our respective price targets for each of those positions and our buy rating on all three remains.

 

Over the last few months, we’ve been talking about the impact of food deflation, which has been confirmed by our Cash-strapped Consumer play that is Costco Wholesale (COST) as well as grocery chain Kroger (KR) and others.

We’ve also called out the inability of restaurants to harness that deflation for their own margins given minimum wage increases and other cost drivers. The latest findings from Fitch Ratings sees restaurant sales slowing this year, and the NPD Group expects traffic will be flat this year, with a 2 percent decline at dine-in restaurants offsetting a 1% increase at quick-service concepts.  We expect confirmation to be had this coming earnings season, and if Kona Grill’s (KONA) 4 percent decline in same-store sales for the December quarter is any indication it’s not going to be pretty.

Still, we know that people need to eat and are continuing to shift toward organic and natural foods and other products, which bodes well for our McCormick & Co. (MKC) and United Natural Foods (UNFI) shares. Recent findings from a new poll conducted by Pew Research Center underscore our bullish position. According to the Pew poll, 55 percent of Americans believe that “organic food, particularly organically grown fruits and vegetables, are healthier than conventional.” The same poll also showed a growing distrust of GMO foods and concern over pesticide use.

A different study conducted by the European Parliament’s Independent Research Service, titled “Human health implications of organic food and organic agriculture,” concluded that eating organic food improves early development, reduces pesticide exposure, strengthens the nutritional value of food, and mitigates disease risks.
We do not see this as a short-term fad and point to a recent report from Research and Markets that forecasts the global market for organic food to grow at “a CAGR of over 14 percent during 2016-2021, on account of high demand for organic food.”

  • Both MKC and UNFI remain Buys at current levels.

 

rogueonecharact-6d3c3120104-originalOn the continued strength of Rouge One at the box office and the news that Content is King investment theme company The Walt Disney Co. (DIS) is firming up plans for a streaming ESPN service, our Disney shares moved higher over the last several days.

The same can be said with our CalAmp (CAMP) shares following management’s presentation at the annual Needham Growth Conference that focused on its expanding market opportunities across fleet management, Connected Car and enterprise asset tracking markets.

Adding Nuance Communications (NUAN)
to the Tematica Select List as Voice Goes Big

Last week was the tech world descended upon Las Vegas for CES 2017. The annual trade show kicks off the new year and introduces a number of new consumer gadgets that we’re likely to see — some this year and others in the coming ones.

Among the sea of announcements, there were a number that focused on one aspect of our Disruptive Technology investing theme and that is the area of voice recognition technology. Over the years we’ve seen various incarnations of this technology, most recently with Siri from Apple (AAPL), Cortana from Microsoft (MSFT), Google Assistant from Alphabet (GOOGL) and Alexa from Amazon (AMZN). Each of these has come to the forefront like in products like Amazon Echo and Google Home that house these virtual digital assistants (VDAs), but for now one of the largest consumer-facing markets for voice interface technology has been the smartphone. Coming in 2016, Parks Associates found that nearly 40 percent of all smartphone owners use some sort of voice recognition software such as Siri or Google Now.

 

 

In 2016, the up and comer was Amazon as sales of its Echo devices were up 9x year over year this past holiday season and “millions of Alexa devices sold worldwide this year.” If you’re a user of Amazon Echo like we are, then you know that each week more capabilities are being added to the Alexa app such as ordering a pizza from Dominos (DPZ), calling for an Uber, checking sports scores and weather to getting holiday cocktail recipes.

As we entered 2017, Amazon announced that Prime members can voice-order their next meal through Amazon Restaurants on their Alexa-enabled devices including the Amazon Echo and Echo Dot. Once an order is placed, Amazon delivery partners deliver the food in one hour or less. Pretty cool so long as you have Amazon Restaurants operating in and around where you live.

 

 

Virtual digital assistants cut across more than just smartphones and devices like Amazon Echo and the recently announced Google Home. According to a new report from Tractica, while smartphone-based consumer VDAs are currently the best-known offerings, virtual assistant technologies are also beginning to penetrate other device types including smart watches, fitness trackers, PCs, smart home systems, and automobiles.

We saw just that at CES 2017 with some landscaping changing announcements for VDAs. Alphabet had several announcements surrounding its Google Home product at CES 2017, including integration into upcoming Hyundai and Chrysler models; and acquiring Limes Audio, which focuses on voice communication systems, and will likely be additive to the company’s Google Home, Hangouts and other products. Microsoft also scored a win for Cortana with Nissan.

While those wins were impressive, the big VDA winner at CES was Amazon as it significantly expanded its Alexa footprint on deals with LG, Dish Network (DISH), Whirlpool (WHR), Huawei and Ford (F). In doing so Amazon has outflanked Alphabet, Microsoft and even Apple in the digital assistant market. To us, that’s another leg to the Amazon stool that offers more support to the share alongside the digital shopping/services, content, and Amazon Web Services businesses. You don’t need to read between the lines to think that we still see big upside to our $975 Amazon price target.

To be fair, Apple originally did not license out its Siri technology and only in June 2016 did it announce that it would open the code behind Siri to third-party developers through an API, giving outside apps the ability to activate from Siri’s voice commands, and potentially endowing Siri with a wide range of new skills and datasets.
Tractica forecasts that unique active consumer VDA users will grow from 390 million in 2015 to 1.8 billion worldwide by the end of 2021.  During the same period, unique active enterprise VDA users will rise from 155 million in 2015 to 843 million by 2021.  The market intelligence firm forecasts that total VDA revenue will grow from $1.6 billion in 2015 to $15.8 billion in 2021.

 

An Overlooked Player in the VDA Segment

Nuance Communications logoThe one drawback when it comes to the VDA market is the players mentioned above have large existing businesses, which means their respective VDA businesses, at least in the next few yeas, will have at best modest influence on their overall financial picture. In keeping with our “buy the bullets not the guns,” coming out of CES 2017 we find ourselves looking at speech technology and voice recognition company Nuance Communications (NUAN).

Nuance’s voice solutions compete in four markets:

  • Healthcare (49 percent of revenue): In this business, Nuance supports clinical documentation workflows and electronic medical record (EMR) adoption through flexible offerings, including transcription services, dictation software for the EMR, diagnostics workflow, and mobile applications. Recently Nuance released Dragon Medical Advisor, an AI Assistant for doctors. More than 500,000 clinicians and 10,000 healthcare facilities worldwide use Nuance’s healthcare solutions, which are sold through customers that include Cerner (CERN), Epic, McKesson (MCK), UPMC, Cleveland Clinic, Siemens, and the Mayo Clinic. Over the last few quarters, Nuance has been transitioning this business from a perpetual license business to a software as a service (SAAS) one, but with that shift expected to be largely completed by the second half of 2017 that revenue drag should be eliminated.
  • Enterprise (20 percent of revenue): This business segment offers automated intelligent self-service solutions that include speech and artificial intelligence (AI) technologies that reduce or replace human contact center agents with conversational systems, across voice, mobile, web and messaging channels. Think of when you call your bank, broker or even consider using the phone to call for a pizza from Dominos (candidly we’re not sure why you would call given the ease of the Domino’s app that can be used on either your smartphone, Apple TV, or Amazon’s Alexa, but hey that’s us). Representative customers include Avaya, BT, Cisco, DiData, Genesys, Huawei, MoshiMoshi, NICE, Telstra, and Verint. Nuance’s customers include: American Airlines, Amtrak, Bank of America, Barclays, Dominos, Delta, Deutsche Telekom, e*trade, ING Bank, Lloyds Banking Group, T-Mobile, Telefonica, Telstra, and Vodafone.
  • Mobile (19 percent of revenue): Here Nuance offers a portfolio of specialized virtual assistants and connected services built on voice recognition, text-to-speech, natural language understanding, dialog, and text input technologies across automotive, device and mobile operator solutions. With regard to automotive in particular, Nuance has announced Daimler, Ford and BMW as customers, and as evidenced at both CES 2017 and the 2017 North American International Auto Show we are nearing the tipping point for the Connected Car, which should bode well for this business segment.
  • Imaging (12 percent of revenue): In this division, segment Nuance provides software solutions and expertise that help professionals and organizations to gain optimal control of their document and information processes. Customers and partners include Ricoh, Xerox, HP, Canon, and Samsung. This business has been bumping along at around 11 to 12 percent of revenue the last few years as Nuance has reorganized itself over the last several quarters.

When we step back from Nuance’s business segments and look at the overall market growth for voice recognition technologies, BCC Research sees it growing to $184.9 billion in 2021, up from $90.3 billion in 2015. Breaking these two markets down into Consumer and Enterprise markets, BCC expects the Consumer market to grow to $95.9 billion in 2021 from $54.4 billion in 2016 and the Enterprise market to reach $79.0 billion by 2021 up from $44.0 billion in 2016. Viewed against that larger market, we see ample room for Nuance to expand beyond the $1.9 billion in revenue it generated in 2016.

Over the last few years, after delivering significant revenue growth during 2010-2014,  the pace of revenue growth, while positive, has dipped. Part of that is due in part to erosion for the transcription business in the company’s Healthcare business, as well as the shift from a contract business model to a Cloud based one that offers integrated solutions. In 2016, roughly 70 percent of the company’s revenue stream was recurring in nature, up from 65 percent or so in 2015.

What this tells us is the bulk of the revenue shift is largely behind the company. Like a turning tanker, these changes take time, but once they catch momentum they tend to pick up speed and Nuance should see its recurring revenue growth to 70-75 percent of overall revenue during 2017. As investors, we like the nature of a recurring revenue model, given that it affords far greater visibility and shares tend to be rewarded with better multiples given that predictability.

We’ve seen the power of this business shift already at Adobe Systems (ADBE), which now has more than 70 percent of its revenue recurring in nature, up from 19 percent in 2011, and its shares that have climbed to just over $108 from $28 at the end of 2011.

Looking Ahead to 2017 for Nuance

The growth businesses at Nuance include its automotive, voice biometrics, omni-channel customer care, unified print and scan solutions, Dragon Medical, CDI and diagnostics. Paving the way is the company’s most recent quarterly bookings, which were up 45 percent year on year. Longer-term we expect more applications across the consumer electronics market to develop. As noted above, Whirlpool is working with Amazon and odds are that means before too long we’ll see VDAs built into various appliances across the kitchen and laundry rooms. In our view, that’s just scratching at the surface.

The big question circling Nuance is the competitive landscape, particularly the move by Amazon, Alphabet and Apple to open up their application programming interface (API) to third-parties. Just like Rackspace (RACK) specializes in Cloud computing, but thus far has remained unharmed by Amazon’s AWS, Nuance specializes in selling to global brands, health care, and large corporations, which are not likely to utilize Google’s free API for its business needs. As you’ve probably notice with Android, one of the issues with a free API is malware and cyber hacking.

It’s also not lost on us that Alphabet recently acquired Limes Audio to improve its voice recognition capabilities. As anyone who has used Apple’s Siri knows, it’s far from perfect in voice recognition and voice to text. In our view, this means Nuance could be an attractive candidate for a larger player that needs to improve its technology positioning.

 

What are NUAN shares worth?

In looking over historic multiples, including P/E and Enterprise Value to Revenue, and applying them to consensus 2017 earnings expectations that call for EPS of $1.59 on revenue of just over $2 billion, we see upside to $21 and downside to just under $15.

At the current share price — $15.45 as of market close on 1/10/17 — NUAN shares are trading at under 10x expected 2017 earnings of $1.59 per share. We certainly like that risk-to-reward trade-off in NUAN shares at a time when voice technology is expanding its market size across the device, automotive and Internet of Things markets.

 

Bottomline on Nuance Communications (NUAN)
  • We’re adding NUAN shares to the Tematica Select list with a price target of $21.
  • Because this is a new position, we are holding off with a stop loss recommendation at this time, preferring to use near-term weakness to scale into the position and improve the cost basis.

 

* We strongly recommend you use the link below to download the full report on Nuance Communications (NUAN), which includes background on our Disruptive Technology thematic as well as financials on NUAN.

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is above; however downloading the full issue provides detailed performance tables and charts. Click here to download.