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WEEKLY ISSUE: Uncertainty is back, but we’re thematically prepared

WEEKLY ISSUE: Uncertainty is back, but we’re thematically prepared

Key points inside this issue:

  • The Fed, Trump, tariffs and the data bring uncertainty back to the market
  • What it means for investors
  • We will continue to hold Disney (DIS), Apple (AAPL), Amazon (AMZN) and AT&T (T) shares.
  • What to watch this week

The Fed, Trump, tariffs and the data bring uncertainty back to the market

Between the number of S&P 500 companies reporting last week to the Fed’s FOMC meeting and the pieces of economic data coming at us, we knew it was going to be a busy and potentially volatile week. What few saw coming was the attempt by Fed Chairman Powell to give the market the 25 basis point rate cut it was expecting and regain the position of the market not knowing exactly what the Fed’s next move might be. But then we received the July ISM Manufacturing Index and the July IHS PMI data for the four global economic horsemen (China, Japan, the eurozone and the US). In aggregate those data points signaled the continued slowdown in the global manufacturing economy.  

Granted, the sequential pick up in the July ADP Employment Report fostered the view the domestic economy hasn’t frozen over just yet, but Friday’s July Employment Report reveled slower job creation month over month. 

Normally, economic data like we’ve received in the back half of last week would be enough to ignite the market doves and stoke the view that another rate cut by the Fed was more likely before we exit 2019. And it was that view that led the major market indices higher on Thursday, that was until President Trump did something that arguably next to no one saw coming – announced another layer of tariffs on China that would go into effect on September 1. The implications of that move, which would likely lead to yet another trimming of forecasts for both the economy and earnings, pulled the market lower on Thursday afternoon. 

And on Friday morning, China responded by saying while it does not want a trade war, its not afraid to fight one. Soon thereafter, President Trump is “open to delaying or halting the 10% tariff on September 1” if China were to take action between now and then. Remember, we shared our concern that trade talks could devolve into playground taunting and fighting. Well, we are there and sticking with the analogy, it’s likely going to keep the stock market on the uncertainty teeter totter for the next few weeks. 

If some were hoping for a more normal August for stocks following this week’s Fed meeting, we’re sorry to say that’s not likely to happen. In the past we’ve shared several analogies about investing – it’s not crock pot cooking, you can’t fix it and forget it or investing is not a like a photo, i.e. snapshot in time, but much like a good film it’s an evolving story. As this latest chapter begins to unfold, it will be mean assessing and re-assessing expectations as new developments are had and their ripple effects determined.

What it means for investors

Odds are this will uncertainty will result in the usual back and forth for the market in the coming weeks, which will also see the usual end of summer low trading volumes. While a good chunk of Wall Street is at the beach, I’ll remain vigilant and continue to leverage our thematic lens.

More than likely, we will see the herd once again focus on domestically focused as well as inelastic business models as it looks for ports of safety. We’ve have a number of these among the Thematic Leaders and the Tematica Select List – Chipotle Mexican Grill (CMG), Dycom Industries (DY), Costco Wholesale (COST), Axon Enterprises (AAXN), AT&T (T), and USA Technologies (USAT). Unlike the shoot from the hip go to choice of the herd that tends to zero in on electric utilities that group of six have the added benefit of thematic tailwinds propelling their respective businesses.

As August drips by, I’ll continue to look for thematically well positioned companies that offer favorable risk to reward tradeoffs in terms of share prices as I look to position us for what lies ahead. In the meantime, I would recommend subscribers catch the August 5, 2019 issue of Bloomberg Businessweek as the cover story focuses the coming streaming video war that I’ve talked about both here and on the Thematic Signals podcast. The author likens it to “The Hunger Games”, and in many respects I can see why that is a good comparison.

While we were recently stopped out of Netflix (NFLX), I’ll remind you that among the Thematic Leaders and Tematica Select List we have several companies — Disney (DIS), Apple (AAPL), Amazon (AMZN), and AT&T in particular – that are focusing on this market. Each brings their own particular set of strengths ranging from content to addressable customer base, but all three have other businesses besides streaming video to drive profits and cash flow that can fund their respective streaming businesses.

  • We will continue to hold Disney (DIS), Apple (AAPL), Amazon (AMZN) and AT&T (T) shares.

What to watch this week

After all the happenings for last week that I described above, this week looks to be yet another frenetic one for corporate earnings with more than 1,100 reports to be had, but the pace of June quarter earnings begins to slow and we face a lighter economic data schedule as well. And to be clear, even though we will face a plethora of June quarter reports, let’s remember that exiting this week roughly 78% of the S&P 500 has reported and next week another 13% of that group will be doing so. What this means is the vast majority of reports next will have far less of an impact on the market. This doesn’t diminish them from an ownership of data and information perspective, but rather a smaller impact is likely on earnings revisions and trading ranges. 

Corporate earnings to watch

In terms of which reports I’ll be focusing on this week, it should come as little surprise that they are the ones touching our various investment themes. Here’s my short list:

  • Monday, August 5: Tyson Foods (TSN), International Flavors & Fragrances (IFF), Insulet (PODD) and ShakeShak (SHAK). 
  • Tuesday, August 6: Tenneco (TEN), ADT (ADT), AMN Healthcare (AMN), Comscore (SCOR), LendingClub (LC), Disney (DIS), 
  • Wednesday, August 7: CVS Health (CVS:NYSE), CyberArk (CYBR), Physicians Realty Trust (DOC), Darling Ingredients (DAR), Skyworks (SWKS), Tivity Health (TVTY), 
  • Thursday, August 8: Activision-Blizzard (ATVI:), Alarm.com (ARLM), Dropbox (DBX), Synaptics (SYNA:Nasdaq), Uber (UBER) 
  • Friday, August 9: US Concrete (USCR)

Economic data to watch

Before we tackle the coming week’s economic data, I’ll mention GDP expectations from the Atlanta Fed and New York Fed started last week off between 2.0%-2.2% and as we exited the week those expectations sat at 1.6%-1.9%. As I touched on above, the employment data we received last week pointed to a still growing economy but the take on the manufacturing economy per the July ISM Manufacturing Index and the July US IHS Markit PMI data pointed to a slowing domestic manufacturing one. 

We have only a handful of meaningful economic data coming at us this week in the form of the July inflation reports and ISM’s July reading on the US service economy. Given our pension for looking at other data set in addition to the formal economic data, we here at Tematica will be on the lookout for the last Cass Freight Index and other truck tonnage figures as well as the weekly railcar loading data. Those have been signaling the slowdown we’ve seen in the government produced economic data, and as such we’ll keep a close watch on them in order to stay one step ahead of the herd. 

Should the coming economic data be continue to disappoint relative to expectations and signal the vector and velocity of the domestic economy is down and even slower than recent revisions suggest, odds are the market will increasingly expect another Fed rate cut sooner than later. Our concern, however, is the intended effect of this week’s rate cut and another one should it come to pass on business investment could be muted by the continued trade uncertainty and weakening global economy. As we’ve seen with falling mortgage rates that didn’t stimulate demand earlier this year, in the near-term businesses may stay on the sidelines given the trade and economic uncertainties despite more favorable interest rates.


What Investors Need to Know About the Implications of Trump’s Tariffs

What Investors Need to Know About the Implications of Trump’s Tariffs

 

A couple of days ago, I shared my view that President Trump’s tariff overtures are more than likely a negotiating tactic as he looks to tackle yet another of his campaign promises – international trade. The resignation of Gary Cohn on Tuesday, President Trump’s top economic adviser and the head of the National Economic Council, have certainly fanned the flames that this might not be a bluff by Trump — either that or Gary Cohn was unwilling to play the game.

I continue to think Trump is following the negotiating strategies he laid out in his 1987 book, Art of the Deal. But as an investor, we have to game out the potential outcomes so we can assess the potential risk and position ourselves accordingly. 

 

Should Trump enact the seemingly unpopular trade tariffs on steel and aluminum, what then? 

For starters, with an increase in the cost of importing from other countries and a lack of price pressure on American suppliers, steel and aluminum will become more expensive to U.S. companies. No big surprise there. The companies impacted will be wide, ranging from manufacturers of aircraft, high-speed rail, cars, trucks, construction equipment, motors, satellite dishes, smartphones, tablets and appliances. And let’s not forget cans, which will impact the price of food, soda and beer, as well as a variety of other products.

What this means is the cost production for Boeing (BA), Ford (F), General Motors (GM), Navistar (NAV), Paccar (PCAR), Caterpillar (CAT, Deere (DE), Cummins (CMI), Apple (AAPL), Dell, Whirlpool (WHR), Coca-Cola (KO), PepsiCo (PEP), Molson Coors (TAP), Anheuser Busch (BUD), and numerous others will rise. 

 

Will those companies look to change to domestic suppliers? 

Most likely, but that will take not only time, but require more domestic capacity to come on line. As we’ve seen in the domestic oil industry, it’s not as easy as flicking a light switch – it takes time, and more importantly, it takes people, the right people. That’s right, the skill set to work in a steel or aluminum plant is not the same as working at McDonalds (MCD), the Gap (GPS) or an AMC Theater (AMC).

What we’re likely to see amid a rise in demand for domestic steel and aluminum is rather similar to what we are seeing in the freight industry. The currently capacity constrained domestic truck market has led to sharp increases in freight costs cited by a growing number of consumer product companies ranging from Tyson Foods (TSN) to J.M. Smucker (SJM) and Ross Stores (ROST). 

The same materials constraints is poised to happen to homebuilders this spring, given the current lumber shortage… and yes the current truck shortage could mean a double whammy for homebuilders like Toll Brothers (TOL), D.R. Horton (DHI), Lennar Corp. (LEN) and the rest of the industry, both public and private, as they truck materials to new building sites.

We’ve talked quite a bit about how rising home prices due to low supply have likely priced out a number of prospective buyers. Let’s also remember the rising level of consumer debt and lack of wage gains for the vast majority of workers that Lenore Hawkins, Tematica’s Chief Macro Strategist, and I have been talking about on the Cocktail Investing Podcast and writing about. What this probably means is more consumers will be priced out of the housing market as homebuilders look to offset rising costs with higher prices. Basic economics. 

Getting back to the impact of the proposed Trump tariffs, while they would help potentially level the playing field for steel and aluminum companies like AK Steel (AKS), Steel Dynamics (STLD), Century Aluminum (CENX), Arconic (ARNC) and other, in the short to medium term they will more than likely lead to higher prices. 

While companies may look to offset those rising costs, the reality is that in today’s world where a public company must at a minimum meet the bottom EPS expectations lest it’s stock price get crushed, odds are they will raise prices to minimize the hit to the profits and the bottom line. We’ve seen this time and time again over the years at Starbucks (SBUX) with a nickel here and there price increase with its latest in September ranging from 10 to 30 cents on a variety of menu items. 

To use the lingo favored by the Fed and economists, we run the risk of inflation. Yes, folks, I said it, inflation, and as we know over the last few weeks that word has become a focus for investors as they look to gauge how far and how fast the Fed will boost rates in 2018 and before too long 2019. We know in watching these higher prices will weigh on the buying activity of Cash-Strapped Consumers and most likely others as items become less affordable. Not sure, consider the median U.S. income last year was all of $31,685 compared to $31,248 in 2000 – over 18 years an income gain of just $437! 

This is where I remind you that the U.S. consumer is a meaningful contributor to the domestic economy, (with consumer spending accounting for nearly 70% of GDP) and Lenore would kick me if I didn’t remind you how far along we are in the business cycle. The combination of rising prices and questionable consumer demand also runs the risk of profit and EPS pressure that would likely weigh on stock prices. 

Boiling it down, the question is does Trump want to run the risk of torpedoing the economy and the stock market, two of his much tweeted about barometers for his presidency?

My thought is probably not.

I do, however, expect Trump and his ego will continue down this negotiation path, ultimately compromising for a better trade deal than the current one. And yes, my fingers are crossed. 

Will it be smooth sailing to that destination? Not likely and we can see last night’s resignation of Gary Cohn, President Trump’s top economic adviser, as a sign the waters will be more than choppy over the next few weeks. 

 

The Response from the EU and Its Potential Impact to the Fed and Interest Rates

Upping the ante, this morning the European Union shared its response to Trump’s proposed metals tariffs saying it would take the case to the World Trade Organization and coordinate its actions with other trade partners that are also against the proposed tariffs from the U.S. The EU went on to share a “provisional list” of U.S. products that would see higher tariffs from the EU, if Trump moves ahead with the import tariffs. The full list has yet to be made public, but among its speculated $3.5 billion impact will to items such as peanut butter, cranberries and oranges. Perhaps EU officials have been busy reading Trump’s Art of the Deal? 

What all this looks like… or at least I hope it is… is a good ol’ fashion game of chicken — international trade negotiation style.

Like most games, there tends to be a winner and a loser, and while it’s possible that Trump comes out ahead on this, the risk he runs will impact the American consumer, the domestic economy and at least certain stocks if not the overall market. 

Remember also that the next monetary policy meeting by the Fed is in two weeks. At its January meeting, the Fed was beginning to shake and bake tax reform implications into its outlooks, and I suspect the Fed heads are likely doing the same with a potential trade war. Do I feel bad for new Fed Chief Jerome Powell? Let’s just say that I wouldn’t want his job, but then again given my pension for calling it like I see it they probably wouldn’t want me. 

 

Lackluster Demand for the Apple iPhone 8 Puts Pressure on OLED and others

Lackluster Demand for the Apple iPhone 8 Puts Pressure on OLED and others

Yesterday we witnessed a sharp decline in technology stocks as evidenced by the declines in Facebook (FB), Amazon (AMZN), Alphabet (GOOGL), Netflix (NFLX) and Apple (AAPL). Regarding Apple shares, yesterday’s move lower simply adds to the recent pressure on the shares we’ve seen since the company’s lackluster September special event as investors question iPhone 8 model demand ahead of the early November launch of the iPhone X. Of course, snafus with the latest Apple Watch and MacOS High Sierra aren’t helping a company that seems plagued either a lack of vision or remaining trapped in a position until technology forces align for its next new product.

Pressure on Apple shares has overflowed and resulted in the same downward pressure on our Universal Display (OLED) shares, slipping from a high of $142 on September 19, down to a hair below $125 when the market closed last evening. We’ll continue to keep OLED shares on the Tematica Select List however, as Apple adopts its technology across other devices, and as demand from other devices (other smartphones, TVs, wearables, automotive interior lighting) climbs in the coming quarters. As a reminder, tomorrow brings the 2017 Analyst Day from Applied Materials (AMAT) and we expect bullish comments for both its semiconductor capital equipment business as well as its display business.

 

Other Market & FED Notes

We’ve noted that we have seen the Wall Street herd rotate sectors as of late, with water and electric utilities being strong performers of late — both part of our Scarce Resource investment theme. While the S&P 500 Volatility Index (VIX) may be near record lows, the recent performance of those safe havens signals that investors are in a wearisome mood. Another group that has performed well over the last several weeks is multinational companies, which have benefitted from the dollar’s renewed weakness in July, August and early September. We’ve seen this with our Amazon (AMZN), International Flavors & Fragrances (IFF), and Facebook (FB) shares to name a few.

More recently, however, we’ve seen the dollar rebound modestly, and with the Fed talking up several interest rate hikes in as many quarters, we are likely to see the dollar move further off early September lows. This brings Fed Chairwoman Janet Yellen’s speech this afternoon into focus. Will we get much more from Yellen on the pace of balance sheet unwinding vs. what the Fed shared last week? Probably not, but we’ll still be looking to parse her usual clear as mud words.

The expected lack of “new info” from the Fed will likely keep the market mentality fixated on the Fed’s forecasted interest rate hike timetable. We here at Tematica prefer to remain data dependent when it comes to contemplating potential Fed rate hikes. That view led Federal Reserve Bank of Minneapolis President Neel Kashkari to reiterate his view yesterday that raising rate now is a bad idea:

“When I look at the economy, I don’t see any signs the economy is close to overheating… I see no need to tap the brakes and attempt to moderate the economy with higher short-term rates.”

Realizing Kashkari is a lone voting wolf inside the Fed, odds are the herd view will continue to influence the prevailing narrative in the near-term. We’ll remain patient as that group will once again take some time to come around to how we see things.

In the short-term, a continued rebound in the dollar is likely to pressure multinational companies ranging from General Electric (GE) and Caterpillar (CAT) to the likes of Amazon, Facebook, Applied Materials, and even MGM Resorts (MGM) that are on the Tematica Select List. With this in mind, we’ll be closely dissecting the forward guidance to be had from Nike (NKE) later today and the Select List’s own McCormick & Co. (MKC), which reports this Thursday (Sept. 28).

As the herd continues to feel its way around, we’re inclined to re-test our thematic thesis on the stocks comprising the Select List, but given what we’ve seen in our Thematic Signals we have reason to believe our thematic tailwinds continue to blow.  As we do this, we’ll remember this week unveils President Trump’s tax reform proposal followed by the administration’s regulatory agenda that will be outlined next week (Oct. 2), not to mention all the amped-up geo-political news between the U.S. and North Korea.

Odds are the next few weeks, will be tumultuous, but let’s remember that “fortune favors the prepared” and that’s what w we aim to be. This means looking for thematically well-positioned companies that offer favorable risk-to-reward dynamics, like the recent addition of Corning (GLW) and Nokia (NOK), as well as opportunities to scale into existing positions on the Tematica Select List.

 

 

No Sleepy End of  Summer in Sight

No Sleepy End of  Summer in Sight

 

We’ve survived the eclipse, and while the display was a bit underwhelming outside of the Beltway, we hope you enjoyed this rare experience that pulled 10 percent of US viewers away from Netflix while it was happening. Rest assured the consumers of streaming content that help power our Connected Society investing theme were back on board soon thereafter propelling Marvel’s The Defenders to a binge viewing pop after dropping last Friday. From time to time we may see speed bumps for our Connected Society investing theme, but much like trying to put toothpaste back into the tube, we don’t see a reversal in this tailwind or any other of those associated with our investing themes anytime soon.

If anything, as we break down the monthly retail sales data, examine data points such as the box office take and maneuverings by companies like Target (TGT) and Wal-Mart (WMT), we see that Connected Society tailwind blowing even harder as we head into the 2017 holiday shopping season. This morning it was shared that Wal-Mart is teaming with Alphabet (GOOGL) to bring Wal-Mart products to people who shop on Google Express, Google’s online shopping mall. What’s significant about this news is that it marks the first time Wal-Mart has made its products available in the U.S. on a website other than its own. Also, too, Wal-Mart is embracing aspects of our Disruptive Technology theme as it makes it products available to customers via Google Home (Google’s answer to Amazon’s Echo) as well as Google Assistant, its artificial intelligence software assistant found in smartphones powered by Google’s Android software.

Clearly, Wal-Mart is shoring up its position and investing for where retail continues to head — a path that is increasingly chartered by the Connected Society. To us, this development, along with Nike’s (NKE) recent teaming with Amazon (AMZN), is a clear signal of what’s happening in retail. It also says that lines are being drawn between those partnered with Amazon and those that aren’t. We suspect many will see this as evidence of the “retail-megeddon” that is upending the retail industry. Here at Tematica, however, our view is Amazon and Wal-Mart are in the thematic sweet spot and are positioned to become the Coke and Pepsi of retail.

We also continue to see Costco Wholesale (COST) emerging as the bronze medal winner in retail. The company’s July retail sales metrics certainly showed it is gaining consumer wallet share as it rides our Cash-Strapped Consumerand Rise & Fall of the Middle-Class tailwinds. Plus, Costco’s business model is also based on collecting membership fees, which continue to grow, and thus insulates it somewhat from the struggles of brick & mortar retail. In our view, if Costco were to acquire Boxed.com, that transaction would be a game changer for Costco’s digital shopping business.

  • We continue to have Buy ratings on Amazon (AMZN), Alphabet (GOOGL), Costco Wholesale (COST) shares with price targets of $1,150,  $1,050 and $190, respectively. 

 

 

The No Man’s Land that is the last two weeks of August. 

As we shared in this week’s Monday Morning Kickoff, trading volumes are likely to be lower these next 10 days ahead of the Labor Day weekend.  Of course, while many try to get their last bit of R&R in at a nearby beach or lake, Washington is once again taking center stage. As you have probably guessed that means some back and forth political maneuvering will push the market around over the coming weeks as renewed hopes of U.S. tax reform contend with President Trump threatening a government shutdown if Congress didn’t present him with a spending bill for the next fiscal year that included funding for a border wall. Not exactly the tone we’d like to hear ahead of the debt ceiling negotiations.

While we ultimately think the debt ceiling will be raised, we’re not looking forward to the “deadline is approaching” drama that will likely unfold. Giving us some reassurance, during a public event on Monday in Kentucky with Treasury Secretary Steven Mnuchin, Senate Majority Leader Mitch McConnell said there was “zero chance — no chance” that Congress would fail to raise the debt ceiling. Of course, that doesn’t mean it’s going to be a walk in the park getting there.

As we watch those developments, we’ve started to get some hints as to what tax reform might look like. Early indications suggest capping the mortgage interest deduction for homeowners, scrapping people’s ability to deduct state and local taxes, eliminating businesses’ ability to deduct interest and allowing for the “repatriation” of corporate profits from overseas. As we’ve seen with the efforts to repeal and replace Obamacare, the devil will be in the details, and more solid ones should emerge in the coming weeks.

Finally, less than a week into NAFTA renegotiations, President Trump has cast doubt on the future of the trade agreement saying, “I think we’ll end up probably terminating NAFTA at some point.” Again, the devil will be in the details, and until those emerge we’re likely to see corporate American hem and haw as it faces several new obstacles that are fanning the flames of uncertainty.

In our view, this is points to a potentially tumultuous next few weeks, low volume end of August followed by September, historically one of the worst months for the stock market. From a Tematica Select List perspective, we’ve seen the recent volatility ding some of the positions, but we remain comfortable given the confirming data points that we are seeing.

For example, during his address Monday night, President Trump announced a new strategy that calls for sending more troops to Afghanistan. Trump provided few specifics about his policy and how much the U.S. military commitment in the region would increase as a result. The decision, however, to further commit rather than withdraw equates to a tailwind for defense spending that is a part of our Safety & Security investing theme. Also, this week, security researchers have discovered several apps on the Google Play store harboring malware, another reminder of the downside to our increasingly Connected Society that provides lift for the cyber security aspect of our Safety & Security investing theme. As we look for details on incremental defense spending, we’ll continue to recommend subscribers add PureFunds ISE Cyber Security ETF (HACK) shares to their holdings if they haven’t already done so.

  • We continue to have a buy on PureFunds ISE Cyber Security ETF (HACK) shares with a long-term price target of $35.

 

 

More Tailwinds for OLEDs

Last week, as it reported a solid earnings beat and raised its outlook for the balance of the year, Applied Materials (AMAT) had several bullish things to say on organic light-emitting diode display demand:

“Display is growing even faster than wafer fab equipment as customers make multi-year investments to address large inflections in both TV and mobile. In TV, a major push to new Gen 10.5 substrates is under way. These huge, 10- square-meters substrates are ideally suited for manufacturing larger-format screens, 60 inches and bigger. We now expect 30 new Gen 10.5 factories to be built over the next several years. At the same time, mobile organic light-emitting diode (OLED) display investment is getting stronger as customers prepare for broad adoption of OLED in smartphones. OLED enables new form factors that result in a larger display area for smartphone, further expanding the overall market.”

We could not have summed it up better ourselves, and that report keeps us bullish on both AMAT and Universal Display (OLED) shares despite the recent pullback both have experienced.

  • We continue to have Buy ratings on both Applied Materials (AMAT) and Universal Display (OLED) shares with prices targets of $55 and $135, respectively

 

USAT Beats Expectations and Offers Bullish Outlook

Yesterday, shares of Cashless Consumption company USA Technologies (USAT) popped in early trading following an earnings and revenue beat for the June quarter. More specifically, the company beat bottom line expectations by $0.01 per share and topped revenues with $34.3 million, $3.2 million ahead of consensus forecasts, and up more than 55% year over year. Ticking through the press release there were a number of positive connection and customer metrics shared by the company and as expected the company offering a bullish outlook for the coming quarters.

That’s the good news.

The less good news is the company fell short when it came to discussing the impact of its recent stock offering that was completed in late July. Yes, during the current quarter, and we find that somewhat disappointing. The company did say, however, that it plans to “to take advantage of opportunities both organic and inorganic that may present themselves in this rapidly evolving landscape” and that means an acquisition or more. When peppered on the earnings conference call, USAT shared that it would seek acquisitions to “enhancing our offering with additional value-added services or allowing us to expand into additional verticals or geographies to drive further growth.”

Not a bad development by any stretch, but it is one that raises some unknowns, particularly for a small company. As we’ve heard many a banker say, the headaches associated with small acquisitions are the same ones with big ones, the only difference is the size of the fee. Given the size of the business as well as the team, the question is will USAT undertake nip and tuck acquisitions that add to its capabilities and expand its footprint or would it look to make a bolder move, potentially swallowing a larger player? We’re fans of the former, while the latter tends to result in some of those headaches such as product, facility, technology and spending integration and rationalization, as well as layoffs.

Given the global proliferation of mobile payments and the first-hand experience I had in Singapore, we’re going to stick with USAT shares for the time being. Based on any potential acquisition, we’ll look to digest the implications and what it may mean for holding the shares.

  • Our price target on USA Technologies (USAT) shares remains $6.

 

 

Disruptive Voice Technology Continues to Take Hold

Last night we shared the news that Barclays (BRC) has enabled voice payments to be made using Apple’s (AAPL) Siri functionality. This is another step forward in the disruptive use of voice technology as an interface across smartphones, intelligent speakers and soon other applications. As more and more applications come to market, we continue to be bullish on shares of Nuance Communications (NUAN) despite the slow tumble they’ve experienced over the last several weeks. As a reminder, the company has inked technology deals with Apple as well as Facebook (FB) to power their respective messaging chat bots even as the use of voice technology proliferates.

  • We remain bullish on Nuance (NUAN) shares, and our price target stands at $21.

 

 

Even Though DY Remains in Radio-Silence, We Continue to Be Patient

Next week Dycom Industries (DY) will report its quarterly results on Wednesday morning (August 30). Despite the ever-increasing need to add incremental wireless capacity and build out next generation wireline networks, in part for wireless data backhaul, to keep up with data demand, DY shares have sunk some 28% over the last three months. This equates to a round trip in the position from a high of just over $110 back to our blended cost basis of $76.68 on the Tematica Select List.

Frustrating to say the least. That frustration is compounded by the lack of news to be had from the company. Its last communique was at the Stifel Industrials Conference back in June. We know network spending at its key customers — AT&T (T), Verizon (VZ) and Comcast (CMCSA) — remains on track as they look to bring incremental 4G and gigabit internet capacity on stream, while beta-ing 5G capacity. Comcast’s recent launch of Xfinity Wireless also likely means additional wireless capital spending will be had in the coming quarters.

  • We’ll continue to be patient with Dycom Industries (DY), which is hovering in oversold territory.
  • Should the shares retreat further into the mid-$60s, we’re inclined to once again scale into the position, improving our cost basis along the way. 

 

 

WEEKLY ISSUE: A Company in Transition Can Be an Opportunity When the Time is Right

WEEKLY ISSUE: A Company in Transition Can Be an Opportunity When the Time is Right

In this Week’s Issue:

  • Updates on Tematica Select List Holdings
  • A Company in Transition Can Be an Opportunity When the Time is Right

 

We have one last major earnings hurrah in the short-term and that will hit on Thursday. From there, the pace of earnings should begin to slow, but like any lengthy meal, it means digestion will ensue. This time around the digestion phase will be the usual matching up of company reports and cross-referencing guidance, but with an eye to how realistic earnings expectations are for the back half of 2017.

In addition to doing our own work on this, as you read this Tematica’s Chief Investment Strategist is winging his way to Singapore to give a presentation on thematic investing. While the trip to and fro will be a lengthy one, including a long layover in Japan, we strongly suspect he’ll have a number of data points and insight to share in the next issue of Tematica Investing that will be published on Aug. 16. That’s right, while others may take off the last two weeks of August, we’ll be coming at you as we close the second month of 3Q 2017 and get ready for September.

Historically September has been one of the worst performing months for the market, and given our concerns about earnings expectations vs. the market’s valuation, the pending normalization of the Fed’s balance sheet and speed of the economy not to mention continued drama in DC and North Korea, we want to dress the investing table properly ahead of entering the last month of the quarter.

 

 

Updates on Tematica Select List Holdings

As we mentioned in this week’s Monday Morning Kickoff, we had a sea of more than 600 companies report their latest quarterly performance. Here are some quick highlights and corresponding actions for those Tematica Select List members that reported last week.

Following Facebook’s (FB) better-than-expected June quarter, in which advertising revenue rose 47 percent year-on-year and mobile revenue jumped 53 percent and the company trimmed back its operating expense guidance, we are boosting our price target on the shares to $200 from $165. At the current share price, we now see just over 15 percent upside to our new price target. Clearly, that is tempting. However, we’d look for the shares to settle following its earnings report and bullish commentary before revisiting the current rating on the shares.

  • We’ve increased our price target to $200 from $165 for Facebook (FB) shares, which offers 18 percent upside from current levels.
  • As we re-issue our Buy rating on FB shares, we would suggest subscribers let the currently over bought shares cool off following last week’s post earnings report climb. We see a compelling line closer to $160.

Also during the week, Amazon (AMZN) reported results that missed expectations, which we attribute to our warning over ramping expenses. Given its outlook, however, the shares finished the week down modestly. We acknowledge that quarter-to-quarter expenses can be tricky when it comes to Amazon, but there is no denying the winds that are at its back. As we enter the Back to School and soon to be upon us holiday shopping period we continue to see Amazon taking consumer wallet share. The fact that it continues to expand its offering while growing its very profitable Amazon Web Services is not lost on us.

  • Our price target on Amazon (AMZN) shares remains $1,150, which keeps the shares a Buy at current levels.
  • As we have said previously, AMZN shares are ones to own, not trade.

Buried inside the earnings report from MGM Resorts (MGM) last week was improved margin guidance, along with a strong event calendar, which in our view offsets the current disruption at its Monte Carlo facility. As a reminder, that facility is being rebranded to Park MGM. On the back of that call, Telsey Advisory Group not only reiterated its Outperform rating, but boosted its price target to $39. We’ll look to see if the near-term event calendar featuring the upcoming McGregor vs. Mayweather fight on Aug. 26 lives up to expectations, before adjusting our $37 price target for this Guilty Pleasure company.

When we added shares of AXT (AXTI) to the Tematica Select List, we knew the business would benefit from our increasingly Connected Society as well as new technologies that are part of our Disruptive Technology investing theme. Today we are boosting our price target to $11 from $9 on shares of this compound semiconductor substrate manufacturer following an upbeat 2Q 2107 earnings report. While the company’s EPS for the quarter was in-line with expectations, quarterly revenue was ahead of expectations and management confirmed the upbeat outlook by core customer Skyworks Solutions (SWKS) as it signaled continued volume gains are to be had in the coming quarters. We continue to see increasing demand for its substrates fueled by wireless and light emitting diode applications as well as the adoption of next generation technologies in data centers and other telecommunication applications. As volume improves, so to should margins and EPS generation as well.

  • We are boosting our price target on AXT Inc. (AXTI) shares to $11 from $9, which keeps a Buy rating intact.

Finally, while Applied Materials (AMAT) shares closed down 8 percent over the last several days, competitor Lam Research (LRCX) offered an upbeat view of semiconductor capital equipment demand on its 2Q 2017 earnings report. On the corresponding earnings call, Lam management shared several confirming data points behind our Applied thesis, including “Demand trends are robust, particularly in memory both in enterprise and consumer end markets. Applications such as machine learning and artificial intelligence are foundational to the next generation of technology innovation, and they are driving strong memory content growth for DRAM and NAND that offer attractive economics for our customers.”

One of the key differences between Applied and Lam is Applied’s position in display technology equipment that is benefitting from the ramp in organic light emitting diodes displays. Lam does not participate in that market and as good as its outlook is for semiconductor capital equipment, which bodes well for Applied, recent news that LG Display would invest several billion dollars to help Apple (AAPL) secure organic light emitting diode display capacity only benefits Applied.

  • We continue to be bullish on both Applied Materials (AMAT) as well as Universal Display (OLED) shares and our respective price targets remain $55 and $125.

A Company in Transition Can Be an Opportunity When the Time is Right

Often times companies that are in transition are ones that are put on the shelf that investors tend not to revisit. While that can be a good thing, there are times when it may not be and that’s the question today. Is Nokia (NOK), the former mobile phone market share leader that bungled the smartphone revolution worth taking another look at? Kind of like a bad relationship, most investors tend to walk away from a stock like a bad breakup, never looking back. But in this case, we think NOK, which was once a darling of our Connected Society investing theme a decade plus ago is showing signs it might be deserving of another chance as it morphs into Asset-lite company.

Let’s remember, Nokia shrewdly sold off its mobile phone business to Microsoft (MSFT) a few years ago fetching $7.2 billion in return. Soon thereafter Nokia sold its Here mapping and locations services business to an automotive industry consortium consisting of Audi, BMW Group and Daimler for $3.1 billion. So yes, the Nokia of today is very different than it was just a decade ago.

What’s left, is a company comprised of two businesses – Nokia Networks and Nokia Technologies. The Networks business is one that includes its mobile networks equipment — the hardware the carries all that cellular data — that is used by carriers across the globe, which are filling in some phase of expanding existing 3G or 4G LTE network coverage, building new 4G LTE networks (like in India) or prepping to test 5G networks. The Networks are a lumpy business as equipment demand peaks as a new technology is ramped and then fades as only incremental spending remains. We’ve seen this with 2G, 3G, and 4G networks, and odds are we will see this again with 5G. The Networks business also includes its services business as well as its IP/Optical Networks business, but the key mobile networks business accounts for

The issue will be one of timing – when does the ramp really begin? – and the competitive landscape, given the emergence of Chinese players like Huawei.
The simplest way to view Nokia Networks is it is one of the equipment vendors that Dycom Industries (DY) would use as it builds out a 4G, 5G or wirelines network for AT&T (T), Verizon (VZ) or Comcast (CMCSA). Its competitors include Ericsson (ERIC) as well as Alcatel Lucent (ALU), but also several Chinese vendors including Huawei and ZTE as well as Samsung.

While many may focus on that lumpy and competitive business, to us here at Tematica the far more interesting business is the company’s licensing arm called Nokia Technologies, a division that taps into our Asset-Lite investment theme that focuses on businesses that leverage intellectual property, patent portfolios and both licensing in and out models, outsourcing and similar business models. It’s an attractive investment theme because it requires little capital to operate, but often generates significant profits. Case in point, Nokia’s Technology division accounts for roughly 7 percent of overall revenue, but it generates more than one-third of the company’s overall operating profit.

Nokia Technology’s assets include the company’s vast mobile IP library, as well as developments in digital health and digital media. Given Nokia’s storied history in the phone market, many smartphone makers license the company’s patents for everything from display technology to antenna design. These licenses tend to span several years, and are extremely profitable. Moreover, Nokia is not resting on its laurels and licensing aging IP – during the first half of 2017, it spent EUR 1.9 billion ($2.2 billion) as it develops digital media, immersive virtual reality, and digital health technologies as well as builds out its mobile and wireline IP portfolio.

We’d note that Apple (AAPL) recently plunked down $2 billion to re-up its licensing agreement with Nokia, after engaging in a patent dispute when the last agreement lapsed. During 2Q 2017 Nokia also ironed out a licensing deal with Chinese smartphone vendor Xiaomi, and has its sight on not only other Chinese vendors, but also expanding its reach as connectivity moves beyond the smartphone and tablet to the home, car and Internet of Things. We see the expanded nature of Nokia’s latest licensing agreement with Apple as a potential harbinger of things to come. On the recent 2Q 2017 earnings call Nokia managements shared that, “instead of a simple patent licensing agreement, we have agreed on a more extensive business collaboration with Apple, providing potential for a meaningful uplift in our IP Routing, Optical Networks and Digital Health business units over time.” In our view, this makes Nokia a looming Disruptive Technology company mixed with a hefty dose of Connected Society.

Now here’s where things get interesting – while Nokia Technologies represented just 7 percent of overall sales in 2Q 2017, it was responsible for more than 60 percent of Nokia’s overall operating profit. Viewed from a different angle, its operating margins are more than 60 percent vs. just 8 percent or so for the Networks business. As one might suspect, the company is targeting a restructuring program to improve profitability at its Networks business, but from our perspective, the real story and the thematic tailwinds that make it attractive are the earnings leverage is tied to the Nokia Technologies business. Should Nokia begin to ink either more licensing deals with Chinese and other smartphone vendors or ones that allow it to expands its IP scope, we could see a meaningful lift in 2018 expectations. Current consensus expectations sit at EPS of 0.35 on revenue of $26.7 billion. That means NOK shares are trading at 18.3x that 2018 forecast, but the question in our mind is after two years with no EPS growth can Nokia grow actually grow its EPS by 35 percent in 2018.

As we’ve learned in the past with InterDigital (IDCC) and Qualcomm (QCOM)sometimes these licensing wins can be lumpy, taking far more time than one might expect. From time to time, it may include legal action as well, which can lead to a rise in legal fees in the short term. Given the company’s net cash position of roughly EUR 4.0 billion ($4.7 billion), we’re not too concerned about its ability to protect itself while continuing to invest in R&D or pay an annual special dividend each year.

As we look for greater near-term clarity at Nokia Technologies and as management looks to restructure Nokia Networks as well as the current valuation, rather than jump on Nokia shares trading at $6.58 at the open this morning as we head into the dog days of summer, we’re placing them onto the Tematica Contender List and we’ll watch for future IP licensing progress or for the shares at about 15% less, at the $5.50 level.

One other item… In an interesting development, a few years ago Microsoft has sold the Nokia brand in two parts to HMD and Foxconn. HMD is a company comprised of former Nokia employees in Finland and through Nokia Technologies it has licensed the sole use of the Nokia brand on mobile phones and tablets worldwide for the next decade, as well as key cellular patents. Meanwhile, Foxconn acquired the manufacturing, distribution and sales arms of Microsoft-Nokia and has also agreed to build the new Nokia phone for HMD. To us, this could be a wild card to watch, but the question will be whether or not they make the move from feature phone to smartphone and have any success? Only time will tell.

 

 

 

WEEKLY ISSUE: Confirming Thematic Data Points Coming At Us In Spades

WEEKLY ISSUE: Confirming Thematic Data Points Coming At Us In Spades

In this Week’s Issue:

  • Thematic Data Points Revealed in Earnings Thus Far
  • What We Expect from Thematic Poster Child Company Amazon
  • Shifting USAT and BETR shares to Hold from Buy
  • Some Quick Tematica Select List Hits on AXTI, MGM, OLED, AMAT and DY

 

With all many plates spinning on sticks this week, thus far we’ve seen a mixed reaction from investors on the most recent developments coming out of Washington, D.C. amid the Affordable Care Act debate and the onslaught of earnings report. As those many details are digested, the market is also weighing what the Fed will say this week when it comes to the tone of the economy as it concludes its latest monetary policy meeting.

As we shared in this week’s Monday Morning Kickoff, we see a low to no probability of the Fed boosting rates near-term, especially given the pending September unwinding of its balance sheet – something we’ve never experienced before. Given that Fed Chairwoman probably doesn’t want to be the one to send the domestic economy into a tailspin, we strongly suspect she and the rest of the Fed heads will stand pat as they offer clues for what is to be had in the coming weeks.

 

Thematic Data Points Revealed in Earnings Thus Far

As we parse through the onslaught of quarterly earnings reports coming at us this week, we continue to find confirming data points for our investing themes. We saw those in spades yesterday as we reviewed Alphabet’s (GOOGL) 2Q 2017 earnings report. If you missed that commentary, you can find it here, but the skinny is Alphabet continues to ride the tailwinds of the Connected Society investment theme and the shares are a core holding on the Tematica Select List.

We expect the same to be true when Facebook (FB) reports its quarterly results after tonight’s market close. Over the last several quarters, Facebook has been incrementally expanding its monetization efforts across all its various platforms and we see more benefits ahead. Just last week the company announced it would be expanding its advertising platform to the company’s Messenger app for smartphones. We expect more details on this, as well as its pending foray into subscription services with newspapers, magazines, and other publishers during the company’s 2Q 2017 earnings conference call. Also on that conference call and earnings release, we’ll be scrutinizing subscriber metrics as well as average revenue per user figures. One of the keys to Facebook’s continued revenue and profit growth will be monetizing non-US users in the coming quarters. Consensus expectations for 2Q 2017 sit at EPS of $1.12 on revenue of $9.2 billion.

  • Even though FB shares have moved past our formal $160 price target, we’ll be putting it under the microscope to determine potential upside to be had based on 2Q 2017 results and the company’s outlook beyond the first half of 2017.
  • Those revisions may not lead to a table pounding “buy” conclusion, but Facebook’s position in our Connected Society investing theme, along with its growing monetization efforts, keep FB shares as a must own for the foreseeable future.

 

What We Expect from Thematic Poster Child Company Amazon

Also later this week, we’ll be getting earnings from the poster child company when it comes to thematic investing – Amazon (AMZN). If you missed our latest Thematic Signals posting that explains this, you can find it here.

Where do we begin with Amazon this week? First, there was the move by Sears (SHLD) to partner with Amazon with regard to selling Kenmore appliances online (including the smart-home ones that include Amazon Alexa). Then there was Amazon debuting its Amazon Pay Places feature, which allows users to utilize their Amazon account like a mobile wallet for a real world version of one-click shopping. Or perhaps you saw the launching of Spark, which allows Prime members to shop a feed of social media-inspired product suggestions. The key takeaway is Amazon continues to flex its muscles, many of which have solid thematic drivers behind them, and it is doing so at a blistering pace. As Tematica Chief Macro Strategy Lenore Hawkins chimed in on a recent episode of Cocktail Investing, “how much coffee does Jeff Bezos drink?”

While we are on the subject of Amazon, late last week, the Federal Trade Commission announced it is investigating Amazon’s discounting policies following a Consumer Watchdog complaint. Candidly, as Amazon continues to expand its footprint, we expect more of such complaints and suspect that will serve only as a distraction. Moreover, given its balance sheet, should any fines be awarded it has ample funds to comply. More sizzle than steak, as it were.

We do NOT expect Amazon to say much with regard to this FTC non-event event when it reports its earnings tomorrow night. Consensus expectations have the company delivering EPS of $1.42 on revenue of $37.18 billion.

We would call out one key concerns ahead of that quarterly report and usually tight-lipped conference call — it seems investors think Amazon can do no wrong and that mindset can lead to excessive whisper expectations. There we said it.

Our concern in the short term remains the potential for Wall Street to have underestimated Amazon’s investment spending in the near term. As we saw above, it has a number of initiatives under way, and given the accelerating shift to digital commerce and potential partnership to be had on top of those with Nike (NKE) and Sears, Amazon may step up its investment spending ahead of the year-end holiday shopping season, thus cutting into its EPS projections.

If we are right, we could see the shares have a cool post-earnings reception. From our perspective, we see that spending as a long-term investment to grow its services and geographic footprint. Any meaningful pullback in the stock would be an opportunity for investors to increase their foothold in the stock in our view.

  • We will remain patient investors with Amazon (AMZN), especially as we enter the holiday spending filled second-half of 2017.
  • Our price target remains $1,150.

 

Shifting USAT and BETR shares to Hold from Buy

Over the last few weeks, shares of Food with Integrity company Amplify Snacks (BETR) and Cashless Consumption play USA Technologies (USAT) have been melting higher.  Amplify Snacks, on the back of merger-and-acquisition interest focused on the “food that is good for you” space, and USAT, following its recent stock offering and bullish transaction volume commentary from Visa (V), JP Morgan (JPM) and others so far this earning season.

  • Those moves either have put BETR and USAT shares over and above or very close to our price targets.
  • We will be mindful of these targets ahead of respective earnings reports, but for now, we are downshifting them to Hold from Buy on the Tematica Select List.

And as a reminder, our Hold rating, it is literally just that, a recommendation for those that own the shares to hold them for the time being. For subscribers who missed these recommendations, we’d be more inclined to revisit this BETR shares below $9.50 given our $11 price target. With USAT shares and our $6 target, we are more inclined to revisit USAT shares at lower levels, and in this case, that means closer to $5.

As we move through this earnings season over the next two weeks, we continue to think we will see opportunities emerge that allow us to capture thematically well-positioned companies at better prices.

 

Some Quick Tematica Select List Hits

 

AXT Inc. (AXTI)

Following an upbeat report for key customer Skyworks (SWKS) last week, we expect solid results this week from Disruptive Technology company AXT Inc. (AXTI). On its earnings call, Skyworks shared it is still in the early innings of a data explosion that is expected to grow sevenfold over the 2016-2021 period, which should benefit wireless semiconductor demand. Connecting the dots, this bodes extremely well for AXT’s substrate business.

  • Consensus expectations for AXTI sit at EPS of $0.05 on revenue of $22.55 million
  • Our price target remains $9 for AXT shares.

 

MGM Resorts International (MGM)

We’re happy to share that Guilty Pleasure company MGM Resorts International (MGM) will be added to the S&P 500 when that index rebalances later today. That should spur incremental buying among mutual funds as well as exchange traded funds that are based on that index.

Getting back to earnings and expectations, the consensus for MGM is EPS of 0.30 on revenue of $2.67 billion. Data of late for gaming in both Las Vegas and Macau have been quite favorable and we view the company’s recent initiation of a quarterly dividend as underscoring management’s confidence in the business over the coming quarters.

  • Given favorable prospects over the medium term, we would look to use any pronounced weakness in MGM shares following the company’s earnings report to scale further into the shares.
  • Our price target remains $37.

 

Universal Display (OLED)

Many investors are focused on Apple’s (AAPL) adoption of organic light emitting diode (OLED) displays for its next iteration of the iPhone, but as subscribers know there is far greater adoption across other smartphone vendors as well as those for TVs, wearables and other applications. That adoption, which is resulting in companies that had previously invested in liquid crystal display technologies shifting their investments to organic light emitting diodes ones.

We’ve seen the ramping demand for OLED equipment at Applied Materials (AMAT), and this week we saw another layer added to the OLED demand/capacity profile when LG Display shared its plan to invest $13.5 billion to boost output of OLED screens over the next three years. Now let’s add that context we always talk about — the investment is roughly 25 percent more than LG Display’s annual capital spending, which likely means it intends to be an aggressive force in the OLED display market. Given that LG is one of Universal’s key customers, with the other being the OLED industry leader Samsung, we see LG’s upsized commitment to OLEDs as a strong tailwind for Universal’s chemical and high margin IP licensing business.

  • Our formal price target of $125 for Universal Display (OLED) shares is under review with a bias to moving it upwards.
  • The company will report its 2Q 2017 results on August 3 and we will adjust that target after that announcement.

 

 

Applied Materials (AMAT)            

The next catalysts for Applied Materials (AMAT) will be earnings from competitor Lam Research (LRCX) later today and Intel (INTC) tomorrow. Inside Lam’s results, we’ll be watching new orders, as well as backlog levels on both a product and geographic basis. In particular, we’ll look for confirmation of data coming out of the recent SemiCon West industry event that pointed to solid memory demand, which bodes well for additional semi-cap equipment demand.

With Intel’s results, we’ll be paying close attention to its capital spending plans for the back half of 2017. Also too, as we mentioned with Universal Display above, LG’s plan to spend $13.5 billion over the next 3 years to ramp its organic light emitting diode capacity bodes rather for Applied’s order book and back log levels over the coming quarters.

  • Our price target on AMAT shares remains $55, which offers ample upside from current levels.

 

 

Dycom Industries (DY)

This week and next will see several of Dycom’s key customers report their earnings, including AT&T (T), Verizon (VZ) and Comcast (CMCSA). Inside those reports, we’ll be looking at not only overall capital spending levels, but in particular, those targeted to mobile and wireline network capacity additions.

Given the continued adoption of streaming services, audio as well as video, we see commentary that networks capacity levels are running at exorbitantly high capacity utilization levels as being very good for Dycom. While we don’t expect any specifics on 5G timetables, we do expect to hear more about testing and beta launches. As Dycom’s key customers issue their quarterly reports, we’ll have much more to say on what it means for DY shares.

  • We continue to rate Dycom (DY) shares a Buy with a $115 price target.

 

 

 

Apple’s WWDC17: An event lacking vision from a company without a visionary

Apple’s WWDC17: An event lacking vision from a company without a visionary

Yesterday, Apple (AAPL) held its annual World Wide Developer Conference (WWDC) at which CEO Tim Cook showcased a number of announcements. While we tend to be Apple devotees when it comes to the hardware and its ease of use, in taking a few steps back, our view is this year’s WWDC is it was one largely filled with refinements and incremental additions. Not entirely surprising, given the fact that Apple is now led by an expert operations manager, Tim Cook, and not a visionary like Steve Jobs. As we see it, Apple will either need to bring in some visionary expertise, or perhaps, and more likely, use it’s war chest of $250 billion to buy some vision in the form of acquisitions, but that’s another story.

We have not been buyers of Apple shares as of late — despite being avid fans, if not a lover of its products — given the transition-like nature of the product cycle that keeps Apple arguably reliant on the iPhone. Instead, for subscribers to our Tematica Research premium service, we’ve recognized the Apple-related opportunity from a different perspective – one that intersects with our tendency to “Buy the Bullets, Not the Guns” and several of our investing themes — Connected Society, Content is King, Cashless Consumption and Disruptive Technologies – with great success along the way. Examples include Universal Display (OLED), Nuance Communications (NUAN) and Applied Materials (AMAT), which are up more than 127 percent, 23 percent and 28 percent, respectively since being added to the Tematica Select List.

In our view, Apple is in a tough spot after setting the bar so high for so long. It too now has to compete with how it once wowed audiences and consumers as it updates existing products and tries to find its footing with new ones. Given its size, install base and the fact that its products are for the most part so simple to use, Apple isn’t likely to go the way of Kodak or Xerox anytime soon.

Getting back to the conference, on the smaller side, there were announcements like Amazon’s (AMZN) Prime Video coming to Apple TV and the upgrades to its Mac line. The real interest was in what the latest release of its mobile operating system iOS 11 brings, with a surprise in that this next iteration is likely to make the iPad a device to be embraced for both business as well as personal use. Perhaps the best worst kept secret heading into the event was Apple’s move into the connected speaker market, and yes Apple did take the wraps off HomePod, which looks to be Apple’s second if not a third potential hub in the home. The first two hubs being the iPhone and Apple TV, both of which connect with Apple’s HomeKit.

 

 

Interestingly, Apple is leading HomePod with music first and as a connected device with Siri second. Perhaps this is because if you’ve ever asked Siri the same questions as you might ask Amazon Alexa, one tends to realize that Siri isn’t the sharpest knife in the drawer, as it lacks the backing of Amazon’s Amazon Web Services and artificial intelligence. This strategy is also likely aiming to spur subscriptions to Apple’s Apple Music service; we can’t tell you how many times Apple shared it offers more than 40 million songs during the keynote presentations. Will this be a viable competitor to Sonos’s smart speakers when it comes to sound quality? Could the HomePod spur Amazon or Alphabet to acquire Sonos? Time will answer both of those questions.

Apple did tout Siri Intelligence several times during yesterday’s presentations, but this appears to be an area of continued investment as Apple catches up to Amazon and Google rather than leapfrogging them in the process and redefining the category. With Amazon’s strategy to make Alexa compatible with autos, the likes of Ford (F) and Volkswagen, as well as consumer appliance companies such as Whirlpool (WHR), it looks like the old OS war between Microsoft and Apple could be played out again in the voice digital assistant space. This raises several questions in our minds – Will Apple license Siri for use outside of Apple products? Will Amazon have the same issues Microsoft had with Windows and device compatibility? Fodder for thought and what it may mean for the future of these interfaces.

Yes, there was some cool new Apple stuff, like the Do Not Disturb While Driving feature, the ability to drag and drop with iOS 11, which in our view was sorely missing for the iPad and Apple’s foray into Virtual Reality (VR). But again, the head turning “wow” factor just wasn’t there. Even with HomePod, it will be interesting to see how it stacks up against Amazon’s Echo products as well as Alphabet’s (GOOGL) Google Home in the coming months. One would have to think these companies are prepping newer models, perhaps with better sound capabilities, ahead of the year-end holiday season.

The problem as we see it is Apple is trapped inside a near yearly refresh rate that makes it challenging to deliver breakthrough features each and every year. Even the new iOS name, iOS 11, is uninspiring.

Who has a blowout birthday when they turn 11?

Even the naming conventions for the new macOS and iMac were iterative in nature with Craig Federighi, Apple’s senior vice president of Software Engineering, getting a good nature laugh along the way.

Now with the WWDC keynote behind us, the next event to watch for Apple will be the unveiling of the much-discussed iPhone 8 model later this year. While Apple did sneak peek a few products yesterday, we heard nothing about the next iPhone model and as the news cycle turns away from WWDC we expect investor speculation to run rampant when it comes to this device later this summer. With 66 percent of Apple’s sales coming from the iPhone over the last two quarters, it’s the one product that Apple has to get right. Odds are it will, and that device will keep Apple as one of the key players in our Connected Society investing theme as its other initiatives – Virtual Reality, Apple Pay, Apple Watch and Apple TV – feel the lift of our Disruptive Technology, Cashless Consumption, Fountain of Youth and Content is King themes.

As these tailwinds blow, our Tematica Select List will surely continue to reap the benefits.

With 2017 Poised to be the Year of Ransomware, More Cyber Spending is on the Way

With 2017 Poised to be the Year of Ransomware, More Cyber Spending is on the Way

With headlines swirling following the WannaCry attack that hit more than 230,000 computers across more than 150 countries in just 48 hours, on this episode of Cocktail investing we spoke with Yong-Gon Chon, CEO of cyber security company Focal Point to get his insights on that attack, and why ransomware will be the cyber threat in 2017. Before we get into that Safety & Security conversation, Tematica’s investing mixologists, Chris Versace and Lenore Hawkins broke down last week’s economic and market data as well as the latest relevant political events. With all the controversy in D.C., there was a lot to discuss concerning the likelihood that the Trump Bump, which was based on assumptions around tax reform, regulatory roll-back, and infrastructure spending is evolving into the Trump Slump as investors realize the anticipated timeline for such was decidedly too aggressive. With mid-term elections looming, we expect the Trump opposition will be emboldened by the controversy surrounding the administration and will put in best efforts to appeal to their constituents. For the market, it’s another reason to see the Trump agenda likely slipping into late 2017-early 2018, and that realization is likely to weigh on robust GDP and earnings expectations for the balance of 2017.

The markets on May 17th suffered their biggest losses in 2017, with the Nasdaq taking the biggest one-day hit since Brexit, as the turmoil in Washington dampens investors’ appetite for risk while raising questions over GDP and earnings growth. While some Fed banks are calling for 2Q 2017 GDP as high as 4.1 percent (quite a jump from 1Q 2017’s 0.7 percent!), the data we’re seeing suggests something far slower. We continue to think there is more downside risk to be had in GDP expectations for the balance of 2017, and the latest Trump snafu is only likely to push out team Trump’s reforms and other stimulative efforts into 2018. If 2Q growth is driven in large part by inventory build, which is what the data is telling us, expect the second half to be significantly weaker than the mainstream financial media would lead you to believe.

While the global financial impact of the WannaCry ransomware attack may have been lower than some other high profile attacks such as ILOVEYOU and MyDoom, the speed at which it moved was profound. We spoke with Yong-Gon Chon, CEO of Focal Point Data Risk about the incident to get some of the perspective and insight the company shares with its c-suite and Board level customers. While many are focusing on WannaCry, Yong-Gon shares that as evidenced by recent content hijackings of Disney (DIS) and Netflix (NFLX), ransomware is poised to be the cyber threat of 2017. Those most likely to be targeted are those organizations that prioritize uptime and whose businesses tend to operate around the clock, making backups and software updates extremely challenging.

While in the past IP addresses may have been scanned once every four to five hours, in today’s increasingly Connected Society, IP addresses are scanned one to ten times every second. As consumers and businesses in the developed and emerging economies increasingly adopt the cloud and other aspects of Connected Society investing theme, we are seeing an explosion in the amount of data as more and more of our lives are evolving into data-generating activities. From wearables to appliances to autos, our homes, offices, clothing and accessories are becoming sources of data that goes into the cloud. With the Rise of the New Middle Class in emerging markets, we are seeing the number of households participating in this datafication grow dramatically, exposing new vulnerabilities along the way. That increasingly global pain point is fodder particularly for cyber security companies, such as Fortinet (FTNT), Splunk (SPLK) and Cisco Systems (CSCO) that are a part of our Safety & Security investing theme.

During our conversation with Yong Gon we learned that companies need to understand that breaches must be viewed as inevitable in today’s Connected Society, network boundaries are essentially a thing of the past. Security can no longer about preventing nefarious actors from gaining entrance, but rather is now about managing what happens once a company’s network has been invaded. From a sector perspective, with all the regulation and reporting requirements in financial services, many of these firms are leading the way in how to best deal with such breached.Uber

For investors who want to understand the potential impact of cybercrime, Yong-Gon Chon suggests looking at how much data a company is generating and how the company is managing the growth of that data, with companies such as Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOGL) and Uber examples of heavy generators. Investors need to look at a company’s cyber risk as a function of the magnitude of its data generation and the company’s level of maturity in addressing that risk. By comparison, companies not affected by attacks such as WannaCry need to be asking themselves why didn’t they get hit? Was it luck or did we do something right? If so, what did we do right and what is the scope of protection we have given what we’ve learned about the latest attack strategies?

We also learned about the new efforts underway globally to develop attribution of cyber threats so as to differentiate between those threats from professional cyber criminals versus the capricious tech savant engaging in ill-advised boundary exploration. Along with this shift is also a change in the boardroom, where cybersecurity is viewed in the context of its potential impact on the business, rather than as a function of a company’s IT department.

One thing we can be assured of is that hackers are watching each other and the good ones are learning what makes attacks fail and where organizations are weakest. As the Connected Society permeates more and more of our lives, these risks become more pernicious and their prevention more relevant to our everyday lives. The bottom line is we are likely to see greater cyber security spending in preventative measures as well cyber consulting as those responsibilities become a growing focus of both the c-suite and board room.

Companies mentioned on the Podcast

  • Amazon.com (AMZN)
  • Apple (AAPL)
  • CVS Health (CVS)
  • Disney (DIS)
  • Facebook (FB)
  • Focal Point
  • JC Penny Co (JCP)
  • Kohl’s (KSS)
  • Macy’s (M)
  • Microsoft (MSFT)
  • Netflix (NFLX)
  • Nordstrom (JWN)
  • TJX Companies (TJX)
  • Twitter (TWTR)
  • Uber
  • United Parcel Service (UPS)
  • Walgreens Boots Alliance (WBA)

Resources for this podcast:

And the Hacking Continues!

And the Hacking Continues!

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After Gapping Up Following Friday’s January Employment Report, The Market Is Trading Sideways Again This Week

Over the last week, the S&P 500 rose 0.6 percent, with the bulk of that move coming on the heels of the January Employment Report. As we pointed out in this week’s Monday Morning Kickoff, the face of that report was mostly positive, and when paired with other January manufacturing reports out last week, it likely paves the way for the Fed heads to start jawboning about a potential rate hike at the March FOMC meeting.

Well, we heard just that when Philadelphia Federal Reserve Bank President Patrick Harker on Monday said an interest-rate hike should be on the table at the U.S. central bank’s next meeting, in March. Should other domestic economic data, like the aforementioned January manufacturing data, continue to improve month over month, we expect the herd view to skew toward a March rate hike.

Looking across the Atlantic, however, as expected we are indeed hearing more about Grexit and Frexit this week. Odds are, we have not heard the last of those rumblings as we head into the 7th inning with 4Q 2016 earnings reports. Given where we are in the current earnings season, we have several updates to share on the Amazon (AMZN), CalAmp Corp. (CAMP), Dycom Industries (DY), Facebook (FB), and International Flavors & Fragrances (IFF) positions on the Tematica Select List.

At the same time, we see not only cyber attacks once again taking over the headlines — or at least what non-President Trump headlines there are — but we see impressive order and booking metrics as cyber security companies report their quarterly results.

This sets us up with a new position for the Tematica Select List so without further ado…

And the Hacking Continues!

Issuing a Buy on PureFunds ISE Cyber Security ETF (HACK) shares
as part of our Safety & Security investing theme

Once again cyber hacking is back in the news on several fronts:

  • The hospitality giant InterContinental Hotels Group (IHG) has confirmed that payment systems of 12 US hotels were victims of a massive data breach between August and December 2016.
  • An anonymous attack took down web-hosting company Freedom Hosting II, which hosts dark websites — sites that require software to access. All told, thousands of dark websites were taken offline in the process.
  • Taiwan is investigating an unprecedented case of threats made to five brokerages by an alleged cyber-group seeking payment to avert an attack that could crash their websites.
  • Norway’s foreign ministry, army, and other institutions have been targeted in a cyber-attack by a group suspected of having links to Russian authorities, according to Norwegian intelligence.

And that’s just a sampling of the cyber attack related headlines over the last few days. When we add in the growing number of corporate cyber attacks as well as those against government institutions (remember those from last November?), we are reminded that a few years ago former Defense Secretary Leon E. Panetta warned that the United States was facing the possibility of a “cyber-Pearl Harbor” and was increasingly vulnerable to foreign computer hackers who could dismantle the nation’s power grid, transportation system, financial networks, and government.

This earnings season we’ve seen a pickup in orders at a number of cybersecurity companies ranging from Fortinet (FTNT) and Checkpoint Systems (CKP) to Proofpoint (PFPT). Sifting through those reports, we find several common items bubbling to the surface:

There is the secular trend in cybersecurity that includes not only adoption of cyber security solutions for Internet of Things and Cloud, but also customers migrating to integrated solutions over single-point ones.

That migration is driving vendor consolidation, which with hindsight explains some of the extended sales cycles we heard about in the back half of 2016.

One positive is companies like Fortinet are seeing a pronounced pick-up in larger deal size, even as they add more customers. With Fortinet, it added 10,000 customers during 4Q 2016, which left it total customer base to more than 300,000. Meanwhile, Fortinet experienced significant growth in its larger deal sizes, up 31-39 percent for deal sizes above $500,000 and $1 million respectively.

This tells us that corporations and other institutions are stepping up their game for this dark side of our Connected Society investing theme. That bodes very well for cybersecurity stocks, which represent a key aspect of our Safety & Security investing theme.

The issue is deciding which one to place our hard-earned capital in… in our view, the near constant one-upmanship between hacker & attackers and cyber security firms looks an awful lot like the gaming console “wars” from a few years ago. Every time there was a hot new game, gamers would flock to the new platform. As cyber attackers become more creative, we suspect we are likely to see some cyber security firms respond more quickly than others, leading to market share shifts and better revenue and profit growth.

 

While this may sound like a complex problem, the solution could not be simpler.

Rather than focus on any one or two cyber security companies, instead we’ll place a basket of them onto the Tematica Select List. That basket is PureFunds ISE Cyber Security ETF (HACK), which counts Fortinet, Checkpoint Software, Palo Alto Networks (PAWN), Proofpoint, Symantec (SYMC), Qualys (QLYS), CyberArk Software (CYB) and Imperva (IMPV) among its top holdings. In sum, those eight positions account for just under 41 percent of the ETF’s assets.

Over the last several months HACK shares have been on a tear, but as our Connected Society theme continues to expand to include more devices (the Connected Car, Connected Home, the Internet of Things) across more of the globe (see Facebook’s 4Q 2016 earnings results below for an example of this), odds are the demand for cyber security solutions will remain robust. Just take a look at how often people in restaurants and elsewhere are checking their smartphones — the Connected Society toothpaste is not going to go back into its tube.

  • As such, we see long legs ahead for the cybersecurity aspect of our Safety & Security investing theme, which to us makes HACK a core, long-term holding.
  • In keeping with that, we are issuing a Buy on PureFunds ISE Cyber Security ETF (HACK), with a long-term price target is $35.
  • We’re inclined to use pullbacks below $25 to improve our cost basis. 

We would point out that cyber security is one aspect of our Safety & Security investing theme, which also includes personal, homeland and corporate security. President Trump continues to speak about rebuilding the US military, which should spur demand for a variety of defense companies. As more clarity comes to these proposed plans, we’ll look to include the proper exposure should valuations offer a compelling entry point. Stay tuned.

 

 

Amazon (AMZN) Connected Society 

Since the calendar turned to 2017, Amazon shares have been on a nice trajectory. Following December-quarter results, however, which included weaker-than-expected guidance for the current quarter, largely due to foreign currency issues, Amazon shares slipped just over 3 percent this past week. Given the comments we’ve heard across the earnings spectrum this reporting season about foreign currency, Amazon was bound to disappoint. Excluding the $558 million unfavorable impact from year-over-year changes in foreign exchange rates throughout the quarter, net sales increased 24 percent compared with fourth quarter 2015 versus the reported 22 percent increase for the quarter.

We also continue to see the company investing for the long term as it builds out its streaming content, expands its Fulfilled By Amazon and other initiatives such as Alexa, its voice digital assistant. Even so, margin expansion at both the North American business, as well as Amazon Web Services, enabled Amazon to handily beat consensus EPS expectations of $1.42 with reported earnings of $1.54 for 4Q 2016. Year over year, EPS improved more than 50 percent despite the stepped-up level of investments in the second half of 2016 and revenue shortfall of nearly $1 billion in the December quarter. To us, this means those who have questioned Amazon’s ability to deliver profitable growth while continuing to invest are likely to rethink their position . . . or they should be.

As investors, our view tends to be skewed to the medium to longer term. It’s that view that recognizes Amazon continues to invest for future growth as it benefits from the accelerating shift to digital shopping and Cloud adoption that led Amazon Web Services (AWS) to grow 47 percent year over year in the December quarter. For 2016 in full, AWS revenue rose 55 percent to more than $12 billion, with margins rising to 30 percent from 23.6 percent in 2015. To put this into context, AWS accounted for just 9 percent of overall Amazon revenue in 2016 but was responsible for just over half of the company’s 2016 operating income.

Turning to Amazon’s North American business, revenues climbed 22 percent in the December quarter, but operating margins in that business rose to 4.7 percent. Doing some quick math, we’d note the incremental margin for the North American business clocked in at 6.8 percent, which tells us the company is indeed realizing volume benefits and other synergies in this business.

Amazon’s international business continues to be a drag on overall profits as it posted operating losses both for the December quarter and for 2016 in full. As we have seen in recent quarters, Amazon will continue to invest for future growth, but it has developed a more disciplined approach, and we suspect that approach will be utilized in the International business as well.

This brings us to the company’s guidance for the current quarter, which fell short of consensus expectations due in part to foreign exchange rates. As Apple (AAPL) CEO Tim Cook noted on that company’s earnings call, foreign exchange will be a “major negative” as the company moves from the December to the March quarter.

The same holds true for Amazon, which shared that it expects foreign currency to impact current quarter revenue by $730 million. Factoring that into the consensus view that expected revenue for the current quarter will land near $36 billion, Amazon’s guidance of $33.25 billion to $35.75 billion, up 14 percent-23 percent year over year, is far more understandable. Stepping back, that year-over-year guidance is in a very challenging retail environment and in our view implies continued share gains at both the North American and AWS businesses. On the operating income guidance, Amazon again offers a range that is wide enough to fly a 747 through.

Stepping back and looking at the company’s competitive positions poised to benefit from their respective Connected Society tailwinds — the shift to digital consumption (shopping, content streaming, grocery) and Cloud adoption — we continue to see favorable revenue and profit growth for AMZN over the long term.

  • We’ll continue to monitor retail sales data and Cloud adoption as well as other relevant data points, but for now, are keeping our $975 price target for Amazon shares as well as our Buy rating. 
  • To be blunt, Amazon is a stock to own, not trade. We’d suggest subscribers who are underweight in the shares use the recent pullback to their long-term advantage.

 

The Walt Disney Company (DIS) Content is King

Last night Content is King company Walt Disney reported December quarter earning of $1.55 per share, $0.06 per share better than consensus expectations. Offsetting that upside surprise, which was partly fueled by the company’s share buyback efforts given the near 4% drop in the share count year over year, revenue for the December quarter came in lighter than expected at $14.78 billion vs. the consensus that was looking for $15.29 billion.

In our view, even though revenue and earnings fell compared to the December 2015 quarter we have to remember the year-ago quarter was one for the record books due in part to the impact of Star Wars: the Force Awakens on several Disney businesses.

  • Given the tone of the underlying business, which should improve throughout the year, and prospects for Disney to further shrink its share count in the coming quarters thereby enhancing EPS metric in the process, we are keeping our $125 price target intact even as several Wall Street firms are boosting their price targets to levels higher or inline with ours.
  • We continue to rate the shares a Buy, but would advise subscribers that are underweight the shares to be more aggressive at price below $105 should they arise in the coming weeks. 

 

Let’s Dig into the Details of Disney’s Latest Quarter

For a year at the company that had been described as one starting off slow and building throughout the year, the December quarter was, in our view, a solid one, especially after factoring in the results from the latest installment of the Star Ware franchise, The Force Awakens.

Without question, the standout-out performance was had at the company’s Parks and Resorts business which delivered a 13% increase in operating income on “just” a 6% revenue increase year over year. That business continues to benefit from tight cost controls as well as price hikes taken during calendar 2016. As we get ready for spring break travel season, we’ll be watching for potential 2017 price hikes at the domestic parks. In late May, Pandora: The World of Avatar will open at Disney’s Animal Kingdom in Orlando, Florida. This follows the roll out of Frozen across several parks, and longer-term yet-to-be-named Star Wars-themed lands at Walt Disney World and Disneyland in 2019.

Near-term, the Parks business will benefit from an extra week in the current quarter, but with the Easter holiday falling later than usual this year and landing in the June quarter that timing issue is expected to weigh on current quarter prospects. Timing will also impact the Studio business, which has just one major release in the current quarter — Beauty & the Beast — which looks to be a strong performer, but will be forced into comparisons to The Force Awakens and Zootopia in the year ago quarter.

Moving past the current quarter, the Studio business has a number of Marvel, Pixar and Star Wars films in the pipeline that include a new Spider-Man movie, a sequel to the Cars film, Guardians of the Galaxy 2 and the next Star Wars installment, all of which makes for a very strong second half of the year.

That brings us to the company’s Media Networks business, which is composed of Cable Networks and Broadcasting. This segment has been one investors have been watching closely given the performance of ESPN over the last several quarters and questions about the broadcasting business as streaming alternative become more robust. Case in point, our own AT&T’s DirecTV Now and a similar service soon to be launched by Hulu. During the yesterday’s earnings conference call, Bob Iger reminded participants of initiatives to bring ESPN content to various streaming platforms (Sling TV, PlayStation Vue, DirecTV Now, and Hulu). After the call, The Wall Street Journal reported a new unannounced but signed deal with YouTube. Combined with its BAMTech acquisition, Disney continues to move in the right direction to reposition the Media Networks business to deliver content to consumers when and where they want it. We’ll be looking for additional color on the YouTube relationship, including advertising revenue potential.

Outside of the company’s performance and business outlook, the biggest news that likely has investor tongues wagging this morning is the news that CEO Bob Iger is open to staying after his contract expires in 2018. We see that helping to calm the transition concerns and reassures investors that Iger is likely to remain on board to groom his successor.

On the housekeeping front, Disney repurchased about 15 million shares for about $1.5 billion during the December quarter. Including the current quarter, Disney has bought back some 22 million shares for approximately $2.2 billion leaving $5-$6 billion to go on its announced plan to spend $7-$8 billion on buying back shares this year.

 

CalAmp (CAMP) Connected Society

CAMP shares rose modestly last week, bringing the year-to-date return to 5.0 percent, which is well ahead of the major market indices on the same basis. As we’ve shared, one of the key near-term catalysts for CAMP shares is the electronic logging device (ELD) mandate, which requires trucking companies to move from paper logbooks to electronic logs to record drivers’ hours of service by Dec. 18, 2017.

Last week, freight transportation companies Landstar (LSTR) and Hub Group (HUBG) reported quarterly earnings and inside those conference calls was some bullish commentary for CalAmp. Landstar shared that it has programs to migrate the non-complaint portion of its truck fleet to ELDs before year-end and it’s “beginning those conversations now in order to make that occur.” While Hub Group did not call out ELD spending specifically, it acknowledged that its capital spending would trend higher year over year in 2017 due in part to technology-related investments. Given the ELD mandate, we suspect there at least a portion of that spending will be to ensure its vehicles comply by the current deadline.

Industry estimates suggest more than one million ELDs will be deployed in the U.S. this year to comply with that mandate. This bodes very well for CalAmp’s core telematics systems business (57 percent of revenue) in the coming quarters. Longer term, we continue to see the company’s business model benefiting from the connected vehicle market, which includes autos, trucks and other equipment like that from customer Caterpillar (CAT).

  • We continue to rate CAMP shares a Buy with a $20 price target.

 

Dycom Industries (DY) Connected Society

As we noted in last week’s Tematica Investing, several of Dycom’s key customers recently reported quarterly earnings and the combined capital spending plans of those customers — AT&T, Verizon, and Comcast — look to be flat to up year over year, with a greater portion of spending on network capacity and new technologies (5G, Gigabit fiber). This week we’ll get quarterly results from CenturyLink (CTL) and given the prevailing trends we expect it, too, will offer a favorable capital spending outlook for 2017 and beyond. Having said that, we will listen for any positive or negative impact in CenturyLink’s $34 billion plan to buy Level 3 Communications (LVLT).

We continue to see Dycom as a prime beneficiary of that wireless and wireline capital spending required to keep feeding our data-hungry Connected Society investment theme. In our view, the current share price offers subscribers who are underweight in Dycom an excellent opportunity to pick up the shares at better prices than we’ve seen recently.

  • We continue to rate Dycom shares a Buy with a $110 price target.

 

Facebook (FB) Connected Society

Despite delivering better-than-expected December-quarter earnings with strong user metrics and average revenue per user (ARPU), FB traded modestly lower following those quarterly results. To us, the one statistic that jumped out at us was the company’s ability to get nearly 30 percent more revenue per user during the quarter.

  • With advertising dollars continuing to shift to digital platforms, we continue to see Facebook’s efforts paying off in the coming quarters. 
  • As such, we continue to rate shares a Buy. As we do this, we’re boosting our price target to $155 from $150.

 

Now onto the quarter results . . . 

Facebook reported December quarter EPS of $1.41, well ahead of the $1.31 per share consensus forecast. Revenue for the quarter climbed more than 50 percent, year over year, to $8.63 billion, besting revenue expectations of $8.49 billion. Sifting through the various metrics from daily active users to mobile daily active users, all the metrics were trending in the right direction with both up 17  to 18 percent year over year.

We continue to see the growing influence of mobile on Facebook’s business with 1.74 billion mobile monthly active users, roughly 93 percent of the company’s monthly active user base. As we mentioned above, we continue to see Facebook capturing advertising share, and it did just that in the December quarter as mobile advertising accounted for roughly 84 percent of its advertising revenue in the quarter. We chalk this up to Facebook monetizing more of its platforms (Facebook, Instagram and now Messenger) as well as the greater use of video. As the company continues to improve its ad targeting across users, we would expect some lift in pricing, which should benefit margins.

Part of our initial investment thesis for Facebook was not only the social network company’s ability to not only expand its reach across the globe, but also improve average revenue per user (ARPU) metrics as it does this. During the quarter, the company’s ARPU climbed more than 30 percent, year over year, on a global basis. As one might expect, ARPU remains skewed heavily to the U.S. and Canada, which clocked in at $80, up some 47 percent year over year. As a result, U.S. and Canada accounted for just over 50 percent of revenue followed by Europe (23 percent), Asia-Pac (15 percent) and Rest of World (10 percent). Even so, all geographies were up double-digits, year over year, from a low of 17 percent (Asia-Pac) to a high of 28.7 percent (Europe).

The bottom line is our thesis on the shares remains intact, and we continue to see the tailwinds blowing hard as advertisers continue to focus on digital advertising. We liken this to the shift to digital shopping by consumers that is benefiting our Amazon (AMZN), $839.40, 5.54 percent) shares. Much like that shift, we do not see the one behind Facebook slowing in the near-term.

 

International Flavors & Fragrances (IFF) 

Rise & Fall of the Middle Class

In a quiet week of trading, with no company-specific news, IFF shares were down 1.6 percent, keeping them in the same range they’ve been in over the last several weeks. We continue to see ample upside to our $145 price target over the coming quarters fueled by rising disposable income, particularly in the emerging markets, but also from the shift in consumer preferences to natural and organic flavors. We saw confirmation in this from competitor Givaudan, which as part of its December-quarter earnings report last week shared that, “Natural flavors have been going at an average of 8 percent over the last two years… and represent more than 40 percent of our flavor sales.”

For its fragrance business, Givaudan achieved double-digit growth in North America and a solid performance in Latin America and the Middle East. We see these results as a positive for IFF when it reports its quarterly results on Feb. 15, but we will remind subscribers that given IFF’s international exposure, currency is likely to weigh on its results as well as its near-term outlook. But as we have said before, we see that largely reflect in the share price. We continue to focus on the growing shift to organic flavors and fragrances, the former of which has soda companies such as Coca-Cola (KO) and PepsiCo (PEP) looking to reformulate their products to exclude sugar.

Longer term, the outlook remains bright for this market as the Freedonia Group’s forecast calls for global demand for flavors and fragrances to reach $26.3 billion by 2020, which would be a 21 percent increase from $21.7 billion in 2015.

  • We continue to rate IFF shares a Buy at current levels.

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Adding defensive measures as earnings season brings back volatility

Adding defensive measures as earnings season brings back volatility

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Our Thoughts on Connected Society Company
Apple’s “Record” Earnings

We wish we could say it’s been a quiet week since our last issue of Tematica Investing, a smooth sailing one in fact, but thanks to the growing political drama coming out of the new White House and a pick up in the velocity of earnings reports this week, the only word we can use to describe it is “frenetic.”

Last night I was a guest on CGTN America to discuss Apple’s (AAPL) quarterly results. The long and short of it is that while Apple CEO Tim Cook called it a record quarter, the reality is the iPhone still accounts for 70 percent of Apple’s overall business. While Cook boasted of strong Apple Watch growth, iPhone shipments were up 5 percent year over year, hardly the robust growth levels we’ve seen in the past.

Meanwhile, the Mac business — the next largest business line next to the iPhone — saw volumes rise 1 percent year over year, while iPad units fell 19 percent compared to the year-ago quarter. If Apple didn’t flex its cash position, which now sits at $246 billion, to buy back stock during the quarter, reported earnings would have been flat year over year.

To us here at Tematica this means until Apple can bring to market a new product, or reenergize an existing one that can jumpstart growth, the company will be tied to the iPhone upgrade cycle. Expectations for the next iteration, the presumed iPhone 8, call for a new body, new display — hence our position in Disruptive Technology company Universal Display (OLED) — and a greater use of capacitive touch that should eliminate the current home button. But we’ll have to see if this new model on the 10thanniversary of the transformative device’s launch will capture the hearts of customers, as the last couple of models have only had a meh response.

Despite Apple’s current reliance on the iPhone, there are hopeful signs in other areas, such as the new AirPods that echo past design glory, an Apple TV business that has 150 million active subscriptions and a growing services business. We’ll continue to keep tabs on this poster child company for our Connected Society company, but with no evident catalyst over the coming months, we’re inclined to sit patiently on the sidelines and pick off the AAPL shares at better prices.

In the meantime, our position in Universal Display (OLED), up 24 percent since initiating the position in October, gives us exposure to any Apple upside as the rumors persist it will integrate the OLED technology into the iPhone 8. As we often like to say — even though it’s somewhat politically incorrect in today’s hyper-sensitive world — “it’s better to buy the bullets, not the gun.”

  • Until there is more confirmation of the integation of OLED’s into the next iPhone, or another thematic tailwind reveals itself, we are maintaining a Hold rating on Universal Display (OLED) as the current price of $66 per share is close to our $68 per share target. 

 

Confirming Thematic Data Points From Earnings Reports and Other Sources

While we are not buyers of Apple shares just quite yet, there was a number of confirming thematic data points shared during the company’s earnings conference call last night:

  • Rise & Fall of the Middle Class — “The middle class is growing in places like China, India, Brazil, but certainly, the strong dollar doesn’t help us.”
  • Cashless Consumption — “Transaction volume was up over 500% year over year as we expanded to four new countries, including Japan, Russia, New Zealand, and Spain, bringing us into a total of 13 markets. Apple Pay on the Web is delivering our partners great results. Nearly 2 million small businesses are accepting invoice payments with Apply Pay through Intuit QuickBooks Online, FreshBooks, and other billing partners. And beginning this quarter, Comcast customers can pay their monthly bill in a single touch with Apple Pay.”
  • Content is King — “In terms of original content, we have put our toe in the water with doing some original content for Apple Music, and that will be rolling out through the year. We are learning from that, and we’ll go from there. The way that we participate in the changes that are going on in the media industry that I fully expect to accelerate from the cable bundle beginning to break down is, one, we started the new Apple TV a year ago, and we’re pleased with how that platform has come along. We have more things planned for it but it’s come a long way in a year, and it gives us a clear platform to build off of… with our toe in the water, we’re learning a lot about the original content business and thinking about ways that we could play at that.”
  • Connected Society — “every major automaker is committed to supporting CarPlay with over 200 different models announced, including five of the top 10 selling models in the United States. “

Aside from Apple, there has been no shortage of thematic data points buried in earnings reports over the last few days. Even though we cut Under Armour (UAA) from the Tematica Select List yesterday, we’d note its Direct to Consumer business, which reflects its online and mobile shopping efforts, rose 26 percent year over year in the December quarter. H&M Stores has announced it will slow its physical store openings and instead focus more of its efforts online.  Both confirming data points for our Connected Society investment theme.

Shifting gears somewhat, a new study from the Food Marketing Institute and Nielsen projects online grocery sales in the U.S. could grow tremendously in the next decade. By 2025, the report suggests that American consumers could be spending upwards of $100 billion on online grocery purchases, comprising some 20 percent of the total market share. Currently, 23% of US consumers purchase groceries through digital channels.

Confirming the accelerating shift toward digital shopping that is a hallmark of our Connected Society investing theme, during the December quarter United Parcel Service (UPS) saw its domestic average daily volumes rose 5% year over year with International domestic growth up more than 20% in Asia and 10% across the Eurozone. Noting the strong growth in Asia, we’d say it likely reflects the Rise aspects of our Rise & Fall of the Middle-Class thematic.

We expect to hear much more on the accelerating shift toward digital shopping when Amazon (AMZN) reports its quarterly earnings tomorrow (Feb. 2).

Getting back to Cashless Consumption, Juniper Research now expects $1.35 trillion to be spent worldwide through mobile wallets by the end of 2017. The nearly 30 percent increase over 2016 spending will be due to users in the Far East and China through Alipay and WeChat while Westerners continue to embrace mobile wallets from Apple Pay, MasterCard (MA) and PayPal.
Turning to our Fattening of the Population theme: 

  • McDonald’s (MCD) is deploying Big Mac vending machines… yes, we know what you’re thinking and there is no way we could make something like that up.
  • Civil servants in the UK have been warned that bringing cake into work for birthdays and celebrations could be a “public health hazard”. The Faculty of Dental Surgery at the Royal College of Surgeons (RCS) warned that in large offices, sweets and cakes have become a daily occurrence and the growing trend is contributing to poor oral health and the obesity epidemic. (There is a “bad teeth” joke somewhere in there, but for once we’ll take a pass on that one) On a serious note, sadly it seems that yes, despite what we may like to think, too much a good thing may not be good for us.

 

 
Hey Alexa, Order My Starbucks

Our most recent addition to the Tematica Select List was Disruptive Technologycompany Nuance Communications (NUAN) given the explosive growth that is expected in voice digital assistants over the coming years. We know that Starbucks (SBUX) has been an early adopter of technology that allows customers to pay and order ahead online with the Starbucks app. Starbucks Mobile Order & Pay currently accounts for more than 7 percent of transactions in US company-operated stores. Building on that, Starbucks has launched My Starbucks Barista, a voice-activated “barista” baked into the company’s existing iOS mobile app that uses artificial intelligence. Currently in beta testing, My Starbucks Barista will be available to 1,000 select US customers initially, with a planned rollout through summer 2017 and an Android version to follow.

As we pointed out when we added NUAN shares to the Tematica Select List, Amazon’s Echo technology is leading the way, and the same holds with Starbucks. Select customers can now use Amazon’s Alexa to order “on command”  and the ability to recall and repeat past favorite drinks is also included. Customers simply need to say “Alexa, order my Starbucks” from wherever they have an Alexa device.

As with My Starbucks Barista, we expect Starbucks will deploy this across more Echo devices in the coming months. What it means is more people adopting the use of voice technology, and we find that very bullish for our NUAN shares.

  • We continue to rate NUAN shares a Buy with a $21 price target, as well as Guilty Pleasure company Starbucks (SBUX) with a price target of $74.

 

 

Beholden to the All-Mighty Buck

Finally, one recurring standout this earnings season is the impact of currency given the dollar’s strength during 4Q 2016. We’ve heard it from Buy-rated McCormick & Co. (MKC), United Parcel Service (UPS) and others, but it was Apple that really hammered the point home. In the earnings call last night, Apple said, “we expect foreign exchange to be a major negative as we move from the December to the March quarter.” Not exactly a surprise, given that 60 percent of its revenue is from outside the US.

 

 

Housekeeping at the House of Mouse

While The Walt Disney Company (DIS) will not report its December quarter results until February 7, we’re boosting our protective stop loss on the shares to $101.50 from $87. Currently, we’re up 10 percent% on a blended basis with the shares and while we are enjoying that nice return, after languishing in the red for a while on the positions we are aware of how volatile earnings season can be. This move in the stop loss should prevent any losses in the Disney position on the Tematica Select List.

Why $101.50? Because our blended buy-in price is $101.50.

Even as we reset this stop loss level, we remain bullish on Disney shares given the slate of Marvel, Pixar and Star Wars films that will hit theaters in coming quarters. We are also encouraged by Disney’s other moves to spread the content wealth across its licensing and parks businesses as well as its exploration of streaming alternatives for ESPN.

  • As we boost our protective stop-loss on DIS to $101.50, our price target for the shares remains $125

 

 

Setting a Stop Loss on Facebook (FB) Shares

We’ve come to appreciate the volatile nature of corporate earnings season and we’re starting to see that once again these last few days. While we continue to see Facebook (FB) benefitting from its monetization efforts across its various social media platforms as advertisers embrace digital over radio, print and broadcast, we’ve noticed a something that could be a near-term issue. Over the last several weeks, we’ve noticed a shift toward people curbing their Facebook usage due to a growing sense of political outrage complete with over the top comments. This has prompted some to start referring to Facebook as “Hatebook”.

Our concern is all of this could lead to a softer short-term outlook than most might be expecting for the current quarter.

  • As such, we’re going to install a protective stop loss at $112 for our FB shares. Better to be prudent ahead of time, than sorry later is our thinking. 

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