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Breaking down earnings from AXT, Nokia and UPS, plus thoughts on Amplify Snacks

Breaking down earnings from AXT, Nokia and UPS, plus thoughts on Amplify Snacks

We are officially in the thick of earnings season with reports from AXT Inc. (AXTI) last night, and both Nokia (NOK) as well as United Parcel Service (UPS) this morning. Below we have comments on the better than expected results from AXT, share why we are going to be patient with Nokia shares for the long-term and how United Parcel Service confirms out thesis on the shares. We also have some thoughts on the recent share price pressure in Amplify Snacks (BETR), and explain why Amazon’s (AMZN) comments and outlook on its Whole Foods business are what we’ll be watching next for this position.

 

Many positives in AXT’s 3Q 2017 earnings report and outlook

Last night compound semiconductor substrate and Disruptive Technology company AXT (AXTI) reported 3Q 2017 top and bottom line results that handily beat consensus expectations and delivered an in-line view on the current quarter. This popped the shares some 7% in aftermarket trading last night and sees the shares trading up nicely today.

More specifically, AXT delivered EPS of $0.11, $0.02 better than the consensus and up dramatically from $0.07 in the year-ago quarter on revenue that rose 29% compared to 3Q 2017. Higher substrate volumes revealed the operating leverage in the company’s business model and led gross margins to soar to 39.5% in the quarter, up from 30.8% in the prior quarter. Other factors aiding the margin comparisons included raw material prices and vendor consolidation as well as product mix, both of which help margins in the coming quarters.

In terms of its outlook for the current quarter, AXT guided revenue and EPS in the ranges of $26-$27 million and $0.07-$0.09, respectively, which compares with the consensus forecast of $26.6 million in revenue with EPS of $0.08. What’s not obvious in those ranges is expected growth at the midpoint of 22% and 47%, respectively. The current quarter, as well as the next one, tend to reflect the seasonal downtick compared to the third quarter 3Q 2017, which tends to house the RF semiconductor ramp for year-end smartphone sales. Given new smartphone models, continued growth in data traffic that is leading further data center investment, and new solar panel applications the outlook for continued year over year growth at AXT remains more than favorable.

For example, Audi and BMW are using solar panels on certain new models to provide power to the vehicle’s climate control system fan without ruining the battery, even when the vehicle is turned off. In addition, Audi and Alta Devices recently announced their partnership to integrate solar cells into panoramic glass roofs of Audi models to generate solar energy that increases the range of Audi electric vehicles. The first of these car prototypes are expected to by the end of this year, and the solar cells utilize compound semiconductor technology that is built on AXT’s substrates.

In the data center arena, companies such as Microsoft (MSFT), Intel (INTC), Cisco (CSCO), Broadcom (AVGO) and a number of others are driving the adoption of silicon photonics to drive data rates of 100 gigabits per second or better. This adoption bodes well for AXT’s higher margin indium phosphide substrates.

Recognizing the seasonal downturn we will face in the coming months, we will continue to be patient with AXTI shares.

  • Our price target on AXT (AXTI) shares remains $11, which for now keeps the shares a Buy at current levels.
  • With regard to that rating, we’ll be watching the $9.90 level, which offers roughly 10% upside to our price target.

 

Nokia: The market focuses on network infrastructure, but it’s the licensing business that matters.

Early this morning Nokia (NOK) reported 3Q 2017 results of €0.09 per share in earnings, €0.03 ahead of expectations even though overall revenue fell 7% year over year to €5.54 billion, a hair shy of the €5.64 billion consensus forecast. In trading today, Nokia shares are getting hit hard given the guidance that calls for continued declines in its Networks Business. We are not surprised by this guidance as we continue to wait for deployments of 5G technology in 2018-2020. Despite that shortfall, continued focus on cost in the Networks Business, as well as ongoing customer wins bode well for the business as the 5G ramp begins.

What we found as rather confirming was the continued growth in its high margin Nokia Technologies business, which rose to 9% of 3Q 2107 sales and 22% of 3Q 2018 gross profits up from 6% and 15%, respectively, in the year-ago quarter. Despite the overall revenue shortfall for Nokia in 3Q 2017, Nokia Technologies led the company’s consolidated margins higher and drove the EPS upside in the quarter. In other words, our thesis behind owning NOK shares was confirmed in this morning’s earnings report. As 5G and other technologies contained in the company’s intellectual property arsenal matriculate in the coming quarters, we see continued improvement ahead for this business and that bodes well for the company’s overall margin and EPS generation.

One of our key strategies has been to use share price weakness to scale into a position on the Tematica Select List provided the underlying investment thesis remains intact. As we saw in Nokia’s 3Q 2017 earnings report, that is the case. As we look for that opportunity, we’d note that Nokia’s Board of Directors plans to propose a dividend of EUR 0.19 per share for 2017, which if history holds will be paid in the first part of 2018. Given the current share price, that is a hefty dividend yield to be had and adds both a layer of support to the shares and adds to the total return to be had.

  • Our price target on Nokia (NOK) shares remains $8.50

 

Quick thoughts on UPS’s 3Q 2107 results

With United Parcel Service (UPS), the results and outlook were in line what we expected and simply put the company’s outlook simply reinforces our shift to digital commerce predicated thesis on the shares. Case in point, UPS sees:

  • Record holiday delivery of about 750 million packages,
  • Deliveries between Black Friday and New Year’s Eve forecasted to increase 5% from 2016
  • 17 of 21 holiday delivery days before Christmas to exceed 30 million packages each.

This latest forecast echoes what we’ve already heard about this holiday shopping season from the National Retail Federation, E-Marketer, and others.

We’ll dig through the UPS’s earnings call in greater detail, but what we’ve heard thus far along with a price increase slated for December 24th keeps our Buy rating and $130 price target intact. As we do that, we’ll also be looking at Amazon’s forecast for the current quarter and its comments on the holiday shopping season.

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

 

Shares of Amplify Snacks under pressure, but Amazon/Whole Foods will be the guide

Finally, our Amplify Snacks (BETR) shares have been under pressure this past week. On the news front, things have been rather quiet and the shares could be coming under pressure as institutional investors being their tax loss selling. We’ll look for confirmation on our thesis – consumers shifting toward food and snacks that are “healthy for you” in quarterly results out tonight from Amazon (AMZN) as it discusses recent performance and its outlook for recently acquired Whole Foods. As we do this, we’ll also be revisiting the dollar’s recent run-up and what it could mean for Amplify given its growing exposure to markets outside of the U.S.

With the shares approaching oversold levels, we are keeping a close eye on the shares. As we mentioned above with Nokia, we certainly like to improve our cost basis provided our investment thesis remains intact.

WEEKLY ISSUE: Some Underperformers Set to Come out from the Shadows

WEEKLY ISSUE: Some Underperformers Set to Come out from the Shadows

Monday was one of those sort-of holidays that saw banks, the post office and schools closed, but domestic stock markets and a number of other businesses open. The result was once again a more subdued start to the week that leads into what is poised to be a focal point for the stock market as 3Q 2017 earnings kickoff. Over the last several days, we saw through earnings from restaurant company Darden (DRI) and Cal-Maine Foods (CALM) and this week the negative 2017 reset from coatings company Axalta Coating Systems (AXTA). This tells me that not only has Wall Street underestimated the impact of September’s hurricane trifecta — a fact we saw in last Friday’s September Employment Report — but it has likely overestimated the current speed of the economy as well.

The next few days will give way to several economic reports that will more fully shine a light on the true speed of the economy, and they will help set the table for what is to come over the next few weeks as literally thousands of companies report. As subscribers, you know through our weekly Thematic Signals and our Cocktail Investing Podcast that I co-host with our Chief Macro Strategist Lenore Hawkins, we are constantly scrutinizing data points with our thematic lens and assessing the market.

Now let’s take a look at our overall market view, which is one of the key backdrops when it comes to investing – thematic or otherwise. As we shared on last week’s podcast, the domestic stock market continues to grind its way higher ahead of 3Q 2017 earnings. This march higher is being fueled in part by the return of investor greed as measured by CNNMoney’s Fear & Greed Index. The question we are increasingly pondering is what are those late to the party seeing that allows them to get comfortable with enough upside to now jump into a market that is trading at more than 19x expected 2017 earnings?

With the market priced to perfection and expectations running high, odds are we are bound to see some disappointment. The fact that margin debt is running at record levels is not lost on us here at Tematica, and it has the potential to exacerbate any near-term bump or pullback in the market.

This has us holding steady with the Tematica Select List, but it doesn’t mean we are being idle. Rather, we are scrutinizing contenders and revisiting price points at which we would scale into existing positions. Not quite our 2017 holiday shopping list, but one that as we approach Halloween could be ripe for harvesting.

 

 

Checking in on some of our outperformers

We’ve benefitted from this push higher as the Select List’s positions in LSI Industries (LYTS), Amplify Snacks (BETR), USA Technologies (USAT), Amazon (AMZN), Alphabet (GOOGL) and International Flavors & Fragrances (IFF) have outperformed the month to date move in the S&P 500. With USAT shares, this has them closing in on our $6.50 price target, while the others have ample upside to our respective price targets.

We continue to rate these stocks as follows:

  • Our price target on LSI Industries (LYTS) remains $10.00
  • Our price target on Amplify Snacks (BETR) remains $10.50
  • Our price target on Amazon (AMZN) remains $1,150
  • Our price target on Alphabet (GOOGL) remains $1,050

With USA Technologies (USAT) shares, we will continue to keep them on the Select List and as we reassess our Thematic Signals and other data points for additional upside to be had relative to our $6.50 price target.

The same is true with International Flavors & Fragrances (IFF), given the accelerating shift away from sugar toward food that is good for you vs. the modest upside to our current $150 price target.

 

It’s not all bad news for the underperformers however

While we like to focus on the outperformers, we tend to spend as much, if not more time, on the ones that are underperforming. Currently, that means shares of Costco Wholesale (COST), Nokia (NOK), MGM Resorts (MGM) and recently added United Parcel Service (UPS).

In reverse order, shares of Connected Society derivative company UPS shares came under pressure following comments that Amazon is once again flirting with expanding its own logistics business. While this may happen, it will take years to replicate the hub and spoke to home delivery service currently offered by UPS that is poised to benefit from the accelerating shift to digital commerce this holiday shopping season. We remain bullish on this position and expect the shares to rebound as we move into the 2017 holiday shopping season. We will look to scale into UPS shares closer to $110 should such a pullback in the shares emerges this earnings season.

Shares of Guilty Pleasure company MGM Resorts continue to languish following the recent Las Vegas shooting. In our view, it will take some time for the perception of the business to recover. As that time elapses, we’ll look to improve our cost basis following the better than expected August Nevada gaming data. Below $30 is where we are inclined to make our move, and our price target stands at $37.

We continue to see favorable data on 5G testing and deployments that bode very well for Nokia’s intellectual property business as well as its communications infrastructure business. Much like MGM shares we will be patient and look to opportunistically improve the cost basis on this Disruptive Technologies Select List position.

We have a more detailed look at Cash-Strapped Consumer company Costco down below, but as you’ll soon read we continue to favor the shares despite some concerning developments.

 

So, what’s up with Costco Wholesale?

As we mentioned above Costco is one of the recent underperformers and it comes following last week’s better than expected quarterly earnings results. The issue is that its the earnings call Costco shared that it is seeing a slowdown in membership rates, which Wall Street took to mean “Here comes Amazon!” While we agree that Amazon is set to continue disrupting traditional retail as it leverages Whole Foods into grocery and meal kits, and continues to focus on apparel, Costco’s issue is it opened 16 new warehouses during the first 9 months of its recently completed fiscal year, so odds are it would see some slowing in membership growth.

For those not convinced that Costco’s business is thriving we would point out the following:

  • September 2017: Net sales up 12%
  • August 2017: Net sales up 10.0% year over year with comparable stores sales up 7.3% (up 5.9% excluding gasoline prices and foreign exchange)
  • July 2017: Net sales up 8.8 percent year over year with comparable store sales up 6.2% (up 5.3% excluding gasoline prices and foreign exchange)
  • June 2017: Net sales up 7.0% year over year with comparable store sales up 6.0% (up 6.5% excluding gasoline prices and foreign exchange)

Looking at that data, we see Costco not only as a company that has continued to improve net sales month over month, but one that is hardly suffering the same fate as traditional brick & mortar retailers. Moreover, we would point out the company had 741 warehouses in operation during the August 2017 quarter, up from 715 a year ago. This led to a 13% increase in its high margin Membership Fee revenue, which accounted for nearly all of its net income during the quarter.

As we have said before, the power in Costco’s business model is the warehouses and membership fee income, and we see this continuing to be the case. As part of our Connected Society theme, we will continue to monitor consumer acceptance of delivered grocery. This includes Costco’s new two-day delivery services for both dry groceries and fresh foods that will be free for online orders exceeding $75 from 376 U.S. Costco stores. Unlike many brick & mortar retailers, Costco is not standing around and watching its competitors outflank it, rather it is responding. To us, this suggests the recent pullback is overdone.

  • We continue to have a Buy on Costco Wholesale (COST) shares, and our price target remains $190.

 

 

 

 

Using an Expectations to Share Price Disconnect to Scale into Amplify Shares

Using an Expectations to Share Price Disconnect to Scale into Amplify Shares

 

  • We are using the recent drop in Amplify Snacks (BETR) shares to scale into the position on the Tematica Select List at current levels, which will also serve to improve our cost basis.

  • Despite revising our price target lower to $10.50 from $11, the sharp move lower in the shares offers more than 43% upside.

 

As we noted in this morning’s Monday Morning Kickoff, both volatility and investor angst rose following the North Korea inspired political drama last week. Over the weekend, a calmer tone emerged and that has the domestic stock market moving rebounding this morning. Candidly, this could turn out to be a dead count bounce, and we continue to have several concerns – second half earnings and GDP expectations, the debut of Trump’s tax reform plan, debt ceiling discussions, and the Fed unwinding its balance sheet. We expect those and any potential re-kindling of the North Korea tension will roil the markets over the coming weeks.

As a reminder, we don’t buy the market. We let our thematic lens be our investing guide as we look for companies that benefit from multi-year tailwinds. While we are prudent investors, we are also opportunistic ones, and that has us scaling into shares of Food with Integrity investment theme company Amplify Snacks (BETR) this morning. Last week, BETR shares fell more than 20 percent following the company’s June quarter earnings report, and that brings the cumulative pullback in the shares to more than 30 percent since recently peaking just under $11 on July 24.

 

So what happened last week that BETR shares fell some 20 percent?

While the company beat on revenue for the quarter and delivered as expected EPS, the company trimmed its outlook. While revenue will continue to benefit from the consumer shift to better-for-you food, Amplify is kicking up its marketing budget to build its brand as it introduces new products, primarily across its Skinny Pop line. While Tematica’s Chief Investment Officer, Chris Versace, is biased toward the original flavor, we know Tematica’s President Chris Broussard is simply jonesing for a cheese flavored variety. He will soon get his wish alongside several new flavors.

Owing to that incremental spend, which we view as a positive as it looks to build awareness of both new and existing products here in the US and abroad, EPS expectations have moved lower for both this year and next. 2017 earnings now sit at 0.38 per share, down from the prior 0.42, and 2018 expectations now sit at 0.48 per share, down from 0.55. In our view, those EPS revisions do not warrant the more than 30 percent correction in the shares over the last several weeks.

While we cannot ignore those EPS revisions, and we’re not as we are trimming our BETR price target back to $10.50 from $11, we will use the mismatch between opportunity, earnings reset and move in the shares to scale into the position on the Tematica Select List. With the shares trading below $7.50 this morning, our revised price target still offers 42% upside from current levels, and that has us keeping our Buy rating intact.

Before we leave you to make this addition, we suspect some may be wondering if our core thesis on the shares has changed, and the answer would be “no.” We also continue to see Amplify as a potential acquisition by PepsiCo (PEP), Snyder’s Lance (LNCE), Post Holdings (POST), General Mills (GIS) or other snack food company.

 

 

 

 

 

Woeful Earnings from Kroger Has Us Tightening Position in UNFI

Woeful Earnings from Kroger Has Us Tightening Position in UNFI

While many have been focused on the retail environment —and we count ourselves among them here at Tematica — we’ve also been watching the painful restaurant environment over the past few months. It’s been one characterized by falling same-store-sales and declining traffic – not a harbinger of good things when paired with rising minimum wages.

For those that are data nut jobs like we are, per TDn2K, same-store sales for restaurants fell 1.1 percent in May, a decline of 0.1 percentage points from April. In May, same-store traffic growth was -3.0 percent. Now for the perspective, the industry has not reported a month of positive sales since February 2016 – that’s 15 months! One month shy of the bad streak the May Retail Sales Report has been on. Clearly not a good operating environment, nor one that is bound to be friendly when it comes to growing revenue and earnings.

Reading those tea leaves, we’ve avoided that the restaurant aspect of our Fattening of the Population investing theme, and with Ignite Restaurant Group filing bankruptcy, Cheesecake Factory (CAKE) warning about its current quarter outlook we confident we’ve made the right decision.

But people still need to eat, and we’ve seen consumers increasingly flock back to grocery stores in 2017. Year to date, grocery retail sales are up 1.7 percent through May. Breaking down the data, we find that in recent months those sales have accelerated, with March to May 2017 grocery sales up 2.8 percent year over year and standalone May grocery store sales up 2.2 percent year over year.

Yet, when grocery company Kroger (KR) reported in-line earnings for its latest quarter, it lowered its 2017 EPS outlook, cutting in the process to $2.00-$2.05 from the prior $2.21-$2.25, with the current quarter to be down year over year. Aside from price deflation in the protein complex and fresh foods, the company cited its results continue to be pressured by rising health care and pension costs for employees, as well as the need to defend market share amid “upheaval” in the food retailing industry. We see that as company-speak for Kroger and its grocery store competitors having to contend with our

We see that as company-speak for Kroger and its grocery store competitors having to contend with our Connected Society investment theme that is bringing in not only Amazon (AMZN), MyFresh, and FreshDirect into the fray, but also leading Wal-Mart (WMT), Target (TGT), and Safeway among others to expand their online shopping capabilities, which in some cases includes delivery. Another reason not to get off the couch when shopping.

Candidly, we’re bigger fans of companies that focus on profits over market share given that short-term market share led strategies, often times with aggressive pricing, tend to sacrifice margins, but focusing on profits tends to lead to better market-share over the long-term. We’ve seen the “strategy” that Kroger is adopting many times in the past and while it may have short-term benefits, increasing prices later on, runs the risk of alienating customers.

Getting back to Kroger’s guidance cut, that news sent Kroger’s shares down almost 20 percent on Thursday and led to United Natural Foods (UNFI) shares to fall more than 3.5 percent, while Amplify Snacks (BETR) slumped by 2 percent. In our view, most of Kroger’s bad news was likely priced into UNFI’s mixed guidance last week when it reported its own quarterly earnings. Without question, 2017 has been a rough ride for UNIF shares despite the Food with Integrity tailwind, but despite Kroger’s guidance cut, management shared on the company earnings call that it continues “to focus on the areas of highest growth like natural and organic products.” Even Costco Wholesale (COST) recently shared it has room to grow in packaged organic food items, excluding fresh), which plays to the strengths at both United Natural Foods and Amplify Snacks.

 

Tightening Our Position in UNFI, But Staying the Course with BETR

With our Food with Integrity thematic tailwind still blowing and UNFI shares down just 7.5 percent relative to our blended cost basis on the Tematica Select List, we’ll remain patient with the position. That said, from a technical perspective the shares are near support levels and if they break through $38.50 the next likely stop is between $33 and $34. Therefore, to manage potential downside risk, we’re instilling a stop loss on UNFI shares at $38.50. As we do this, we’ll acknowledge the tougher operating environment and reduce our UNFI price target to $50 from $65, which still offers upside of just over 25 percent from current levels.

  • We are keeping our Buy rating on United Natural Foods, but trimming our price target back to $50 from $65.
  • We are instilling a stop loss at $38.50 to manage additional downside risk near-term.

With regard to Amplify Snacks, with today’s close the shares are down just 6 percent from our late April Buy recommendation. Generally speaking, these single digit stocks tend to be volatile and require some extra patience, and that’s the tact will take with BETR shares. Our price target remains $11.

  • We continue to have a Buy on Amplify Snacks (BETR) shares and our price target remains $11.

 

 

 

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

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

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

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

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

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

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

 

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

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

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

 

Food with Integrity Theme Seen in Retail Sales Report As Well

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

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