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Looking past this week’s market relief rally

Looking past this week’s market relief rally

As expected, the last few days in the market have been a proverbial see-saw, which culminated in the sharp market rally following the mid-term elections. The outcome, which saw the Democrats gain ground in Washington, was largely expected. We’ll see in the coming weeks and months the degree of gridlock to be had in Washington and what it means for the economy, but we have to remember several other concerning items remain ahead of us. To jog memories, these include the next round of budget talks between Italy and EU, which should occur next week; continued rate hikes by the Fed as it looks to stave off inflation and get more tools back for the next eventual recession; and upcoming trade talks between the US-China.

While we like the mid-week, market rebound and what it did for the Thematic Leaders as well as positions on the Select List, the upcoming events outlined above suggest near-term caution is still warranted. Shares of McCormick & Co. (MKC) International Flavors & Fragrances (IFF) as well as Altria (MO), AMN Healthcare (AMN) and Costco Wholesale (COST) have been on a tear of late. Earlier this week, Costco reported its October same-store sales results, which once again confirmed this Middle-class Squeeze company is taking wallet share.

Yesterday, mobile infrastructure company Ericsson (ERIC) held its annual Capital Markets event at which it spoke in a bullish tone over 5G rollouts, so much so that it raised its 2020 targets. I see that along with other similar comments in the last few weeks as very positive for our positions in Digital Infrastructure leader Dycom (DY) and Disruptive Innovator Nokia Corp. (NOK) as well as AXT Inc. (AXTI) shares.

 

Axon’s – September quarter earnings and an upgrade

Over the last few weeks, share of Safety & Security Thematic Leader Axon Enterprises (AAXN) have come under considerable pressure, but on Tuesday night the company reported September quarter earnings of $0.20 per share, crushing the consensus view of $0.13 per share as both revenue and earnings before interest, taxes, depreciation, and amortization (EBITDA) soared. Axon then reiterated its full-year guidance which hinged on the continued adoption of its Axon camera and cloud-storage business. Year over year, the number of cloud seats booked by customers rose to 325,200 exiting September up from 187,400 twelve months earlier. The combination of the 25% pullback in the shares quarter to date and that upbeat outlook led JPMorgan Chase to upgrade the shares to Overweight from Neutral.

Yes, we are down with the shares, but as the market settles out I’ll look to add to the position and improve our cost basis along the way. I continue to expect Axon will eventually acquire rival Digital Ally (DGLY) and its $31 million market cap, removing the current legal overhang on the shares. Our price target remains $90.

 

Disney earnings on deck tonight

After tonight’s market close, Disney (DIS) will report its quarterly results, and while we are not expecting any surprises for the September quarter, it’s the comments surrounding the company’s streaming strategy and integration of the Fox assets that will be in focus. Expectations for the September quarter are EPS of $1.34 on revenue of $13.73 billion. Our position on Disney has been and continues to be that based on the success of its streaming services, investors will need to revisit how they value DIS shares as it goes direct to the consumer with a cash-flow friendly subscription business model. Our price target for DIS shares remains $125.

 

Del Frisco’s earnings to follow next week

Monday morning, Del Frisco’s Restaurant Group (DFRG) also postponed its quarterly earnings report from until Tuesday, Nov. 13, citing “additional time required to finalize the accounting and tax treatment of our acquisition of Barteca Restaurant Group, disposition of Sullivan’s Steakhouse, a secondary offering of common stock and debt syndication.”

Coincidence? Perhaps, but it raises questions over the bench strength of these companies as they reshape their business. If you’ve ever been in a negotiation, you know things can slip, but following GNC’s postponement, we are at heightened alert levels with Del Frisco’s. We knew this was going to be a sloppy earnings report and we clearly have confirmation; our only question is why didn’t the management team wait to announce its earnings date until it had dotted its Is and crossed its Ts on all of these items?

To some extent, I am expecting a somewhat messy report in light of the sale of its Sullivan’s business and its common stock offering early in the quarter that raised more than $90 million. In parsing the company’s report, I will be focusing on revenue growth for the ongoing business as well as its profit generation considering that earnings-per-share comparisons could be challenging if not complicated versus the year-ago quarter. Nonetheless, the reported quarterly results will be gauged at least initially against the consensus view, which heading into the weekend sat at a loss per share of $0.25 on revenue of $120 million. For the December quarter, one of the company’s seasonally strongest, Del Frisco’s is expected to guide to EPS near $0.23 on revenue of $144 million.

So far this earnings season we’ve heard how restaurant companies including Bloomin’ Brands Inc. (BLMN), Ruth’s Hospitality Group (RUTH), Del Taco Restaurants Inc. (TACO), Chipotle Mexican Grill Inc. (CMG) and more recently Wingstop Inc. (WING) are seeing their margins benefitting from food deflation. Along with a pickup in average check size owing to prior price increases, these companies have delivered margin improvement and expanding EPS. I expect the same from Del Frisco’s. When coupled with an expected uptick in holiday spending and consumer sentiment running at high levels, we remain bullish on DFRG shares heading into Monday’s earnings report. Our price target on DFRG shares remains $14.

 

What to Watch Next Week

On the economic front, we’ll get more inflation data in the form of the October CPI report next week, which follows tomorrow’s October PPI one. In both we hear at Tematica will be scrutinizing the year over year comparisons and given the growing number of companies issuing price increases we expect to see those reflected in these October as well as November inflation reports. If the figures come in hotter than expected, expect that to reignite Fed rate hike concerns. Also, next week, we have the October reports for Retail Sales and Industrial Production as well as the first look at November with the Empire Manufacturing and Philly Fed indices.

With the October Retail Sales report, we’ll be once again parsing it to compare against the October same-store sales reported yesterday by Costco Wholesale (COST), which were up 8.6% year over year (+6.6% core). Odds are we will once again have formal confirmation that Costco is taking consumer wallet share.

Compared to the more than 1,200 earnings reports we had this week, the 345 or so next week will be a proverbial walk in the park. there will be several key reports to watch including Home Depot (HD), Macy’s (M), JC Penney (JCP), Williams Sonoma (WSM), and WalMart (WMT). We’ll be matching their forecasts for the current quarter up against the 2018 holiday shopping forecasts from the National Retail Federation, Adobe (ADBE) and others that call for overall holiday shopping to rise 4.0%-5.5% with online shopping climbing more than 15% year over year. I continue to see that as very positive for our shares in Amazon (AMZN), Costco and United Parcel Service (UPS) as well as McCormick & Co. (MKC).

Perhaps the biggest wild card next week will be the Italian budget and as we near the end of this week, things are already getting heated on that front. Today, the Italian government said it is sticking with its plan to rapidly increase public spending despite the budget dispute with the European Union, and it has no intention of revising its plan by next week. As background, Italy is the third largest economy in the EU, and if a joint resolution is not reached we expect this to reignite talk of “Italeave,” which will stoke once again questions over the durability of the EU. Given its size compared to Greece, the Italian situation is one we will be watching closely in the coming days.

WEEKLY ISSUE: Confirming Data Points for Apple and Universal Display

WEEKLY ISSUE: Confirming Data Points for Apple and Universal Display

Key points inside this issue:

  • The Business Roundtable and recent data suggest trade worries are growing.
  • Our price target on Costco Wholesale (COST) shares remains $250.
  • Our price target on Apple (AAPL) and Universal Display (OLED) shares remain $225 and $150, respectively.
  • Changes afoot at S&P, but they still lag our thematic investing approach

 

While investors and the stock market have largely shaken off concerns of a trade war thus far, this week the stakes moved higher. The U.S. initiated the second leg of its tariffs on China, slapping on $200 billion of tariffs on Chinese imports of food ingredients, auto parts, art, chemicals, paper products, apparel, refrigerators, air conditioners, toys, furniture, handbags, and electronics.

China responded, not only by canceling expected trade talks, but by also implementing tariffs of its own to the tune of $60 billion on U.S. exports to China. Those tariffs include medium-sized aircraft, metals, tires, golf clubs, crude oil and liquified natural gas (LNG). Factoring in those latest steps, there are tariffs on nearly half of all U.S. imports from China and over 50% of U.S. export to China.

Should President Trump take the next stated step and put tariffs on an additional $267 billion of products, it would basically cover all U.S. imports from China. In terms of timing, let’s remember that we have the U.S. mid-term elections coming up before too long — and one risk we see here at Tematica is China holding off trade talks until after those elections.

On Monday, the latest Business Roundtable survey found that two-thirds of chief executives believed recent tariffs and future trade tension would have a negative impact on their capital investment decisions over the next six months. Roughly one-third expected no impact on their business, while only 2% forecast a positive effect.

That news echoed the recent September Flash U.S. PMI reading from IHS Markit, which included the following commentary:

“The escalation of trade wars, and the accompanying rise in prices, contributed to a darkening of the outlook, with business expectations for the year ahead dropping sharply during the month. While business activity may rebound after the storms, the drop in optimism suggests the longer term outlook has deteriorated, at least in the sense that growth may have peaked.”

Also found in the IHS Markit report:

“Manufacturers widely noted that trade tariffs had led to higher prices for metals and encouraged the forward purchasing of materials… Future expectations meanwhile fell to the lowest so far in 2018, and the second-lowest in over two years, as optimism deteriorated in both the manufacturing and service sectors.”

As if those growing worries weren’t enough, there has been a continued rise in oil prices as OPEC ruled out any immediate increase in production, the latest round of political intrigue inside the Washington Beltway, the growing spending struggle for the coming Italian government budget and Brexit.

Any of these on their own could lead to a reversal in the CNN Money Fear & Greed Index, which has been hanging out in “Greed” territory for the better part of the last month. Taken together, though, it could lead companies to be conservative in terms of guidance in the soon-to-arrive September quarter earnings season, despite the benefits of tax reform on their businesses and on consumer wallets. In other words, these mounting headwinds could weigh on stocks and lead investors to question growth expectations for the fourth quarter.

What’s more, even though S&P 500 EPS expectations still call for 22% EPS growth in 2018 vs. 2017, we’ve started to see some downward revisions in projections for the September and December quarters, which have softened 2018 EPS estimates to $162.01, down from $162.60 several weeks ago. Not a huge drop, but when looking at the current stock market valuation of 18x expected 2018 EPS, remember those expectations hinge on the S&P 500 group of companies growing their EPS more than 21% year over year in the second half of 2018.

 

Any and all of the above factors could weigh on corporate guidance or just rattle investor’s nerves and likely means a bumpy ride over the ensuing weeks as trade and political headlines heat up. As it stands right now, according to data tabulated from FactSet, heading into September quarter earnings, 74 of 98 companies in the S&P 500 that issued guidance, issued negative guidance marking the highest percentage (76%) since 1Q 2016 and compares to the five year average of 71%.

Not alarmingly high, but still higher than the norm, which means I’ll be paying even closer than usual attention to what is said over the coming weeks ahead of the “official” start to September quarter earnings that is Alcoa’s (AA) results on Oct. 17 and what it means for both the Thematic Leaders and the other positions on the Select List.

 

Today is Fed Day

This afternoon the Fed’s FOMC will break from its September meeting, and it is widely expected to boost interest rates. No surprise there, but given what we’ve seen on the trade front and in hard economic data of late, my attention will be on what is said during the post-meeting press conference and what’s contained in the Fed’s updated economic forecast. The big risk I see in the coming months on the Fed front is should the escalating tariff situation lead to a pick-up in inflation, the Fed could feel it is behind the interest rate hike curve leading to not only a more hawkish tone but a quicker pace of rate hikes than is currently expected.

We here at Tematica have talked quite a bit over consumer debt levels and the recent climb in both oil and gas prices is likely putting some extra squeeze on consumers, especially those that fall into our Middle-Class Squeeze investing theme. Any pick up in Fed rate hikes means higher interest costs for consumers, taking a bigger bite out of disposable income, which means a step up in their effort to stretch spending dollars. Despite its recent sell-off, I continue to see Costco Wholesale (COST) as extremely well positioned to grab more share of those cash-strapped wallets, particularly as it continues to open new warehouse locations.

  • Our price target on Costco Wholesale (COST) shares remains $250.

 

Favorable Apple and Universal Display News

Outside of those positions, we’d note some favorable news for our Apple (AAPL) shares in the last 24 hours. First, the iPhone XS Max OLED display has reclaimed the “Best Smartphone Display” crown for Apple, which in our view augurs well for other smartphone vendors adopting the technology. This is also a good thing for our Universal Display (OLED) shares as organic light emitting diode displays are present in two-thirds of the new iPhone offerings. In addition to Apple and other smartphone vendors adopting the technology, we are also seeing more TV models adoption it as well. We are also starting to see ultra high-end cars include the technology, which means we are at the beginning of a long adoption road into the automotive lighting market. We see this confirming Universal’s view that demand for the technology and its chemicals bottomed during the June quarter. As a reminder, that view includes 2018 revenue guidance of $280 million-$310 million vs. the $99.7 million recorded in the first half of the year.

Second, Apple has partnered with Salesforce (CRM) as part of the latest step in Apple’s move to leverage the iPhone and iPad in the enterprise market. Other partners for this strategy include IBM (IBM), Cisco Systems (CSCO), Accenture (ACN) CDW Corp. (CDW) and Deloitte. I see this as Apple continuing to chip away at the enterprise market, one that it historically has had limited exposure.

  • Our price target on Apple (AAPL) and Universal Display (OLED) shares remain $225 and $150, respectively.

 

Changes afoot at S&P, but they still lag our thematic investing approach

Before we close out this week’s issue, I wanted to address something big that is happening in markets that I suspect most individuals have not focused on. This week, S&P will roll out the largest revision to its Global Industry Classification Standard (GICS) since 1999. Before we dismiss it as yet another piece of Wall Street lingo, it’s important to know that GICS is widely used by portfolio managers and investors to classify companies across 11 sectors. With the inclusion of a new category – Communication Services – it means big changes that can alter an investor’s holdings in a mutual fund or ETF that tracks one of several indices. That shifting of trillions of dollars makes it a pretty big deal on a number of fronts, but it also confirms the shortcomings associated with sector-based investing that we here at Tematica have been calling out for quite some time.

The new GICS category, Communications Services, will replace the Telecom Sector category and include companies that are seen as providing platforms for communication. It will also include companies in the Consumer Discretionary Sector that have been classified in the Media and Internet & Direct Marketing Retail subindustries and some companies from the Information Technology sector. According to S&P, 16 Consumer Discretionary stocks (22% of the sector) will be reclassified as Communications Services as will 7 Information Technology stocks (20% of that sector) as will AT&T (T), Verizon (VZ) and CenturyLink (CTL). Other companies that are folded in include Apple (AAPL), Google (GOOGL), Disney (DIS), Twitter (TWTR), Snap (SNAP), Netflix (NFLX), Comcast (CMCSA), and DISH Network (DISH) among others.

After these maneuverings are complete, it’s estimated Communication services will be the largest category in the S&P 500 at around 10% of the index leaving weightings for the other 11 sectors in a very different place compared to their history. In other words, some 50 companies are moving into this category and out of others. That will have meaningful implications for mutual funds and ETFs that track these various index components and could lead to some extra volatility as investors and management companies make their adjustments. For example, the Technology Select Sector SPDR ETF (XLK), which tracks the S&P Technology Select Sector Index, contained 10 companies among its 74 holdings that are being rechristened as part of Communications Services. It so happens that XLK is one of the two largest sector funds by assets under management – the other one is the Consumer Discretionary Select Sector SPDR Fund (XLY), which had exposure to 16 companies that are moving into Communications Services.

So what are these moves really trying to accomplish?

The simple answer is they taking an out-of-date classification system of 11 sectors – and are attempting to make them more relevant to changes and developments that have occurred over the last 20 years. For example:

  • Was Apple a smartphone company 20 years ago? No.
  • Did Netflix exist 20 years ago? No.
  • Did Amazon have Amazon Prime Video let alone Amazon Prime 20 year ago? No.
  • Was Facebook around back then? Nope. Should it have been in Consumer Discretionary, to begin with alongside McDonald’s (MCD) and Ralph Lauren (RL)? Certainly not.
  • Did Verizon even consider owning Yahoo or AOL in 1999? Probably not.

 

What we’ve seen with these companies and others has been a morphing of their business models as the various economic, technological, psychographic, demographic and other landscapes around them have changed. It’s what they should be doing, and is the basis for our thematic investment approach — the strong companies will adapt to these evolving tailwinds, while others will sadly fall by the wayside.

These changes, however, expose the shortcomings of sector-based investing. Simply viewing the market through a sector lens fails to capture the real world tailwinds and catalysts that are driving structural changes inside industries, forcing companies to adapt. That’s far better captured in thematic investing, which focuses on those changing landscapes and the tailwinds as well as headwinds that arise and are driving not just sales but operating profit inside of companies.

For example, under the new schema, Microsoft (MSFT) will be in the Communications Services category, but the vast majority of its sales and profits are derived from Office. While Disney owns ESPN and is embarking on its own streaming services, both are far from generating the lion’s share of sales and profits. This likely means their movement into Communications Services is cosmetic in nature and could be premature. This echoes recent concern over the recent changes in the S&P 500 and S&P 100 indices, which have been criticized as S&P trying to make them more relevant than actually reflecting their stated investment strategy. For the S&P 500 that is being a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value.

As much as we could find fault with the changes, we can’t help it if those institutions, at their core, stick to their outdated thinking. As I have said before about other companies, change is difficult and takes time. And to be fair, for what they do, S&P is good at it, which is why we use them to calculate the NJCU New Jersey 50 Index as part of my work New Jersey City University.

Is this reclassification to update GICS and corresponding indices a step in the right direction?

It is, but it is more like a half step or even a quarter step. There is far more work to be done to make GICS as relevant as it needs to be, not just in today’s world, but the one we are moving into. For that, I’ll continue to stick with our thematic lens-based approach.

 

WEEKLY ISSUE: Adding back a specialty contractor to Select List

WEEKLY ISSUE: Adding back a specialty contractor to Select List

 

  • We are issuing a Buy on Dycom Industries (DY) shares with a $125 price target as part of our Connected Society investing theme.
  • We are adding LendingClub (LC) shares to the Tematica Investing Contender List and will revisit the shares following the resolution of the current FTC complaint.
  • Our price target on Costco Wholesale (COST) and Amazon (AMZN) shares remain $210 and $1,750, respectively.
  • Our long-term price target on shares of Applied Materials (AMAT) remains $70.

As we inch along in the second half of the current quarter, the stock market is once again dealing with the flip-flopping on foreign trade. Last week there appeared to be modest progress between China and the US but following comments from President Trump on the pending summit with North Korea and “no deal” regarding China’s bankrupt ZTE, trade uncertainty is once again gripping the markets. Several weeks ago, I cautioned we were likely in for some turbulent weeks – some up some down – as these negotiations got underway. In my view, there will be much back and forth, which will keep the stock market on edge. I’ll continue to utilize our thematic lens and look for compelling long-term opportunities in the coming weeks, just like the one we are about to discuss…

 

Adding back shares of Dycom (DY) to the Tematica Investing Select List

Late last summer, we exited our position in specialty contractor and Connected Society food chain company Dycom Industries (DY) that serves the mobile and broadband infrastructure markets. Yesterday, following an earnings miss and reduced guidance from the company, its share dropped 20% to $92.64. The reason for the miss and outlook revisions stemmed from weather-related concerns during the February and March months as well as protracted timing associated with key next-gen network buildouts.

Clearly disappointing, but we have seen such timing issues before in the buildouts of both 3G and 4G/LTE networks before. In today’s stock market that double disappointment hit DY shares, no different than it has other companies that have come up short this earnings season.

We’ve often used pronounced pullbacks in existing positions to sweeten our average cost basis, and today we’re going to use this drop in DY shares to add them back to the Tematica Investing Select List.

Why?

Two reasons.

First, the inevitability of 5G network deployments from key customers (AT&T) and Verizon (VZ). Those two alongside their competitors have Sprint (S) and T-Mobile (TMUS) have committed to launching 5G networks by year-end, with a buildout to a national footprint to follow over the ensuing quarters. AT&T and Verizon accounted for 24% and 16% of the quarter’s revenue with Comcast (CMCSA) clocking in at just under 22% and Centurylink (CTL:NYSE) around 12%. This positions Dycom extremely well not only for the pending 5G buildout, but also the gigabit fiber one that is underway at cable operators like Comcast. Amid the timing disruptions with AT&T and Centurylink that led to the earnings disappointment and outlook cut, Dycom called out solid progress with Verizon, as its revenue rose more than 80% year over year. There’s also an added bonus – Dycom has little exposure to Sprint and T-Mobile, which are planning to merge and based on what we’ve seen in the past that means spending cuts are likely to be had as they consolidate existing assets and capital expansion plans.

Here’s the thing, while it is easy to get caught up in yesterday’s DY share price drop, it’s akin to missing the forest for the trees given the network upgrades and next-gen buildouts that will occur not over the coming months, but over the coming quarters.

Dissecting Dycom’s quarterly earnings and revised outlook that calls for EPS of $1.78-$1.93 in the first half of the year, to hit its new full-year target EPS of $4.26-$5.15 it means delivering EPS of $2.98-$3.22 in the back half of the year. In other words, a pronounced pick up in business activity that likely hinges on a pickup in network buildout activity from its customers.

I do expect Wall Street price target revisions and analyst commentary to weigh on DY shares in the near-term. Even I am cutting my once $140 price target for the shares to $125. That $140 target was based on 2019 EPS of $7.10 per share and given the company’s comments yesterday I expect 2019 EPS forecasts to be revised down to the $6.00-$6.50 range.

As the 5G buildout gets under way, the reality is that several quarters from now, such EPS and price target cuts could prove to be conservative, but I’d rather be in the position to raise our price target as the company beats EPS expectations. That revised 2019 EPS range derives a price target for DY shares of $120-$130. For now, we’ll split the difference at $125, which still offers almost 35% upside from current share price levels.

  • We are issuing a Buy on Dycom Industries (DY) shares with a $125 price target as part of our Connected Society investing theme.

 

Putting LendingClub shares onto the Contender List

As team Tematica has been discussing over the last several weeks in our writings and on our Cocktail Investing Podcast, we’re seeing increasing signs of inflation in the systems from both hard and soft data points. This likely means the Fed will boost rates four not three times in 2018 with additional rate hikes to be had 2019. That’s what’s in the front windshield of the investing car, while inside we are getting more data that points to a stretched consumer.

  • Per the May 2018 Consumer Debt Outlook report from Lending Tree (TREE), Americans are on pace to amass a collective $4 trillion in consumer debt by the end of 2018. This means Americans are spending more than 26% of their income on consumer debt, up from 22% in 2010 with the bulk of that increase due to non-house related borrowing.
  • The Charles Schwab’s (SCHW) 2018 Modern Wealth Index that reveals three in five Americans are living paycheck to paycheck.
  • A new report from the Federal Reserve finds that 40% of Americans could not cover an unexpected $400 expense and 25% of Americans have no retirement savings.

 

As consumer debt grows, it’s going to become even more expensive to service as the Fed further increases interest rates. On its recent quarterly earnings conference call, LendingClub’s (LC) CFO Tom Casey shared that “Borrowers are starting to see the increased cost of credit as most credit card debt is indexed to prime, which has moved up 75 basis points from a year ago…We have observed a number of lenders increase rates to borrowers…We know that consumers are feeling the increase in rates.”

Again, that’s before the Fed rate hikes that are to come.

The bottom line is it likely means more debt and higher interest payments that lead to less disposable income for consumers to spend. Unfortunately, we see this as a tailwind for our Cash-strapped Consumer investing theme as well as a headwind for consumer spending and the economy. We’ve seen the power of this tailwind in monthly retail same store sales from Costco Wholesale (COST), which have simply been off the charts, and in monthly Retail Sales reports that show departments stores, sporting goods stores and others continue to lose consumer wallet share at the expense of non-store retailers like Amazon (AMZN). The drive is the need to stretch what disposable spending dollars a consumer has.

The reality is, however, that those that lack sufficient funds will seek out alternatives. In some cases that means adding to their borrowings, often times at less than attractive rates.

With that in mind, above I mentioned LendingClub. For those unfamiliar with the company, it operates an online credit marketplace that connects borrowers and investors in the US. It went public a few years ago and was heralded as a disruptive business for consumers and businesses to obtain credit based on its digital product platform. That marketplace facilitates various types of loan products for consumers and small businesses, including unsecured personal loans, unsecured education and patient finance loans, auto refinance loans, and unsecured small business loans. The company also provides an opportunity to the investor to invest in a range of loans based on term and credit.

Last year 78% of its $575 million in revenue was derived from loan origination transaction fees derived from its platform’s role in accepting and decisioning applications on behalf of the company’s bank partners. More than 50 banks—ranging in total assets of less than $100 million to more than $100 billion—have taken advantage LendingClub’s partnership program.

LendingClub’s second largest revenue stream is derived from investor fees, which include servicing fees for various services, including servicing and collection efforts and matching available loans with capital and management fees from investment funds and other managed accounts, gains on sales of whole loans, interest income earned and fair value gains/losses from loans held on the company’s balance sheet.

The core loan origination transaction fee business along with the consensus price target of $5.00, which offers compelling upside from the current share prices, has caught my interest. However, there is one very good reason for why I am recommending we wait on LC shares.

It’s because the Federal Trade Commission (FTC) has filed a complaint against LendingClub, charging that it has misled consumers and has been deducting hidden fees from loan proceeds issued to borrowers. Moreover, as stated in the FTC’s complaint, Lending Club recognized that its hidden fee was a significant problem for consumers, and an internal review by the company noted that its claims about the fee and the amount consumers would receive “could be perceived as deceptive as it is likely to mislead the consumer.”

Given the potential fallout, which could pressure LC shares, we’ll sit on the sidelines with LendingClub and look for other companies that are positioned to capitalize on this particular Cash-strapped Consumer pain point.

  • We are adding LendingClub (LC) shares to the Tematica Investing Contender List and will revisit the shares following the resolution of the current FTC complaint.
  • Our price target on Costco Wholesale (COST) and Amazon (AMZN) shares remain $210 and $1,750, respectively.

 

Sticking with shares of Applied Materials

Last week Disruptive Technology company Applied Materials (AMAT) reported quarterly results that once again topped expectations but guided the current quarter below expectations. As I mentioned above with Dycom shares, the current market mood is less than forgiving in these situations and that led AMAT shares to give back much of the gains made in the first half of May.

The shortfall relative to expectations reflected reported weakness in high end smartphones, which is slowing capital additions for both chips and organic light-emitting diode display equipment. This is the latest in a growing number of red flags on smartphone demand, which in my view is likely to be the latest transition period in the world of smartphones. For those wondering about our Apple (AAPL) shares, the company already issued a sequentially down iPhone forecast when it reported its own earnings several weeks back as it upsized its own buyback program.

Again, looking back on my Dycom comments above, mobile carriers are about to embark on building out their 5G networks, which will drive incremental RF semiconductor chip demand as well as drive demand for new applications, such as semi-autonomous and autonomous cars. I see 5G devices with near broadband data speeds driving the next smartphone upgrade cycle. When that happens, there are also other technologies, such as artificial intelligence, augmented reality, and virtual reality that will be moving into a greater number of these and other devices. On its earnings call, Applied shared it’s starting to see ramping demand for artificial intelligence, big data a cloud related applications. I see more of this happening in the coming quarters… again, the long-term forest vs. the quarterly tree… and I haven’t even mentioned the internet of things (IoT).

Another driver I’m watching for Applied’s semi-cap business is the ongoing buildout of in-China semiconductor capacity. The item to watch for this is The National Integrated Circuitry Investment Fund, which represents the Chinese government’s primary vehicle to develop the domestic semiconductor supply chain and become competitive with the U.S.  chip industry leader the US. That fund is reportedly closing in on an upsized 300 billion-yuan fund ($47.4 billion) fund vs. the expected 120 billion-yuan ($18.98 billion) to support the domestic chip sector. As we have seen in the headlines with ZTE as well as the Broadcom (AVGO) bid for Qualcomm (QCOM), the semiconductor industry has taken a leading role in the current U.S.-China trade conflict. As I continue to watch these trade discussions play out, I’ll only be assessing implications for the National Integrated Circuitry Investment Fund and our Applied Materials shares.

In terms of organic light emitting diode displays and revisiting shares of Universal Display (OLED), the industry is still in a digestion period given the capacity ramp for that technology and the smartphone transition I touched on above. We’ve got OLED shares on the Tematica Investing Contender List and I’ll be watching them and signs of ramping demand as we move through the summer months.

While we wait, I expect Applied will continue to put its robust share repurchase program to use. As we learned in its quarterly earnings report last week, during the quarter, Applied used $2.5 billion of its $8.8 billion share repurchase authorization to repurchase 44 million shares, roughly 4% of the outstanding share count coming into the quarter. I suspect that once the post-earnings quiet period is over, Applied will be putting more of that program to work. I see that as limiting downside from current levels.

Finally, a quick reminder that come June, Applied will be paying its first $0.20 per share dividend.

  • Our long-term price target on shares of Applied Materials (AMAT) remains $70.
  • As we monitor signs of organic light emitting diode display demand, we continue to have shares of Universal Display on the Tematica Investing Contender List

 

 

Special Alert: Apple added to the Tematica Investing Select List

Special Alert: Apple added to the Tematica Investing Select List

 

KEY POINTS FROM THIS ALERT:

  • We are adding shares of Connected Society company Apple (AAPL) to the Tematica Investing Select List with a $200 price target.
  • In our view, Apple and its new iPhone models are a 2018 story, and we see the recent string of upwardly revised expectations continuing as Apple tweaks its iPhone production and takes newer models global.
  • We would look to use pullbacks in the AAPL shares to improve our long-term cost basis.

This morning we are adding, some would say finally, Apple (AAPL) to the Tematica Select List. It’s no secret that those of us at Tematica are hardcore users of the company’s products — from MacBooks, iPhones and iPads, to the Apple Watch, Time Machine and various other devices. Despite its deep bench of product, Apple, at least for now, is a smartphone company. Even ahead of the recent launches of its iPhone 8, 8S and iPhone X products, Apple derived the bulk of its revenue and profits from the iPhone.

Apple does have other businesses like Apple TV that bolster its position in our Connected Society investing theme, and the company appears to be branching out into live content similar to Tematica Investing Select List companies Amazon (AMZN) and Facebook (FB). We suspect that like many past products and services, Apple will look to unveil its content offering when it is ready, not when the financial media thinks it will. We see that as an added tailwind on the horizon for AAPL shares, provided it can get the content right. Case in point, we were not won over by Apple’s Carpool Karaoke series; however, per the financial press, Apple appears to have recognized its shortcoming and has gone on a hiring spree to course-correct this effort.

 

For many subscribers, the probable question is “Why now?”

Candidly, we have always kept eyes on Apple’s business given how it touches our Connected Society investing theme as well as its shares. Were we underwhelmed by the company’s September event? Yes, we were, given the staggered nature of the new iPhone launches and the simple fact the company kicked off the event discussing how it was going to revolutionize its Apple Stores vs. talking products. There was also the concern that iPhone sales would pause as shoppers waited for the iPhone X to hit shelves not to mention rumored component shortages.

Over the last few days, orders for the iPhone X commenced and early indications suggest it will be a brisk seller. Almost all Apple store channels are now reporting 5-6 week delivery times for new iPhone orders across all configurations of size and color, which means new online orders will not be fulfilled until early December. The initially low production volumes were due to component constraints for the new 3-D face-scanning sensor and a circuit board for a new camera were to blame and Apple is expected to have this corrected in the coming weeks.

Turning to the iPhone 8, while sales have been tepid ahead of the iPhone X launch in the U.S., this morning a new report from Canalys shows the iPhone 8 has led Apple to break a run of sales decreases that stretches back six quarters. Per the report, Apple should see a 40% annual growth to 11 million iPhone units China during the quarter. As with any new product launch, we see Apple tweaking production between these new iPhone models to better match demand.

In our view, we are likely to see Apple up its iPhone X product and dial back production for the iPhone 8, which is a nice but modest upgrade from the iPhone 7 — a model that continues to sell well. That’s right, it’s not just about the new models – the older ones, which are less expensive, help drive Apple sales in the all-important emerging markets like India, where smartphone penetration is far lower than in the U.S. In the U.S., smartphone penetration passed 80% last year. By comparison, roughly one-third of mobile phone users have a smartphone in India, and that figure is expected to only move higher in the next few years.

As we look back on prior iPhone launches, we find ourselves saying “I’ve seen this movie before” and we have. It usually bodes rather well for Apple and we expect that to be the case once again given the large install base Apple has for the iPhone. Last summer Apple sold its 1 billionth iPhone, but as we know from experience and upgrades, not all phones sold are still in use. According to research from UBS, the number of active devices is around 800 million, roughly 80% larger than when Apple debuted the iPhone 6. Simply put, the larger the number of active users, the larger the number of people upgrading every time Apple unveils a new smartphone, especially as newer versions of iOS tend to make older iPhone painfully slow.

There is also the added benefit of Apple putting would-be iPhone buyers in a box as they look to match either an iPhone upgrade or a new purchase with storage needs. Given the increasing usage of the camera for pictures and video, Apple has upped available storage, but that comes at a cost. We see this as well as the iPhone X helping move Apple’s average iPhone selling prices higher in the coming months.

Apple will report its 3Q 2017 results later this week, and odds are given the timing of the new iPhone model launches the company will get a pass of sorts on that performance. In our view, the guidance will be what investors will be focused on, and they will be listening, as will we, not only on iPhone production commentary, but the timing around these models being launched in other markets. As these models go truly global, it makes the iPhone story and thus Apple’s story a 2018 event. We are not alone in that thinking given that current revenue expectations for 2018 have Apple delivering 17% growth to $266.8 billion vs. 5.5% growth this year. As this occurs, odds are the Wall Street bulls will once again return to AAPL shares, and we want to be there ahead of them.

We recognize Apple can have great quarterly earnings report that leads to AAPL shares popping, but from time to time the company has issued results that caused some degree of investor indigestion. We want to be positioned for the former, but we will use the latter should it happen later this week to improve the cost basis for AAPL shares on the Tematica Investing Select List for the longer-term. In our view, Apple is one of the companies that will expand its offering as our Connected Society continues to expand past smartphones and computers to the home, car and the Internet of Things. Apple is paving the way for proprietary content, adding to its position in the home with its HomePod digital assistant and growing its partnerships in Corporate America.

 

Apple’s story is far from over.

Our price target on Apple shares is $200 or 18x expected current 2018 consensus EPS of $11.16. We’d note that over the last few weeks that 2011 consensus EPS figure has crept up from $10.67, and there is the rather likely possibility we will see that figure move even higher as we enter 2018. Over the last several quarters, Apple has regained its past track record for beating bottom line expectations and given the high profile nature of the iPhone X we would not be shocked to learn Apple has once again sandbagged expectations for the second half of 2017.

Over the last five years, Apple shares have peaked at an average P/E multiple of 16x and bottomed out at 11x. That suggests an upside vs downside tradeoff in the shares between $120-$180, vs. the current share price near $160. As we noted above, we strongly suspect Apple will surprise to the upside in 2018 and could deliver EPS between $12-$13; the current high estimate for Apple EPS in 2018 sits at $13.29. In the coming quarters, provided Apple’s EPS beating track record continues, we see 2018 EPS expectations moving higher, and Wall Street bumping up price targets along the way. If Apple stumbles near-term, we would look to aggressively scoop up the shares between $140-$145.

  • We are adding shares of Connected Society company Apple (AAPL) to the Tematica Investing Select List with a $200 price target.
Checking the 2017 Corn Harvest and our Teucrium Corn Fund shares

Checking the 2017 Corn Harvest and our Teucrium Corn Fund shares

Key Points from This Post:

  • We remain long-term bullish on Teucrium Corn Fund (CORN) shares given a new China-related wrinkle that could reshape supply-demand dynamics for corn.

  • Near-term, we are entering the peak harvest season for Corn, and we’re watching the weather in the western domestic corn region that could crimp this year’s harvest, which is already shaping up to be the weakest in the last four years.

  • Our long-term price target on CORN shares remains $25

 

In mid-July, we added shares of the Teucrium Corn Fund (CORN) to the Tematica Investing Select List as a Rise & Fall of the Middle Class and Scarce Resource investment theme play on one of the most widely used and consumed commodities – corn. Since that addition of those CORN shares, even though they are off their late August bottom at $17.13, the position is still down 11.5% as of last night’s market close. While we are patient investors, we are human (yes, it’s true!) and that can lead to bouts of frustration with a position. When that happens, being the professional investors that we are, we turn back to the investing premise that led to adding the shares in the first place, checking the data along the way to determine if the thesis remains intact. If it is, then we will remain patient; if not, then we have some decisions to make.

In the case of corn supply-demand dynamics, the below chart is the latest data from the Crop Progress Report published by the U.S. Department of Agriculture’s National Agriculture Statistics Service (NASS):

 

 

What the data above depicts is the current corn crop is shaping up to be the weakest in the last four years. The same data set shows a growing percentage of the current corn crop is in Poor or Very Poor condition. If this condition persists, let alone rises, it will impact the coming harvest. Simple supply-demand dynamics means a weaker than expected supply will likely lead to higher corn prices.

What this means is we’ll be watching the progress of the 2017 harvest, and September-October is the peak time for that activity. As of this past Sunday night, just 7% of the U.S. corn crop had been harvested vs. the 5-year average of 11%. While that may seem like a small percentage difference, remember that’s on a base of millions of metric tons.

What’s likely to hamper the harvest and its yield this year is the weather. While the weather in the eastern corn-growing region of the U.S. is looking favorable with dryer, warmer weather, it’s looking rather different in the western corn belt that is the eastern Dakotas, Minnesota, and northern Iowa. In that region, forecasts are calling for dramatically cooler temperatures that could result in scattered frost next week. If that happens, we are likely to see the percentage of the current corn crop that is Poor/Very Poor climb past the current 39% level. Such a move would boost corn prices as well as our CORN shares.

Further complicating the corn supply-demand equation in the medium to longer-term is news that China plans to dramatically boost ethanol use in its gasoline supply, moving to E10 blends by 2020 to help combat pollution and smog. If this move comes to pass, it could lead to a meaningful shift in corn demand dynamics given that China is the world’s largest car market, but is the third largest consumer of ethanol fuel. According to S&P Global Platts, China has the “capacity to produce maybe a billion gallons of ethanol, and that would have to be increased ten-fold to get to this E-10 mandate.” That sound you just heard was eyebrows being popped higher on what that could mean for corn prices.

Near-term we will continue to monitor the weather and what it means to the current corn crop. Should milder than expected weather emerge, and weigh on corn prices in the coming weeks, we’ll look to use that weakness to improve our long-term position in CORN shares given the potential game changer in corn demand in the medium-term.

 

 

Wedbush upgrade confirms our stance on Starbucks

Wedbush upgrade confirms our stance on Starbucks

Over the weekend, Barron’s published an excerpt from Wedbush’s price target hike and upgrade on Starbuck (SBUX) shares last week. We’ve been patient with the shares during the summer given it’s a seasonally weaker time frame for the company. As the summer comes to an end, we are encouraged by Wedbush’s findings that Starbucks same-store sales are trending better than expected. We attribute this in part to the company’s revamping and expanding its food menu, which is likely driven higher consumer tickets.

As we head into the cooler months, we suspect the demand for hot beverages and food will lead to further sequential improvements in domestic same-store sales. We also see the company’s global same-store sales benefitting from the recent decision to buy the remaining 50% share of its East China business from long-term joint venture partners Uni-President Enterprises and President Chain Store for approximately $1.3 billion in cash. With the agreement, Starbucks will assume 100% ownership of approximately 1,300 Starbucks stores in Shanghai and Jiangsu and Zhejiang Provinces. As part of that announcement, Starbuck reiterated plans to have a total of 5,000 stores in mainland China, the company’s fastest-growing market outside of the U.S.,  by 2021. In our view, this roll-out keeps Starbucks within our Rise & Fall of the Middle Class and Affordable Luxury tailwinds.

  • Our price target on Starbucks (SBUX) shares remains $74.

We are upgrading Starbucks (ticker: SBUX) to Outperform from Neutral. We are increasing the price target to $60 from $57.

Checks indicate U.S. comps tracking in line with expectations. Our recent checks of 5% of U.S. co-owned locations point to same-store-sales (SSS) growth in line with fiscal-fourth-quarter consensus of 3.5%. Mobile order and pay continues to be cited as a meaningful driver with increased frequency. We continue to model 3% for the fiscal fourth quarter, but based on our checks we view a rounded-up 4% U.S. comp as realistic should this trend continue through September.

Source: Starbucks to See Boost From China Acquisition – Barron’s

Samsung Electronics confirms our thesis on Applied Materials

Samsung Electronics confirms our thesis on Applied Materials

 

Given all the attention that organic light emitting diode displays are getting ahead of Apple’s (AAPL) pending launch of its next iPhone, it’s understandable that Applied Material’s (AMAT) display business would be the center of attention. Early this morning, however, Samsung Electronics confirmed the other key drivers behind our bullish stance on AMAT shares – ramping semiconductor capital spending to not only meet growing global demand for chips but also China’s intent to become a key manufacturing hub for chips.

With Samsung accounting for 12%-18% of Applied revenue stream over the last three years, we see Applied as very well positioned to capture capital spending dollars at Samsung for capacity in China as well as around the globe in the current and coming quarters.

  • Our price target on Applied Materials (AMAT) shares remains $55.

SEOUL (Reuters) – Samsung Electronics Co Ltd expects to invest $7 billion over the next three years to expand its NAND memory chip production in China’s northwestern city of Xi’an, the South Korean tech giant said on Monday. In a regulatory filing Samsung said it approved $2.3 billion of the expected investment of $7 billion on Monday.

The firm accounted for 38.3 percent of global NAND flash memory chip revenue in April-June, the latest data from researcher IHS showed.

China is trying to develop its own memory chip producers but it is likely to be several years before they can compete with existing makers, analysts said. Samsung Electronics said a memory chip boom that propelled it to record profit in the second quarter was likely to continue in the July-to-September quarter.

Source: Samsung Electronics to invest $7 billion to boost China NAND chip output

Tencent set to Stream 2017, 2018 and 2019 NFL games in China

Tencent set to Stream 2017, 2018 and 2019 NFL games in China

We’re not only seeing a blurring of our Content is King and Connected Society investing themes here in the U.S., we’re seeing in China as well in a deal between Tencent and the NFL. Live news and sports were two of the holdouts in streaming content, but with Google (GOOGL) adding streaming news to YouTube;  Amazon (AMZN), and Facebook (FB) streaming live sporting events this fall, and Disney (DIS) bringing a streaming ESPN service to market next year we think the TV broadcast only business is resembling the newspaper industry around 2001-2002.

 

Tencent is to become the exclusive live streaming partner in China for the National Football League’s American football games. The social media, games and streaming giant will air live and on-demand selected preseason games, all Thursday Night Football, Sunday Night Football and Monday Night Football games, as well as selected Sunday afternoon games, the playoffs, the Pro Bowl and the Super Bowl for the 2017, 2018 and 2019 seasons. The deal also includes non-game NFL content.

NFL live games and content will be available through Tencent’s NFL sections on both mobile and desktop terminals including Tencent Sports, QQ.com, Tencent Video, Kuai Bao, Penguin Live, the Tencent Sports app, the Tencent Video app, the Tencent News app, as well as its social networking services, QQ and WeChat. At the end of June, the combined monthly active users of Tencent’s social communications platforms, Weixin and WeChat, was over 960 million.

Source: Tencent to Stream NFL in China | Variety

PwC Data Confirms Our Content is King Investing Theme

PwC Data Confirms Our Content is King Investing Theme

We’ve touched on this aspect of our Content is King investing theme before, but nothing like data from PricewaterhouseCoopers to confirm it and the theme itself!

Box-office markets over the next few years are expected to grow more quickly abroad than in North America, where receipts have been relatively flat and are forecast to expand only modestly. That dynamic already is changing the way movies get made in Hollywood, as studios focus on big-tent productions like superhero epics that play across borders, or find story lines they know will fly in censorious countries.The Wall Street Journal used analysis by PricewaterhouseCoopers to give a fuller picture of the five fastest-growing box-office markets around the world.

Source: A Look at the Five Fastest-Growing Markets for Movies – WSJ

Disney Seeks to Cater to China’s Growing Middle Class

Disney Seeks to Cater to China’s Growing Middle Class

Rising disposable incomes in the emerging economies and especially in China have led to a trade up in diets, a thirst for the branded products and now travel and entertainment. This is already starting to influence content decision at the major movie studios and airline destinations,  and this will only accelerate as the influence grows.

Walt Disney Co. has hosted over 600,000 visitors at its first theme park in mainland China since trial operations started early May, and its “enormous potential” has already prompted Disney to expand the resort, said Chief Executive Officer Robert Iger.

The government has predicted China’s $610 billion tourism industry will double by 2020, spurred by a growing middle class. DreamWorks Animation SKG Inc. plans to open its $2.4 billion DreamCenter and Haichang Ocean Park Holdings will unveil what’s slated to be China’s biggest marine park next year. Six Flags Entertainment Corp. is due to open its first park outside North America in 2019.

Source: Disney Sparks Theme-Park Battle to Entertain China’s Middle Class – Bloomberg