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Weekly Issue: Many Confirming Data Points from Retail Sales Report

Weekly Issue: Many Confirming Data Points from Retail Sales Report

 

KEY POINTS FROM THIS ISSUE:

  • Our price target on Amazon (AMZN) shares remains $1,750
  • Our price target on United Parcel Service (UPS) remains $130
  • Our price target on Costco Wholesale (COST) remains $210.
  • Our price target on Habit Restaurant (HABT) shares remains $11.50
  • Our price target on Applied Materials (AMAT) shares remains $65.
  • Our price target on Apple (AAPL) shares remains $200.

 

Yesterday, we received the latest monthly Retail Sales report and it once again confirmed not only several of our investing themes, but also several of our Tematica Investing Select List holdings as well. While I and others at Team Tematica put these and other such reports through the grinder to ensure we understand what the data is telling us, I have to say some reports are more of a pleasure to read than others. In this case, it was a great read. First, let’s dig into the actual report and then follow up with some thematic insight and commentary. 

April Retail Sales – the data and comments

Per the Census Bureau, April total Retail Sales & Food Services rose 4.7% year over year, with the core Retail Sales ex-auto parts and food services up 4.8% compared to April 2017. A modest downtick compared to the year over year growth registered in March, but a tad higher than the February comparison.

Subscribers will not be bowled over to learn the two key retail drivers were gas stations (up 11.7% year over year) followed by Nonstore retailers (9.6%). The two categories that have been a drag on the overall retail comparisons – Sporting goods, hobby, book & music stores and Department Stores – continued to do the same in April falling  1.1% and 1.6%, respectively. Scanning the last few months, the data tells us things have gotten tougher for those two categories as the last three months have happened.

With gas stations sales up nearly 11% over the last three months compared to 2017, real hourly earning’s barely up per the latest from the Bureau of Labor Statistics and consumer debt up to 26% of average disposable income (vs. 22% during the financial crisis per the latest LendingTree Consumer Debt Outlook) there’s no way to sugar coat it – something had to give and those two continue to take the brunt of the pain. As gas prices look to move even higher as we switch over to more costly summer gas blends and interest rates poised to move higher, it means consumers will continue to see discretionary spending dollars under pressure.

In keeping with our Connected Society and Cash-strapped consumer investing themes, consumers are turning to digital shopping to hunt down bargains and deals, while also saving a few extra bucks by not heading to the mall. That is, of course, positive confirmation for our position in Amazon (AMZN) shares as well as United Parcel Service (UPS) shares, which have had a quiet resurgence thus far in 2018. That move serves to remind us that connecting the dots can lead to some very profitable investments, and as I like to say – no matter what you order from Amazon or other online shopping locations, the goods still need to get to you or the person for which they are intended. I continue to see UPS as a natural beneficiary of the accelerating shift toward digital commerce.

  • Our price target on Amazon (AMZN) shares remains $1,750
  • Our price target on United Parcel Service (UPS) remains $130

 

April retail sales confirms our bullish stance on Costco

Costco Wholesale (COST) shares have been on a tear since their February bottom, and in my view each month we get a positive confirmation when Costco reports its monthly sales data as increasingly Cash-strapped Consumers look to stretch their disposable dollars was had in Costco Wholesale’s (COST) April same-store-sales report. For the month, Costco’s US sales excluding gas and foreign exchange rose 7.9%, once again showing the company continues to take consumer wallet share. As for the critics over how, late Costco had been to digital commerce, over the last few months its e-commerce sales have been up 31%-41% each month. While still an overall small part of Costco’s revenue stream, the management team continues to expand its digital offerings putting it ahead of many traditional brick & mortar focused retailers.

Finally, we need to touch on one of the key profit generators at Costco – membership fee revenue, which is tied to new warehouse openings.  If we look at the company’s recent quarterly earnings report we find that 73% of its operating profit is tied to that line item. As part of its monthly sale report, Costco provides an updated warehouse location count as well. Exiting April Costco operated 749 warehouse locations around the globe, the bulk of which are in the U.S. and that compares to 729 warehouses exiting April 2017. That number should climb by another 17 new locations by the end of August and paves the way for continued EPS growth in the coming quarters.

  • Our price target on Costco Wholesale (COST) remains $210.

 

Two favorable data points for recently added Habit Restaurant shares

Last week, we added shares of Habit Restaurant (HABT) to the Tematica Investing Select List with an $11.50 price target. Since then, we’ve had two positive data points, including one found in yesterday’s Retail Sales report. The first data point was from TDn2K, a firm that closely watches monthly restaurant sales. For the month of April, TDN2K reported same-store sales for the month rose 1.5%, the best showing in over 30 months. The April Retail Sales report showed year over year April retail sales at Food services & drinking places rose 3.8%, bringing the trailing 3-month total to up 3.6% on a year over year basis.

While our investment thesis on HABT centers on the company’s geographic expansion, these data points point to an improving business for its existing locations. Paired with the pending menu price increase, we see this data pointing a stronger operating environment in the coming quarters.

  • Our price target on Habit Restaurant (HABT) shares remains $11.50

 

Gearing up for earnings from Applied Materials

After tomorrow night’s close Disruptive Technologies company Applied Materials (AMAT) will report its quarterly earnings. Expectations call for it to deliver EPS of $1.14 on revenue of $4.45 billion. For those at home keeping score, those figures are up 44% and 26%, respectively, on a year over year basis.

As the current earnings season got underway, we heard very positive commentary on the semiconductor capital equipment market from several competitors, including Lam Research (LRCX). This lays the groundwork for an upbeat report despite the softness we are seeing in the organic light emitting diode display market. With more smartphone models poised to adopt that display technology, including more favorably priced ones from Apple (AAPL), Applied’s outlook for its Display business tomorrow night could be the canary in the coal mine for shares of Universal Display (OLED).

With regard to the core semiconductor capital equipment business, I continue to see longer-term opportunities for it associated with a number of emerging technologies and applications (growing memory demand, 5G chips sets, 3D sensing, smarter automobiles and homes, and augmented reality to virtual reality and the Internet of Things) that will drive incremental chip demand in the coming years. I’m also hearing that China’s state-backed semiconductor fund, The National Integrated Circuitry Investment Fund, is closing in on an upsized 300 billion-yuan fund ($47.4 billion) fund vs. the expected 120 billion-yuan ($18.98 billion) to support the domestic chip sector. This buildout was one of my focal points behind adding AMAT shares to the Select List over a year ago.

Since then AMAT shares are up more than 50%, and this upsized demand from China is poised to drive them even higher in my view. Before that can happen, however, the semiconductor industry has taken a leading role in the current U.S.-China trade conflict. This means I’ll continue to monitor this development closely.

As we get ready for the upcoming earnings report, let’s also remember Applied buyback program. I suspect the company was in buying shares during the April lows. We’ll get a better sense when we compare year over year share counts once I have the earnings report in my hands.

  • Our price target on Applied Materials (AMAT) shares remains $65.

 

Tim Cook confirms Apple’s move into original content

Apple’s move into original content has to be one of the worst-kept secrets in some time. There have been hiring’s of key people for key roles as well as content partners that have spilled the beans, but now Apple CEO Tim Cook quietly confirmed the move while appearing on “The David Rubenstein Show: Peer-to-Peer Conversations” on Bloomberg Television by saying

“We are very interested in the content business. We will be playing in a way that is consistent with our brand,” Cook told Bloomberg. “We’re not ready to give any details on it yet. But it’s clearly an area of interest.”

A summary of that conversation can be found here, and my $0.02 on this is Apple will be looking to leverage original content to increase the sticky factor for its devices as well as attract new customers for those devices. This is similar to the strategy behind its services business that includes iCloud, Apple Music, Apple Pay and other offerings. We could hear more of this in a few weeks at Apple’s 2018 World Wide Developer Conference but given the expectation for its content to roll out after March 2019 odds are we won’t hear much just yet.

  • Our price target on Apple (AAPL) shares remains $200.

 

 

 

WEEKLY ISSUE: Robust Earnings and March Retail Sales Bode Well for Select List

WEEKLY ISSUE: Robust Earnings and March Retail Sales Bode Well for Select List

 

Once again, the stock market has shrugged off moves in the geopolitical landscape and mixed economic data to start the week off higher. Not surprising as the highly anticipated 1Q 2018 earnings season has gotten underway and based on what we saw the last two days so far so good. For the record, we had 44 companies that reported better than expected top and bottom line results, a number of them high profile companies such Bank of America (BAC), Netflix (NFLX), Goldman Sachs (GS), Johnson & Johnson (JNJ), and CSX (CSX).

Like I said, so far so good, and while we’re getting some additional nice EPS beats this morning, we’re still very early on in the 1Q 2018 earnings season. Make no mistake, it’s encouraging, but we have a long way to go until we can size up 1Q 2018 earnings performance vs. the high bar of expectation that calls for roughly 18% EPS growth year over year for the S&P 500.

That’s why I’ll continue to parse the data — earnings and otherwise — as it comes through. Last week and this week, we’ll get more of that for March, and that means we can get a view on how those data streams performed in full for 1Q 2018. Case in point, on Monday we received the March Retail Sales Report, which on its face came in at 0.6%, better than expected, and excluding autos and food services the metric also 0.6% vs. February. That translated into a 4.7% increase for retail ex-auto and food services year over year for the month. Stepping back, the data found in Table 2of the report showed that line item rose 4.3% year over year for all of 1Q 2018.

With that information, we can size up which categories contained in the report gained wallet share and identify those that lost it. The two big winners for 1Q 2018 were gasoline stations, up 9.7%, which was no surprise given the rise in gas prices over the last three months, and Nonstore retailers, which also rose 9.7%. We see that data as very favorable for our Amazon (AMZN) shares and boding well for Costco Wholesale (COST) given its growing e-commerce business. Contrasting that figure against the -0.6% for department store sales in 1Q 2108 confirms the ongoing shift in how and where consumers are shopping. Not good news in our view for the likes of JC Penney (JCP) and other mall anchor tenants.

The hardest hit category during 1Q 2018 was Sporting Goods, hobby, book & music stores, which fell 4% year over year. Remember, we’re seeing these categories impacted as well by the shift to digital commerce, streaming services such as newly public Spotify (SPOT) and programs like Amazon’s Kindle Unlimited that looks to be the Netflix (NFLX) of books, audiobooks, and magazines. In my view, the other shoe to drop for this Retail Sales Report category is the Toys R Us bankruptcy that is poised to do to the toy industry what the Sports Authority bankruptcy and subsequent liquidation sales did to Under Armour (UAA), Nike (NKE) and Adidas among others. We’ll get a better picture on that when toy company Mattel (MAT) reports its quarterly results later this week.

I’d also call out that Clothing & Clothing Accessories store retail sales for 1Q 2018 rose just 3.0%, signaling slower growth than overall retail sales – a sign that consumers are spending their disposable dollars on other things or elsewhere. Over the last year, we’ve more than touched on the transformation that is underway with digital shopping, and we continue to see Amazon as extremely well positioned. Likely augmenting that Amazon has moved its Amazon Prime Wardrobe service, its “try before you buy offering,” from beta to launch.

Of course, it requires Prime membership and we see this service as helping drive incremental Prime subscriptions, especially as Amazon continues to improve its apparel offering, both private label and branded. Another headwind to clothing retailers looks to be had in Walmart’s (WMT) upcoming website overhaul that is being reported to have a “fashion destination” that will leverage its partnership with Lord & Taylor. With branded apparel companies looking to reach consumers, some with their own Direct 2 Consumer businesses and others by leveraging third party logistic infrastructure, we’ll keep tabs on Walmart’s progress and what it means for brick & mortar clothing sales. If you’re thinking this should keep our Buy rating on shares of United Parcel Service (UPS), you’re absolutely right.

The bottom line is the March Retail Sales report served to confirm our bullish view on both Connected Society companies Amazon and UPS as well as Cash-Strapped Consumer play Costco.

  • Our price target on Amazon remains $1,750
  • Given its strong monthly same-store sales data and ongoing wallet share gains as it opens additional warehouse locations, we are boosting our Costco Wholesale (COST) price target to $210 from $200
  • Our long-term price target on United Parcel Service (UPS) shares remains $130

 

 

Robust Earnings from Lam Research Bode Well for Applied Materials

Last night Applied Materials (AMAT) competitor Lam Research reported stellar 1Q 2018 earnings and issued an outlook that topped Wall Street expectations. For the quarter, shipments of its semiconductor capital equipment rose 19% year over year, which led revenue to climb more than 30% year over year for the quarter. Higher volumes and better pricing led to margin expansion and fueled a $0.43 per share earnings beat with EPS of $4.79. All in all, a very solid quarter for Lam, but also one that tell us demand for chip equipment remains strong. Those conditions led Lam to guide current quarter revenue to $2.95-$3.25 billion vs. the consensus view of $2.94 billion.

From growing memory demand, 5G chips sets, 3D sensing, smarter automobiles and homes, and augmented reality to virtual reality and the Internet of Things, we continue to see a number of emerging technologies that are part of our Disruptive Technologies investing theme driving incremental chip demand in the coming years that will fuel demand for semi-cap equipment. We see this as a very favorable tailwind for our Applied Materials shares. Also, let’s not forget Applied’s recently upsized dividend and buyback programs, which, in my view limits potential downside in the shares.

  • Our price target on shares of Applied Materials (AMAT) remains $70.

 

The Habit Restaurant – Loving the Burgers and Shakes, but Not the Shares Just Yet

People need to eat. That’s a pretty recognizable fact. Some may eat more than others, some may eat less; some may eat meat, others may not. But at the end of the day, we need food to survive, but in some cases for comfort at the end of a long day.

As investors, we recognize this and that means considering where and what consumers eat, and also identifying companies that are poised to benefit from other opportunities as well. One such opportunity is geographic expansion, and with restaurants, it often means expanding across the United States.

Typically, expansion is driven by new store openings, which in turn drive sales. Tracing back its expansion over the last several years, Chipotle Mexican Grill (CMG) had to build up to 2,363 locations. Even with that number of locations, per Chipotle’s recently filed 10-K, the company still expects to “open between 130 and 150 new restaurants in 2018.” At that pace, it would take quite a while before Chipotle had as many locations as McDonald’s (MCD) (more than 14,000) or Starbucks (SBUX) (just under 14,000) in the U.S. exiting last year.

A little over a year ago, Restaurant Brands (QSR), the company behind Tim Hortons and Burger King, acquired Popeye’s in part for food-related synergies but also the opportunity to grow Popeye’s through geographic expansion. In 2016, Popeye’s had some 2,600 locations compared to more than 7,500 Burger Kings in the U.S. For those wondering, that’s greater than the 2,251 locations Jack in the Box (JACK) had in 2017.

This brings us to  The Habit Restaurants (HABT), a Guilty Pleasure company if there ever was one.

With just 209 Habit Burger Grill fast-casual locations in 11 states spread between the two coasts, Habit has ample room to expand its concept serving flame char-grilled burgers and sandwiches, fries, salads and shakes. And if you’re wondering how good Habit is, don’t just listen to me (one of those 209 locations is just a few miles away from him), the company was named “best tasting burger in America” in July 2014.

In 2017, the company recorded revenue of $331.7 million from which it generated EPS of $0.16. For this year, consensus expectations have it serving up revenue near $393 million, up around 18% year over year, but EPS of $0.05 — a sharp drop from 2017.

What I’m seeing is Habit hitting an inflection point as it engages a national advertising agency, opens 30 new locations this year (7-10 in first-quarter 2018) and contends with higher wage costs (up 6%-7% vs. 2017), as well as test markets breakfast. Making matters challenging, the overall restaurant industry has been dealt a tough hand during the first two months of 2018 as winter weather and cold temperatures led to reduced traffic and same-store sales industry-wide, according to research firm TDn2K.

While a recent survey of March restaurant sales published by Baird showed a pick-up, the question I am pondering is to what degree will restaurant sales rebound on a sustained basis as the winter weather fades? I’m asking this question full well knowing the level of credit-card and other debt held by consumers as the Fed looks to hike interest rates several times this year.

Do I like the long-term potential of Habit?

Yes, and I would recommend their burgers, fries, and shakes – without question. That said, the company is not without its challenges, especially as McDonald’s begins to roll out its fresh beef offering nationwide. I had one of those a few days ago and in my view, it’s a clear step up from what Mickie D’s had been serving. You may be getting the idea that I like burgers, and I can easily confirm that as well as my fondness for chocolate shakes.

By most valuation metrics, HABT shares are cheap, but as we all know, cheap stocks are usually cheap for a reason. As such, we want to see how the company performed during the first quarter, the quarter in which the greatest number of new locations were to be opened. Typically, new locations drive up costs, and given the uptick in wage costs, this combination could weigh on the company’s bottom line.

All of this has us sitting on the sidelines with Habit Restaurants shares, which means adding them to Tematica Investing Contender List as part of our Guilty Pleasure investing theme.

WEEKLY ISSUE: Examining an Aging of the Population Contender as we wait for the Fed

WEEKLY ISSUE: Examining an Aging of the Population Contender as we wait for the Fed

 

Key Points from this Issue:

  • We’ll continue to stick with Facebook shares, and our long-term price target remains $225.
  • We continue to have a Buy rating and $1,300 price target on Alphabet (GOOGL) shares.
  • Our price target on Amazon (AMZN) shares remains $1,750.
  • We are adding shares of Aging of the Population company Brookdale Senior Living (BKD) to the Tematica Investing Contender List

 

The action has certainly heated up this week, with more talk of trade restraints with China, two more bombings in Austin, Texas and renewed personal data and privacy concerns thanks to Facebook. And that’s all before the Fed’s monetary policy concludes later today when we see how new Fed Chair Jerome Powell not only handles himself but answers questions pertaining to the Fed’s updated forecast and prospects for further monetary policy tightening. Amid this backdrop, we’ve seen the major US stock market indices trade off over the last week, but as I shared in this week’s Monday Morning Kickoff, what Powell says and how the market reacts will determine the next move in the market.

I continue to expect a 25bps interest rate hike with Powell offering a dovish viewpoint given the uncertainty emanating from Washington, the lack of inflation in the economy and the preponderance of weaker than expected data that has led to more GDP cuts for the current quarter than upward revisions. As of March 16, the Atlanta Fed’s GDP Now reading stood at 1.8% for 1Q 2017 vs. 5.4% on Feb. 1 – one would think Powell and the rest of the Fed heads are well aware of this.

We touched on these renewed personal data and privacy concerns earlier in the week, and the move lower in Facebook (FB) shares in response is far from surprising. As I wrote, however, I do expect Facebook to instill new safeguards and make other moves in a bid to restore user trust. At the heart of the matter, Facebook’s revenue model is reliant on advertising, which means being able to attract users and drive usage in order to serve up ads. As it is Facebook is wading into original content with its Watch tab and moves to add sporting events and news clearly signal there is more to come. I see it as part of a strategy to renews Facebook’s position as a sticky service with consumers and one that advertisers will turn to in order to reach consumers as Facebook focuses on “quality user engagement.”

The ripple effects of these renewed privacy concerns weighed on our Alphabet/Google (GOOGL) shares, which traded off some 4% over the last week, as well as other social media companies like Twitter (TWTR) and Snap (SNAP). The silver lining to all of this is these companies are likely to address these concerns, maturing in the process.

Not a bad thing in my opinion and this keeps Alphabet/Google shares on the Tematica Investing Select List, while the company’s prospect to monetize YouTube, mobile search, Google Express (shopping) and Google Assistant keep my $1,300 price target intact. Per a new report from Reuters, Google is working with large retailers such as Target Corp (TGT), Walmart (WMT), Home Depot (HD), Costco Wholesale (COST and Ulta Beauty (ULTA) to list their products directly on Google Search, Google Express, and Assistant. I see this as Alphabet getting serious with regard to Amazon (AMZN) as Amazon looks to grow its advertising revenue stream.

  • We’ll continue to stick with Facebook shares, and our long-term price target remains $225.
  • We continue to have a Buy rating and $1,300 price target on Alphabet (GOOGL) shares.
  • Our price target on Amazon (AMZN) shares remains $1,750.

 

On the housekeeping front, earlier in the week, we shed Universal Display (OLED) shares, bringing a close to one of the more profitable recommendations we’ve had over the last year here at Tematica Investing. Now let’s take a look at a Brookdale Senior Living and our Aging of the Population investing theme.

 

Brookdale Senior Living – A well-positioned company, but is it enough?

One of the great things about thematic investing is there is no shortage of confirming data points to be had in and our daily lives. For example, with our Connected Society investing theme, we see more people getting more boxes delivered by United Parcel Service (UPS) from Amazon (AMZN) and a several trips to the mall, should you be so inclined, will reveal which retailers are struggling and which are thriving. If you do that you’re also likely to see more people eating at the mall than actually shopping; perhaps a good number of them are simply show rooming in advance of buying from Amazon or a branded apparel company like Nike (NKE) or another that is actively embracing the direct to consumer (D2C) business model.

While it may not be polite to say, the reality is if you look around you will notice the domestic population is greying More specifically, we as a people are living longer lives, which has a number of implications and ramifications that are a part of our Aging of the Population investing theme. There are certainly issues of having enough saved and invested to support us through our increasingly longer life spans, as well as the right healthcare to deal with any and all issues that one might face.

According to data published by the OECD in 2013, the U.S. expectancy was 78.7 years old with women living longer than men (81 years vs. 76 years). Cross-checking that with data from the Census Bureau that says the number of Americans ages 65 and older is projected to more than double from 46 million today to 75.5 million by 2030, according to the U.S. Census Bureau. Other data reveals the number of older American afflicted with and the 65-and-older age group’s share of the total population will rise to nearly 25% from 15%. According to United States Census data, individuals age 75 and older is projected to be the fastest growing age cohort over the next twenty years.

As people age, especially past the age of 75, it becomes challenging for individuals to care for themselves, and this is something I am encountering with my dad who turns 86 on Friday. Now let’s consider that roughly 6 million Americans will have Alzheimer’s by 2020, up from 4.7 million in 2010, and heading to 8.4 million by 2030 according to the National Institute of Health. Not an easy subject, but as investors, we are to remain somewhat cold-blooded if we are going to sniff out opportunities.

What all of this means is we are likely to see a groundswell in demand over the coming years for assisted living facilities to house and care for the aging domestic population.

One company that is positioned to benefit from this tailwind is Brookdale Senior Living (BKD), which is one of the largest players in the “Independent Living, Assisted Living and Memory Care” market with over 1,000 communities in 46 states. The company’s revenue stream is broken down into fives segments:

  • Retirement Centers (14% of 2017 revenue; 22% of 2017 operating profit) – are primarily designed for middle to upper income seniors generally age 75 and older who desire an upscale residential environment providing the highest quality of service.
  • Assisted Living (47%; 60%) – offer housing and 24-hour assistance with activities of daily living to mid-acuity frail and elderly residents.
  • Continuing care retirement centers (10%; 8%) – are large communities that offer a variety of living arrangements and services to accommodate all levels of physical ability and health.
  • Brookdale Ancillary Services (9%; 4%) – provides home health, hospice and outpatient therapy services, as well as education and wellness programs
  • Management Services (20%; 6%) – various communities that are either owned by third parties.

 

In looking at the above breakdown, we see the core business to focus on is Assisted Living as it generated the bulk of the company’s operating profit stream. This, of course, cements the company’s position in Tematica’s Aging of the Population theme, but is it a Contender or one for the Tematica Investing Select List?

 

Changes afoot at Brookdale

During 2016 and 2017, both revenue and operating profit at Brookdale came under pressure given a variety of factors that included a more competitive industry landscape during which time Brookdale had an elevated number of new facility openings, which is expected to weigh on the company’s results throughout 2018. Also impacting profitability has been the growing number of state and local regulations for the assisted living sector as well as increasing employment costs.

With those stones on its back, throughout 2017, Brookdale surprised to the downside when reporting quarterly results, which led it to report an annual EPS loss of $3.41 per share for the year. As one might imagine this weighed heavily on the share price, which fell to a low near $6.85 in late February from a high near $19.50 roughly 23 months ago.

During this move lower in the share price, Brookdale the company was evaluating its strategic alternatives, which we all know means it was putting itself up on the block to be sold. On Feb. 22 of this year, the company rejected an all-cash $9 offer as the Board believed there was a greater value to be had for shareholders by running the company. Alongside that decision, there was a clearing of the management deck with the existing President & CEO as well as EVP and Chief Administrative Officer leaving, and CFO Cindy Baier being elevated to President and CEO from the CFO slot.

Usually, when we see a changing of the deck chairs like this it likely means there will be more pain ahead before the underlying ship begins to change directions. To some extent, this is already reflected in 2018 expectations calling for falling revenue and continued bottomline losses. Here’s the thing – those expectations were last updated about a month ago, which means the new management team hasn’t offered its own updated outlook. If the changing of the deck history holds, it likely means offering a guidance reset that includes just about everything short of the kitchen sink.

On top of it all, Brookdale has roughly $1.1 billion in long-term debt, capital and leasing obligations coming due this year. At the end of 2017, the company had no borrowings outstanding on its $400 million credit facility and $514 million in cash on its balance sheet. It would be shocking for the company to address its debt and lease obligations by wiping out its cash, which probably means the company will have to either refinance its debt, raise equity to repay the debt or a combination of the two. This could prove to be one of those overhangs that keeps a company’s shares under pressure until addressed. I’d point out that usually, transaction terms in situations like this are less than friendly.

While I like the drivers of the underlying business, my recommendation is we sit on the sidelines with Brookdale until it addresses this balance sheet concern and begins to emerge from its new facility opening drag and digestion. Odds are we’ll be able to pick the shares up at lower levels. This has me putting BKD shares on the Tematica Investing Contender List and we’ll revisit them in the coming months.

 

 

Weekly Issue: Looking for Trump-Proof Companies

Weekly Issue: Looking for Trump-Proof Companies

We exited last week with the market realizing there was more bark than bite associated with President Trump’s steel and aluminum tariffs. That period of relative calm, however, was short-lived as the uncertainty resumed in Washington yesterday in the form of changeups in the administration with Trump letting go Secretary of State Rex Tillerson just after agreeing to talks with North Korea, and more saber rattling with trade actions against China for technology, apparel, and other imports. This also follows Trump’s intervention in the proposed takeover of Qualcomm (QCOM) by competitor Broadcom (BRCM).

While many an investor will focus on the “new” volatility in the market, I’ll continue to use our thematic lens to look for companies that are “Trump-Proof” in the short-term. That’s not a political statement, but rather a reflection of the reality that the modus operandi of President Trump and his Twitter habit often cause significant swings in the market as the media attempts to digest and interpret his comments.

How will we find these so-called Trump-proof companies? By continuing to use our thematic lens to uncover well-positioned companies that are benefitting from thematic tailwinds that alter the existing playing field, regardless of the latest noise from Washington politicians.

At least for now, volatility is back in vogue and that is bound to drive headlines and other noise. I’ll continue to focus on the data, and if you read this week’s Monday Morning Kickoff you know we are in the midst of a whopper of a data week. While the Consumer Price Index (CPI) for February was in line with expectations, and on a year over year basis core rose 1.8% — the same as in January — which should take some wind out of the inflation mongers. This morning we have the February Retail Sales report, which in my view should once again serve up confirming data for our positions in Amazon (AMZN) and Costco Wholesale (COST), which continue to benefit from our Connected Society and Cash-strapped Consumer investing themes.  Later in the week, the February reading on Industrial Production should confirm the demands that are exacerbating the current heavy truck shortage here in the U.S. – good news for the Paccar (PCAR)shares on the Tematica Investing Select List.

 

 

An Update on Our Once Star Performer, Universal Display (OLED)

A few weeks ago, I shared an update on Universal Display (OLED) shares, which have been essentially treading water following the company’s December quarter results. Later today, the management team will be presenting at the Susquehanna’s Seventh Annual Semi, Storage & Tech Conference. Odds are the management team will reiterate its view on market digesting the organic light emitting diode capacity additions made over the last several quarters, but I expect they will also describe the growing number of applications that will come on stream in the next 3-6 quarters.  As of late February, Susquehanna had a positive rating on OLED shares with a price target of $200 and I suspect they will have some bullish comments following today’s presentation.

 

Considering the ripples to be had with the latest Connected Society victim, Toys R Us

Over the weekend we were reminded of the situation facing many brick & mortar retailers that are failing to adapt their business to ride our Connected Society investing theme. I’m referring to toy and game retailer Toys R Us, the one-time Dick’s Sporting Goods (DKS) or Home Depot (HD) of its industry. Like several sporting goods retailers and electronic & appliance retailers such as Sports Authority, Sports Chalet, and HH Gregg that have gone belly up, if Toys R Us doesn’t get a last-minute lifeline or find a buyer it will likely file Chapter 7.

It’s been a rocky road for the one-time toy supermarket company as it entered bankruptcy in September, aiming to emerge with a leaner business model and more manageable debt. The company obtained a new $3.1 billion loan to keep the stores open during the turnaround effort, but results worsened more than expected during the holidays, casting doubt on the chain’s viability. The company entered this year with more than 800 stores in the U.S. — under both the Toys “R” Us and Babies “R” Us brands, but by January, it announced the shuttering of 180 locations.

The pending bankruptcy to be had at Toys R Us is but the latest in the retail industry, but it’s not likely to be the last. Claire’s Stores Inc., the fashion accessories chain with a debt load of $2 billion, is also preparing to file for bankruptcy in the coming weeks as is Walking Co. Holdings Inc.

What these all have in common is the increasing shift by consumers to digital commerce and the growing reliance on retailers for what is termed the direct to consumer (D2C) business model. Certain branded apparel, footwear, and other consumer product companies, like Nike (NKE) have embraced Amazon’s formidable logistics capabilities and this has benefitted our United Parcel Service (UPS) shares. As we have said before, and we recognize it sounds rather simplistic, when you order products online they have to get to where they are being sent. Hello UPS!

Now let’s consider the ripple effect of the pending Toys R Us bankruptcy.

When events such as this occur, there is a liquidation effect and a subsequent void. As we saw when Sports Authority went bankrupt, the businesses at Nike and Under Armour (UAA) were impacted by liquidation sales in the short term. At the same time, both lost the recurring sales associated with Sports Authority. Odds are we will see the same happen with Toys R Us with companies like Mattel (MAT) and Hasbro (HAS) taking it on the chin. In my view these companies are already struggling as teens, tweens and kids of all ages shift to digital games, apps and e-gaming, which are aspects of our Connected Society and Content

In my view these companies are already struggling as teens, tweens and kids of all ages shift to digital games, apps and e-gaming, which are aspects of our Connected Society and Content is King themes. When was the last time you saw an elementary schooler play with Ken or Barbie? More likely they are on an iPad or Microsoft (MSFT) Xbox while their older siblings are playing the new craze sweeping the nation – Fortnite. And yes, that it appears the rumors are true and Fornite will soon be available across Apple’s iDevices.

Looking at the financial performance of Mattel, not even the all mighty Star Wars franchise could save them from delivering declining revenue and earnings this past holiday shopping season. On the liquidation front, we are likely to see the toys businesses at Target (TGT) as well as Walmart (WMT) take the brunt of the blow. But here too this is likely just another hit as these two retailers have already been dealing with falling revenue at Mattel and Hasbro. Walmart is the largest customer for Mattel and Hasbro, accounting for about 20% of total sales for each toy maker. Both toy companies get nearly 10% of their revenue from Target too.

One of the investing strategies that I employ with the Select List is “buy the bullets, not the guns” which refers to buying well-positioned suppliers that serve a variety of customers. In situations like what we are seeing in the brick & mortar retail sector, we can turn that strategy upside down and uncover those companies, like Mattel and Hasbro, that we as investors should avoid given the multiple direct and indirect headwinds they are currently facing or about to.

 

WEEKLY ISSUE: The Impact of Tariffs and Continued Rundown of Select Positions

WEEKLY ISSUE: The Impact of Tariffs and Continued Rundown of Select Positions

 

Our Latest Thoughts on Trump Tariffs

The stock market roller coaster of the last few weeks is clearly continuing. This week we have President Trump’s potential steel and aluminum tariffs take center stage, shifting the attention away from Fed Chief Jerome Powell last week. When I shared with you my view the market would trade data point to data point until the end of the Fed’s Mar. 20-21 monetary policy meeting, I certainly didn’t expect let alone anticipate these tariffs and their escalating conversation to be a part of it. In a post earlier this week, I shared my view that Trump is once again utilizing the negotiating strategy he laid out in his book, Art of the Deal. In another one today, I gamed out what is likely to happen should Trump go forward with the tariffs.

Last night’s resignation of Trump economic advisor Gary Cohn has certainly fanned the flames of uncertainty over the tariffs, with more people thinking that Trump is “serious.” In an effort to counterbalance that resignation, this morning Commerce Secretary Wilbur Ross shared that Trump “has indicated a degree of flexibility on tariffs for Canada and Mexico.” That Cohn-related walk-back by Secretary Ross, combined with comments made yesterday by Treasury Secretary Steven Mnuchin that indicated that “once a new NAFTA deal is reached, the trading partners wouldn’t be subject to the tariffs” confirms my view that Trump remains on the Art of the Deal negotiation path.

In my post earlier this morning about the tariffs, I shared that we will likely see choppy waters as this issue comes to a resolution and leads up to the Fed’s next monetary policy meeting conclusion on March 21. Expect volatility to remain in place and the coming economic data will either amplify or quell its magnitude. Barring any breaking news, I’ll be on The Intelligence Report with Trish Regan on FOX Business to discuss all of this at 2 PM ET today.

While many fret over the market swings, my perspective is that the domestic economy remains on firm footing and barring a trade war volatility will allow us to pick up thematically well-positioned companies at better prices. A great example of this was had earlier this week with the February heavy truck orders that served to confirm my thesis behind Paccar (PCAR) shares.

When Costco Wholesale (COST) reports its quarterly results after the market close, we should see similar confirmation in the form of not only wallet share gains via its top line results, but also in rising membership fees as more consumers look to stretch the disposable income they do have, a key component of our Cash-Strapped Consumers investment theme.

To set the stage for Costco’s report tonight, consensus expectations for the quarter sit at EPS of $1.46 on revenue of $32.7 billion, up from $1.17 and $29.8 billion in the year-ago quarter. As a reminder, one of the key differentiators for Costco is the high margin membership fees that are poised to grow as the company continues to open new warehouses. This means, at least for me, that roadmap, will be one of the areas of focus on the company’s post-earnings conference call. I’ll also be listening to see the impact of tax reform on the company’s outlook for 2018.

  • Our price target on Paccar (PCAR) shares remains $85.
  • Our price target on Costco Wholesale (COST) shares remains $200.

 

 

Getting back to the Tematica Investing Select List

In last week’s issue, I began sharing some much-needed updates across the Select List, and I’m back at it again this week with a few more. Over the next few weeks, I’ll look to round out the list before we break at the end of March and get ready to gear up for 1Q 2108 earnings season.

Yes… I know… before too long it will once again be time for that zaniness.

All the more important to share these updates with you so we set the table for the earnings meal to be had.

 

Amazon (AMZN),  Connected Society

Simply put, Amazon shares have been a champ so far in 2018 rising more than 30%, which brings the return on the Select List to more than 100% since being added back in 2016. I’ve said these shares are ones to own, not trade given the accelerating shift to digital commerce, and growing adoption of the high margin, secret sauce that is Amazon Web Services as more businesses turn to the cloud. As filled with creative destruction as those two businesses are, it looks like Amazon is poised to offer further disruption in the healthcare and financial services business given conversations with JPMorgan (JPM), Berkshire Hathaway (BRK.A), Capital One (COF) and others.

I’ve raised our price target several times on AMZN shares, and it increasingly looks like that will have to happen again and then some depending on how soon these new layers of disruption materialize.

  • Our price target on Amazon (AMZN) shares remains $1,750.

 

Starbucks (SBUX), Guilty Pleasure

Year to date, Starbucks shares are essentially unchanged compared to where they were trading as we exited 2017. And the same is true if we look at the shares over the last year – they are up modestly. What we are dealing with here is a company that is once again in transition as it looks to invigorate its domestic business while growing its presence in still underserved markets outside the US like China and Italy. One of the central strategies in both areas is to leverage its high-end Reserve Roastery concept, which keeps the company very much in tune with our Guilty Pleasure investing theme.

Historically speaking, Starbucks has been a company that has been able to successfully pivot its business when it has stumbled, and in our view, that merits some patience with the shares. Helping fuel that patience is the knowledge that Starbucks intends to return $15 billion to shareholders over the next three years in the form of dividends and buybacks.

  • Our price target on Starbucks (SBUX) shares remains $68

 

Disney (DIS), Content is King

Disney shares have traded off some 3% thus far in 2018, which is not unsurprising given we are in the seasonally weakest part of the year for the company. That said, the latest Marvel film, The Black Panther, is crushing it at the box office and ups the ante for the next Avengers film that will hit theaters in a few months. Disney continues to leverage these and other characters as it revamps its theme parks and hotels, which should drive attendance despite yet another round of price increases.

The big “wait and see” for Disney over the coming months will be its move into its own streaming services for both ESPN and eventually a Disney content-centric service. While I see this as Disney making the right moves to address the chord cutting headwind that is part of our Connected Society investing theme, to paraphrase the great film Bull Durham, just because Disney builds it doesn’t mean people will stream it. In a positive move, Disney installed James Pitaro as the new president of ESPN. Mr. Pitaro’s background as chairman of Disney Consumer Products and Interactive Media, as well as the head of Yahoo! Media, sends investors the signal that getting the streaming services in place will be a top priority going forward for ESPN.

The next catalyst to be had for Disney will be spring break and then the summer movie season. Between now and then, I expect Disney will continue to put its massive buyback program to work.

  • Our price target on Disney (DIS) shares remains $125

 

United Parcel Service, Connected Society

Our UPS shares were hard hit earlier in the year given renewed concerns that Amazon would expand its own logistics offering. At the time, my view was this was an overblown concern, and it still is. This week, we saw Stifel Nicolaus warm up to the shares, upping them to a Buy rating with a $121 price target given what it sees as a “strong underlying package and freight businesses.”

Each month in the Retail Sales report we see the share gains had at non-store retailers, and we know companies ranging from Costco and Walmart (WMT) to Nike (NKE) and many others are embracing the Direct to Consumer (D2C) business model. All of this bodes well for UPS shares over the coming year.

The one potential hiccup to watch will be negotiations with the Teamsters Union this summer. If that brings the shares near or below our Select List entry point, I’ll look to scale into this position ahead of the seasonally strong second half of the year.

  • Our price target on United Parcel Service (UPS) shares remains $130.

 

 

Blue Apron and GNC, two examples of the struggle to fight against thematic headwinds

Blue Apron and GNC, two examples of the struggle to fight against thematic headwinds

 

In Tematica Investing, we focus on companies that are benefitting from tailwinds associated with our investment themes. As a good institutional portfolio manager knows, avoiding problematic investments is critical as they can sabotage returns to be had from well-positioned ones. In our Tematica lingo, that means avoiding companies that have thematic headwinds bearing down on their businesses and buying companies that are rising the tailwinds.

 

No need to revisit Blue Apron shares

We’ve been bearish on shares of Blue Apron (APRN) and we’ll try not to pat ourselves too hard on the back as we take a victory lap on that call.

As we saw yesterday, there is a good reason to remain that way as Walmart (WMT) is formally getting into the meal kitting business. While many were expecting Amazon (AMZN) to leverage its Whole Foods Market business with its own meal kitting offering (we still are), Walmart is leveraging its position as the largest grocer to enter the fray. The goal for the brick & mortar retail giant is to help build its digital footprint as well as take share from the restaurant industry, which has been pressured by weak traffic and average ticket pressure. Odds are Walmart is also looking to ride the consumer shift toward healthier eating and snacking that is part of our Food with Integrity theme along with a hefty dose of our Connected Society one.

All in all, this looks like a good extension for Walmart and one that is poised to make an already challenging environment even more so for Blue Apron.

 

 

Struggling GNC Holdings looks East

Another company that has been running into a significant thematic headwind is GNC Holdings (GNC). Once a dominant player in the sports performance and nutrition space (otherwise known as body-building), the supplement retailer has been attempting to reposition itself to a wider audience as a seller of “health, wellness and performance products.” As the performance market has moved online and to other sources, GNC has been attempting to capture more women and appeal to the Boomers and their set of nutritional needs, which are far different than the iron clangers in the free weight section of the gym.

To say this stock price chart looks like a one-way roller coaster that only goes down would be an understatement. A better comparison would be an alpine slide that starts extremely high up a mountain, has several twists and turns, but only goes in one direction – down. Since peaking in late 2013 near $60, that’s exactly what we’ve seen with GNC shares as its profits turned to losses despite a comparatively modest dip in revenue over the last few years.

 

 

In perusing the company’s latest 10K filing, the company offers up an explanation of sorts: “Prior to 2017, we had been experiencing declining traffic trends leading to decreasing same-store sales in our retail stores. After extensive consumer research and market analysis, we determined that our business model needed to be reimagined.”

Not exactly what a shareholder, existing or prospective one, wants to hear, but at least we can credit the management for not acting like an ostrich with their head in the ground as Amazon rolled into space as did others. The combination of having to “reimagine” its business model as well as fend of competitors led annual Selling, General & Administrative expenses to rise over 2015-2017 as revenue shrank, pushing GNC to deliver bottom-line losses.

Digging into the financials, the company experienced negative same-store sales in every quarter during 2016 and the first two of 2017. Making matters worse, average transaction amount was in negative territory over the last five quarters, and sales at GNC.com sales were falling as well. December 2017 quarterly sales were up 0.2% in company-owned stores vs. down 1.2% in the September 2017 quarter.

Not exactly a recipe for success, but clear signs the company could be in turnaround mode. What makes this potential turnaround interesting is the new partnership with CITIC Capital and Harbin Pharmaceutical Group. As a way of background, CITIC Capital is a global investment firm with a strong position in China and the Harbin Pharmaceutical Group is a joint venture of several China-based pharmaceutical companies. CITIC will invest $300 million in the form of a newly issued convertible perpetual preferred security with a 6.5% coupon payable in cash or in kind and a $5.35 conversion price. GNC will use the funds to repay existing debt and for other general corporate purposes, and on an as-converted basis, CITIC will hold roughly 40% of GNC’s outstanding equity. That’s a significant shareholder and one that will also appoint a total of five members to GNC’s newly expanded 11 member board.

The company expects the transaction to close in the second half of 2018, but it will require regulatory approval in both the U.S. and China. Given the current geopolitical tensions we are reading about almost daily, there could be some speed bumps associated with these approvals. Also too, GNC is ramping marketing associated with its recently launched pricing strategy and loyalty program, One New GNC strategy in the current quarter. This likely means margin pressure is poised to continue.

The bottom line is even though GNC is facing steep competitive domestic pressures, it’s new relationships could pivot its business but there are several hurdles to be overcome. Keyword being “could.” The risk related question I find myself asking is “Yes, I understand what the management team is saying, but what if the pivot or turnaround doesn’t happen as expected?”

We’ve seen many a company that in the face of thematic headwinds and mounting competitive pressures have attempted to reposition their businesses. Few have succeeded. My gut tells me that GNC, much like Blue Apron, Blackberry (BBRY), Angie’s List, GoPro (GPRO), Fitbit (FIT) and others, is on the road to nowhere for investors. But that’s my gut, which means reminding myself to keep an open mind and watch the data as it becomes available.

 

 

 

WEEKLY ISSUE: Is Inflation Rearing Its Ugly Head or Not?

WEEKLY ISSUE: Is Inflation Rearing Its Ugly Head or Not?

Today is the day that we here at Tematica, and other investors as well, have been waiting for to make some semblance of the recent stock market volatility. Earlier this morning we received the January Consumer Price Index (CPI), one of the closely watched measures of that now dirty word – inflation. As a quick reminder, the market swings over the last two weeks were ignited by the headline wage data in the January Employment Report, as well as other signs, such as rising freight costs that led us to add shares of Paccar (PCAR) to the Tematica Investing Select List earlier this week. This topic of resetting inflation expectations and what it may mean for the Fed and interest rates has been a topic of conversation on recent Cocktail Investing Podcast between Tematica’s Chief Macro Strategist Lenore Hawkins and myself.

 

What the January CPI Report Showed and Its Impact on AMZN, COST and UPS

The headline figures from the January CPI report showed the CPI rose 0.5% month over month in January, which equates to a 2.1% increase year over year. Keeping in sync with the headline figure, which includes all categories, the consensus expectation was for a 0.3% month over month increase. The driver of the hotter than expected headline print was the energy index rose, which climbed 3.0% in January, and we’ve witnessed this first hand in the gasoline price jump of late. Excluding the volatile food and energy components, the “core” CPI index was up 0.3% month over month in January, coming in a bit ahead of the expected 0.2% increase. On a year over year basis, that core figure rose 1.8%, which is in keeping with the 1.7%-1.8% over the last eight months. Month over month gas and fuel prices were up 5.7% and 9.5%, respectively.

Late yesterday, the American Petroleum Institute released data showing a 3.9 million barrel increase in crude stockpiles for the week ended Feb. 9, along with a 4.6 million barrel rise in gasoline stocks and a 1.1 million barrel build in distillates. With crude inventories once again on the rise as US oil production has risen in response to the recent surge in oil prices from September to late January, we’ve seen oil prices retreat to December levels and odds there is more relief to come.

As we wait for others, who if you’ve seen the whipsaw in stock market futures today are simply reacting to the January headline CPI figure, to get some clearer heads about themselves and digest the internals of the report, I’ll share our thoughts on the January Retail Sales report that was also published this morning.

Staring with the headline figure, January Retail Sales came in at -0.3% month over month, falling short of the 0.2% consensus forecast. Excluding auto and food, January core retail sales fell 0.3% month over month; on a year over year basis, retail sales rose 3.9% with nonstore sales leading the way (up 10.2%) followed by gas stations sales (up 9.0% year over year), which is of little surprise given our January CPI conversation above. We do see that nonstore figure as further confirmation for not only our Amazon (AMZN) and United Parcel Service (UPS) shares, but also our Costco Wholesale (COST) ones as it continues to embrace our Connected Society theme.

  • Our price target on Amazon (AMZN) shares remains $1,750
  • Our price target on Costco Wholesale (COST) shares remains $200
  • See my comments below for my latest thoughts on UPS shares

 

Market’s Knee-Jerk Reaction to January Retail Sales Offered Opportunity in PCAR, Not BGFV

Despite the 3.9% year over year January Retail Sales print, the market is focusing on the month over month drop, which was one of the weakest prints in some time. Here’s the thing, we here at Tematica have been talking about the escalating level of debt that consumers have been taking on as a headwind to consumer spending and despite the post-holiday sales, consumers tend to ramp spending down after the holidays. Odds are these two factors led to that month over month decline, but even so up 3.9% year over year is good EXCEPT for the fact that gas station sales are bound to fall as gas prices decline.

If we look at these two reports, my take on it is a skittish stock market is once again knee-jerk reacting to the headline figures rather than understanding what is really going on. The initial reaction saw Dow stock market futures fall from +150 to -225 or so before rebounding to -125. As data digestion occurs, odds are concerns stoked by the initial reactions will fade as well

With market anxiety still running higher compared to this time last year or even just six months ago, I expect the market to cue off the major economic data points to be had in the coming weeks building to the Fed’s next FOMC meeting on March 20-21. As I pointed out on this week’s podcast, at that meeting we’ll get the Fed’s updated economic forecast and I expect that will have chins wagging over the prospects of three or four rate hikes to be had in 2018.

In the meantime, I’ll continue to look for opportunities like I saw with Paccar (PCAR) shares on Monday, and avoid pitfalls like the one I mentioned yesterday with Big Five Sporting Goods (BGFV). And for those wondering, per the January Retail Sales Report, sporting goods sales 7.1% in January. Ouch! And yes, I always love it when the data confirms my thesis.

  • Our price target on Paccar (PCAR) shares remains $85

 

Waiting on Applied Materials Earnings Announcement

After today’s market close, Applied Materials (AMAT) will share its latest quarterly results, and update its outlook. As crucial as those figures are, in recent weeks we’ve heard positive things from semi-cap competitors, which strongly suggests Applied should deliver yet another good quarter and a solid outlook. Buried inside those comments, we’ll get a better sense as to the vector and velocity for its products, both for chips as well as display equipment.

Those comments on the display business will also serve as an update for the currently capacity constrained organic light emitting diode market, one that we watch closely given the position in Universal Display (OLED) shares on the Tematica Investing Select List. I see this morning’s announcement by Universal that it successfully extended its agreement with Samsung though year-end 2022 with an optional 2-year extension as reminding investors of Universal’s position in the rapidly growing technology. With adoption poised to expand dramatically in 2018, 2019 and 2020, I continue to see OLED shares as a core Disruptive Technologies investment theme holding.

  • Our price target on Applied Materials (AMAT) shares remains $70
  • Our price target on Universal Display (OLED) shares remains $225

 

 

Should We Be Concerned About UPS Amid Amazon Announcement?

Several paragraphs above I mentioned United Parcel Service (UPS) shares, and as one might expect the headline reception to the January Retail Sales Report has them coming under further pressure this morning. That adds to the recent news that our own Amazon (AMZN) would be stepping up its business to business logistics offering and competing with both UPS and FedEx (FDX). Of course, this will take time to unfold, but these days the market shoots first and asks questions later. At the same time, we are entering into a seasonally slower time of year for UPS, and while yes consumers will continue to shift toward digital shopping as we saw in today’s retail sales report, the seasonal leverage to be had from the year-end holidays is now over.

 

 

While it may sound like we are getting ready to give UPS shares the ol’ heave ho’, along with the February market gyrations, it’s been a quick ride to the $106 level from $130 for UPS shares, and this has placed them into the oversold category. From a share price perspective, the shares are back to levels last seen BEFORE both the 2017 Back to School and year-end holiday shopping seasons. With prospects for digital shopping to account for an even greater portion of consumer wallets in 2018 and 2019 vs. 2017, we’re going to be patient with UPS shares in the coming months as we wait for the next seasonal shopping surge to hit.

  • Our long-term price target on UPS shares remains $130.

 

Big Five Sporting Goods is no sporting chance without e-commerce

Big Five Sporting Goods is no sporting chance without e-commerce

You’ve probably noticed that retailers are doing all they can to clear out winter-related items as they prepare for the spring season. It means sales, sales, sales, and in some cases compressed margins. Walk through almost any mall, and you’ll see signs for buy one get one free, buy one get the next one 50% off, and so on.

When we think of spring, most of us tend to think of spring break and the start of spring sports, particularly for school age kids. Why that age? Because they tend to grow, and that means each year new items ranging from athletic shoes, cleats, pants, shirts, jerseys, helmets, and other pieces of athletic wear tend to be bought.

Notice I said usually. In 2017, according to Census Bureau data found in the December Retail Sales Report, sales at sporting goods, hobby, book and music stores were unchanged in the December quarter and fell 3.4% for the year in full. One of those reasons is actually good news for our Amazon (AMZN) shares as non-store retail sales rose 12.7% year over year in December and was up 10% for all of 2017 compared to 2016. The sporting goods category wasn’t the only one to be hit by the shift to digital commerce – for perspective, compared to retail sales (excluding food and auto sales) that rose 4.4% in 2017, digital sales rose nearly 2.3x faster. As we like to say at Tematica, it’s all about connecting the data dots and ahead of Amazon’s December quarter results those retail data points were rather revealing.

The question we have to ponder is whether people are not buying athletic equipment for their kids or, if they are shifting where they buy it — from sporting goods stores like Dick’s Sporting Goods (DKS) to big box retailers like Target (TGT), Walmart (WMT), Costco Wholesale (COST) and discount retailers, as well as online at Amazon (AMZN).

We’re also seeing another factor on the competitive landscape: Foot Locker (FL) and Finish Line (FINL) move to expand from athletic footwear into athletic wear. Those factors led to several sporting good chains, such as Sports Authority, Sports Chalet, MC Sports and others, to file for bankruptcy.

 

And that brings us to Big 5 Sporting Goods (BGFV)

For those unfamiliar with the company, at the end of 2017 it operated 435 stores in 11 states and offered athletic shoes, apparel and accessories, as well as a broad selection of athletic equipment for team sports, fitness, camping, hunting, fishing, tennis, golf, winter and summer recreation and roller sports. Pretty much a full- service sporting goods store complete with a digital platform as well.

Has Big Five been spared the pain that has been felt in the sporting goods industry?

In a word, no, and we can say this because earlier this month it reported disappointing fourth-quarter 2017 sales that included same-store sales falling 9.4%. Those top line results led the company to revise its bottom line results for the quarter into the red. While some of this can be attributed to mild December temperatures that led to weak demand for cold weather products, the reality is Big Five’s same store sales excluding winter-related and firearm-related products were down low-single digits for the quarter. This tells us that something else is afoot, and odds are it’s the increasingly competitive landscape.

In response to that disappointing fourth-quarter 2017 pre-announcement, Big Five Sporting Goods shares have slumped some 27% since the start of 2018. And this leads us to the obvious question – should we be interested in BGFV shares at current levels?

At the current share price, based on historic multiples and current earnings expectations of $0.55-$0.56 per share last year and this year vs. $0.82 per share in 2016, there’s upside to $6.00-$6.25 per share. Not exactly upside enough to get excited for a business that is being challenged and expected to deliver contracting revenue in the first half of 2018.

Odds are BGFV shares will get cheaper before they get expensive, and while that could make them tempting to some, we’ll take a pass at least until the company’s e-commerce efforts become material to its overall revenue and profit. Based on what I heard on the company’s last earnings call, it’s going to be some time until that happens…if it does…  that means the company is poised to be trapped in the headwind of our Connected Society investing theme. In other words, more pain as Amazon and even Walmart continue to rise the tailwind of that theme to revenue and profits.

Earnings from Apple, Amazon, Alphabet and UPS lead to several price target changes… and not all of them are moving higher

Earnings from Apple, Amazon, Alphabet and UPS lead to several price target changes… and not all of them are moving higher

 

In the last 24 hours we’ve had four Tematica Investing Select List positions – United Parcel Service (UPS) Amazon (AMZN), Alphabet (GOOGL) and Apple (AAPL) – report their quarterly earnings. Across the four companies, it was a mixed bag — on one hand, we have solid performance and profits at Amazon and Apple, while on the other hand, both United Parcel Service and Alphabet lagged in converting their respective topline strength into profits. We’re going to dig into company specifics below, but in summary:

  • We are increasing our long-term price target on Amazon shares to $1,750 from $1,400, which keeps our Buy rating on the shares in place. As a quick reminder, we continue to see Amazon as a company to own not trade
  • We are maintaining our $200 price target on Apple, which also keeps our Buy rating intact.
  • With Alphabet shares, we are now boosting our price target to $1,300 from $1,150, which offers upside of 15% from current levels. Subscribers that are underweight GOOGL shares are advised to let the full impact of last night’s earnings announcement be had and wade into the shares in the coming days.
  • We are trimming our United Parcel Service price target to $130 from $132.

 

United Parcel Service

Shares of United Parcel Service slumped throughout the early part of the day yesterday, and while they did recover off their lows, the day ended with the shares down just over 6% following the company’s December quarter earnings report. Inside that report, the company reported slightly better than expected top-line results of $18.83 billion, up 11.2% year over year, vs. the expected $18.2 billion. The issue that pressured UPS shares was revealed in the 2.5% year over year increase in EPS to $1.67 even though that figure was slightly ahead of expectations. Comparing those two growth rates as well as looking at the year over year drop in operating margin for the quarter to 12.2% from 13.1%, we find UPS’s network capacity was once again overwhelmed by the shift to digital shopping in the US. Outside of that business, its profits climbed at its International business as well as Supply Chain and Freight Segment.

Near-term following the year-end holiday shopping season we are entering the seasonally slower part of the year for UPS’s business. If historical patterns repeat, we’re likely to see the shares range-bound over the coming months with them trending higher as more data shows the continued shift toward digital shopping that is powering its UPS Ground business. With more pronounced share gains likely to reveal themselves in the shopping-heavy back half of the year, we’re inclined to be patient investors with UPS, reaping the rewards as more companies continue to embrace the direct-to-consumer business model either on their own or through partnerships with other companies, like Amazon. We will continue to monitor oil and at the pump gas prices, which could be a headwind to UPS’s efforts to improve margins at its US Domestic business in the coming months. In terms of the company’s 2018 outlook, it guided EPS between $7.03-$7.37 billion, a 20% increase year over year at the midpoint, which is in line with expectations.

 

Apple

After the market close yesterday, Apple reported December quarter results that bested Wall Street expectations on the top and bottom line even though iPhone shipments fell short of expectations and dipped year over year. More specifically, the company served up EPS of $3.89 per share, $0.04 ahead of consensus expectation on revenue of $88.29 billion, which edged out expectations of $87.6 billion. While Apple once again bested expectations, the truly revealing revenue and EPS comparisons are had versus the December 2016 quarter as revenue rose 12.6% year over and EPS 16%.

Year over year revenue improvement was had in the iPad and Services business — the latter benefitting from Apple’s continued growth in active devices, which hit 1.3 billion in January, up from 1.0 billion just two years ago. Mac sales, in terms of revenue and units, edged lower year over year and Apple Watch volumes rose 50% year over year on the strength of Apple Watch 3.  Despite the 1.2% year over year drop in iPhone shipments, the higher priced newer models drove the average selling price in the December 2017 quarter to hit roughly $795 up from $695 in the year ago quarter. That pricing surge led iPhone revenue to climb 12.5% to $61.6 billion. Digging into the results, we find the year over year improvements even more impressive when we consider iPhone X didn’t go on sale until early November and the December 2017 quarter had one less week compared to the December 2016 one.

All in all, it was a solid December quarter for Apple, and as we all know, there has been much speculation over iPhone production levels in the first half of the year, particularly for iPhone X. While Apple did issue its take on the March quarter – revenue between $60-$62 billion (vs. $52.9 billion in the March 2017 quarter), gross margin between 38%-38.5% and operating expenses $7.6-$7.7 billion – it was its usual tight-lipped self when it came to device shipments.

Let’s remember chatter over the last few weeks was calling for steep cuts to iPhone X shipments, but Apple ended the December quarter with channel inventories near the lower end of its 5-7-week target range. On the earnings call, Apple shared that iPhone should be up double digits year over year in the March 2018 quarter with the non-iPhone businesses up double digits as well. If we assume iPhone average selling prices remain relatively flat quarter over quarter, back of the envelope math suggests Apple is likely to ship 48-49 million iPhone units – roughly a 3%-5% drop in shipments year over year. That is far less than the talking heads were talking about over the last few weeks and explains why Apple shares rallied in aftermarket trading.

We see this as a positive for our Universal Display (OLED) shares as well – our price target on those remains $225.

From our perspective, the Apple story remains very much intact and with several positives to be had in the coming quarters. When Apple reports its March quarter results, we expect a clearer picture of how Apple plans to leverage the benefits of tax reform on its capital structure and share potential dividend and buyback plans. Next week, Apple’s HomePod will be released and before too long we expect to hear more about iPad and other product refreshes before the talk turns to WWDC 2018. Along the way, we hope to hear more concrete plans over Apple’s push into original content, a move we continue to think will make its ecosystem even stickier and likely result in even more people switching to Apple devices.

  • Our price target on Apple (AAPL) shares remains $200.

 

Amazon

Turning to Amazon, we were expecting a strong quarter given all the data points we received over the accelerated shift to digital shopping during the 2017 holiday season and we were not disappointed. For the December quarter, Amazon’s net sales increased 38% to $60.5 billion. Excluding the $1.1 billion favorable impact from year-over-year changes in foreign exchange rates, the quarter’s net sales still increased a robust increased 36% year over year. By reporting segments, North America revenues rose an impressive 42% year over year, International by 29% and Amazon Web Services (AWS) just under 45%.

More impressive than the segment revenue results was the year over year move in operating income in North America, which rose 107% for the quarter, and the increase in sales in AWS (Amazon’s cloud computing division), with sales increasing 46% for the quarter. That led the company’s overall operating income to climb to $2.1 billion in the quarter, up significantly from $1.3 billion in December 2016 quarter. In our view, after delivering 11 quarters of profitability, Amazon has shown the naysayers that it can prudently invest to drive profitable growth and innovation. Period.

The seasonally strong shopping quarter resulted in Amazon’s North America division being the largest generator of profit for the quarter, a role that is usually had by AWS. Looking at the profit picture for the full year 2017, we find AWS generated nearly all of the company’s operating profit. We continue to be impressed by Amazon’s ability to win not just profitable cloud market share but fend off margin erosion as players like Alphabet and Microsoft (MSFT) look to win share in this market.

If we had to find one issue to pick with Amazon’s December quarter report it would be the continued losses at its International business. Those losses tallied $0.9 billion in the December 2017 quarter and $3.06 billion for all of 2017.  We understand Amazon continues to expand its footprint in Europe and Asia, replicating the Prime and content investments it has made in the US, to drive long-term growth. As we have said before, Amazon is leveraging its secret weapon, AWS (10% of 2017 sales but more than 100% of 2017 operating profits), and its cash flow to fund these long-term investments and as patient investors, we accept that. We would, however, like to have a better understanding what the timetable is for bringing the International business up to at least to break even so it’s no longer a drag on the company’s bottom line.

In typical Amazon fashion, Amazon’s earnings press release contained a plethora of highlights across its various businesses, but the few that jumped out at us were:

  • In 2017, more than five billion items shipped with Prime worldwide.
  • More new paid members joined Prime in 2017 than any previous year — both worldwide and in the U.S.
  • Amazon Web Services (AWS) announced several enterprise customers during the quarter: Expedia, Ellucian, and DigitalGlobe are going all-in on AWS; The Walt Disney Company and Turner named AWS their preferred public cloud provider; Symantec will leverage AWS as its strategic infrastructure provider for the vast majority of its cloud workloads; Expedia, Intuit, the National Football League (NFL), Capital One, DigitalGlobe, and Cerner announced they’ve chosen AWS for machine learning and artificial intelligence; and Bristol-Myers Squibb, Honeywell, Experian, FICO, Insitu, LexisNexis, Sysco, Discovery Communications, Dow Jones, and Ubisoft kicked off major new moves to AWS
  • AWS continues to accelerate its pace of innovation with the release of 497 significant new services and features in the fourth quarter, bringing the total number of launches in 2017 to 1,430.

 

Those are but a few of the three-plus pages of highlights contained in the December quarter’s earnings press release. These and others show Amazon continues to expand its reach, laying the groundwork for further profitable growth in the coming quarters.

In characteristic fashion, Amazon issued revenue guidance for the current quarter that was in line with expectations – $47.75 – $48.7 billion – that equates to year over year growth between 34%-42%. Per usual, the company also issued it “you could drive a truck through it” operating income forecast calling for $0.3-$1.0 billion for the quarter.

  • We are boosting our price target on Amazon (AMZN) shares to $1,750 from $1,400 and we continue to view them as ones to own for the long-term as the company continues to disrupt the retail industry and is poised to make inroads into others.

 

Alphabet/Google

Rounding out yesterday’s earnings blitzkrieg, was Alphabet, which delivered yet another 20% plus increase in revenue for the December quarter. The performance bested Wall Street expectations, but the company’s bottom line disappointed and missed the consensus by $0.37 per share.

For the record, Alphabet reported December quarter EPS of $9.70 vs. the expected $10.07 on revenue of $32.32 billion. At 85% of overall revenue for the quarter, advertising remains the core focus of revenue. Year over year in the quarter, the company’s advertising revenue rose 22% with growth compared to the year ago quarter also had at its Network Members’ properties and other revenue segments.

The difference between the company’s top line beat and bottom line miss can be traced primarily to its Traffic Acquisition Costs (TAC) — the fees it pays to partner websites that run Google ads or services. Those fees climbed 33% year over year to resemble 24% of advertising revenue vs. 22% in the December 2016 quarter. The continued rise in TAC reflects the ongoing shift in the company’s mix toward mobile, which makes the increase not a surprising one as mobile search and content consumption continues to grow faster than desktop.

On a positive note, the company prudently managed operating expenses, which accounted for 26.6% of revenue in the quarter down from 27% a year ago. The net effect led Alphabet’s overall operating margin for the quarter to slip to 24% from 25% in the December 2016 quarter.

Outside of the core advertising business, the company continues to make progress on its other initiatives better known as Google Other, which includes cloud, its Pixel phones and Google Play. On the earnings call, the management team called out that Google Cloud has surpassed $1 billion, a notable achievement but to be fair the company lags considerably behind Amazon in the space. That said, ongoing cloud adoption leaves ample room for future growth in the coming quarters.

Turning to the company’s Other Bets segment, which houses its autonomous vehicle business Waymo, Google Fiber, home security and automation business Nest and its Verily life sciences business units, it continues to be a drag on overall profits given the operating loss of $916 million on revenue of $409 million. The positive to be had is the unit’s revenue climbed 56% year over year and size of the operating drag compressed 16% vs. the year-ago quarter and was less than $940 million it was Wall Street expected it to be. We see that as progress given the less than mature nature of the businesses housed in Other Bets. As they mature further, we expect them to be less of a drag on overall profits with several of them potentially adding to the valuation argument to be had for the shares as they become a more meaningful piece of the overall revenue mix.

On the housekeeping front, the company’s Board authorized the repurchase up to an additional $8.6 billion of its Class C capital stock. With more than $101 billion on the balance sheet in cash and equivalents exiting 2017 the company has ample funds to opportunistically repurchase shares.

  • The net impact of Alphabet’s bottom line miss looks to have the shares open lower this morning, which when paired with our new $1,300 price target (up from $1,150) offers some 15% upside to be had. That along with our view the company’s search and advertising businesses make it a core holding even as it grapples with the transition to mobile from desktop.

 

This week’s earnings season game plan

This week’s earnings season game plan

 

We have quite the bonanza of corporate earnings for holdings on the Tematica Investing Select List. It all kicks off tomorrow with Corning (GLW) and picks up steam on Wednesday with Facebook (FB). The velocity goes into over drive on Thursday with United Parcel Service (UPS) in the morning followed by Amazon (AMZN), Alphabet/Google (GOOGL) and Apple (AAPL). Generally speaking, we expect solid results to be had as each of these companies issues and discuss their respective December quarter financials and operating performances.

Given the recent melt-up in the market that has been fueled in part by favorable fundamentals and 2018 tax rate adjustments, we expect to hear similar commentary from these Tematica Select List companies over the coming days. The is likely to be one of degree, and by that I mean is the degree of tax-related benefits matching what the Wall Street herd has been formulating over the last few weeks? Clearly, companies that skew their geographic presence to the domestic market should see a greater benefit. The more difficult ones to pin down will be Facebook, Apple, Amazon and Google, which makes these upcoming reports all the more crucial in determining the near-term direction of those stocks.

We are long-term investors that can be opportunistic, provided the underlying investment thesis and thematic tailwinds are still intact. Heading into these reports, the thematic signals that we collect here at Tematica tell me those respective thematic tailwinds continue to blow.

As we await those results, we continue to hear more stories over Apple slashing iPhone X production levels as well as bringing a number of new iPhone models to market in 2018. These reports cite comments from key suppliers, and we’ll begin to hear from some of them tomorrow when Corning reports its quarterly results. We’ll get more clarity following Apple’s unusual tight-lipped commentary on Thursday, and even if production levels are indeed moving lower for the iPhone X we have to remember that Apple’s older models have been delivering for the company in the emerging markets. Moreover, the company could unveil a dividend hike or upsized repurchase program or perhaps even both as it shares the impact to be had from tax reform. As I shared last week, there are other reasons that keep us bullish on Apple over the long-term and our strategy will be to use any post-earnings pullback in the shares to improve our cost basis.

In digesting Apple’s guidance as well as that offered by other suppliers this week and next we’ll be keeping tabs on Universal Display (OLED), which is once again trading lower amid iPhone X production rumors. As I pointed out last week, Apple is but one customer amid the growing number of devices that are adopting organic light emitting diode displays. We remain long-term bullish on that adoption and on OLED shares.

We’ve received and shared a number of data points for the accelerating shift toward digital shopping in 2017 and in particular the 2017 holiday shopping season. We see that setting the stage for favorable December quarter results from United Parcel Service and Amazon later this week. We expect both companies to raise expectations due to a combination of upbeat fundamentals as well as tax reform benefits. With Amazon, some key metrics to watch will be margins at Amazon Web Services (AWS) as well as investment spending at the overall company in the coming quarters. As we have shared previously, Amazon can surprise Wall Street with its investment spending, and while we see this as a positive in the long-term there are those that are less than enamored with the company’s lumpy spending.

In Alphabet/Google’s results, we’ll be looking at the desktop/mobile metrics, but also at advertising for both the core Search business as well as YouTube. Sticking with YouTube, we’ll be looking for an update on YouTube TV as well as its own proprietary content initiatives as it goes head to head with Netflix (NFLX), Amazon, Hulu and Apple as well as traditional broadcast content generators.

In terms of consensus expectations for the December quarter, here’s what we’re looking at for these six holdings:

 

Tuesday, JANUARY 30, 2018

Corning (GLW)

  • Consensus EPS: $0.47
  • Consensus Revenue: $2.65 billion

 

Wednesday, January 31, 2018

Facebook (FB)

  • Consensus EPS: $1.95
  • Consensus Revenue: $12.54 billion

 

Thursday, FEBRUARY 1, 2018

United Parcel Service (UPS)

  • Consensus EPS: $1.66
  • Consensus Revenue: $18.19 billion

 

Alphabet/Google (GOOGL)

  • Consensus EPS: $10.00
  • Consensus Revenue: $31.86 billion

 

Amazon (AMZN)

  • Consensus EPS: $1.84
  • Consensus Revenue: $59.83 billion

 

Apple (AAPL)

  • Consensus EPS: $3.81
  • Consensus Revenue: $86.75 billion