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Our Costco thesis remains intact

Our Costco thesis remains intact

Last night Costco Wholesale (COST) reported quarterly results that in our view are being misinterpreted by investors. While the company reported EPS for the quarter came in at $1.59 per share that included a $0.17 per share tax benefit that resulted from tax legislation passed by Congress vs. the expected $1.45 per share, it’s top line results continue to show Costco making wallet and market share gains. Net sales for the quarter came in at $32.3 billion, a 10.8% increase over the $29.1 billion achieved in the year-ago quarter. Excluding the impact of FX and gas, Costco sales rose 5.4% year over year for the quarter.

In our view, context is key and pitting Costco top-line results vs. those for Target (TGT) or Kroger (KR) confirm those share gains. For their latest quarters, Target reported adjusted top-line growth of 3.6% year over year, while this morning Kroger reported year over year sales growth of 2.7% excluding fuel. Also, scrutinizing Costco’s internal metrics confirm those share gains.  These include membership renewal rates (90.1% in the U.S. for the quarter) and membership growth (50.4 million member households vs. 49.9 million at the end of the prior quarter).

From a geographic perspective, U.S. sales rose 7.1% (5.7% ex-gas and FX); Canada + 8.7% (2.5% ex gas and FX); and Other/International up 15.7% (7.4% ex gas and FX) for the quarter with E-commerce sales up more than 28% year over year. Those share gains were also reflected in the February same-store sales data that was shared last night as well. For the month, net sales rose 12.8% to $10.21 billion with:

  • US up 9.0% (7.5% ex-FX and gas)
  • Canada +8.4% (up 3.2% ex-FX and gas)
  • Other/International up 22.2% (14.1% ex-FX and gas)
  • E-commerce +38% (up 37% ex-FX and gas)

In addition to the brick & mortar wallet share gains being had, we’d also note the reported E-commerce growth metrics. Management has continued to focus on improving its digital offering while also improving its search capabilities and checkout experience. I also suspect its relationship with Instacart and others is driving digital grocery, which should alleviate bearish concerns over Amazon as it relates to Costco’s business.

On a side note, I was at a local Costco this past weekend when it opened, and it was not only packed to the gills, but the checkout lines were several people deep as was the new membership line.

From a fundamental perspective, we see the company has benefitted and continues to do so from the lack of domestic wage growth for roughly 80% of the workforce over the last year that is prompting debt-laden consumers to stretch disposable spending dollars where they can. The latest data from the Federal Reserve showing a gap up in credit card charge-offs in 4Q 2017 vs. 4Q 2016 serves as a confirming point and sets the stage for more should the Fed boost interest rates as expected. The bottom line is given economic constraints, Cash-Strapped Consumers will continue to flock to Costco be it in person or online as the company continues to expand its offering.

As we have discussed previously, one of the key differentiators for Costco is its high margin membership fee business, which accounts for more than 70% of the company’s pre-tax income. During the quarter Costco slowed its pace of new warehouse openings to 1 from 5 in the prior quarter but shared it aims to open two in the current quarter followed by 18 openings and three relocations in the subsequent quarter. All told, Costco will open 22-23 new locations during the current fiscal year, which sets the stage for continued membership fee income growth in the coming quarters.

Understanding these two perspectives keeps us bullish on COST shares.

  • Our price target on Costco Wholesale (COST) shares remains $200

 

 

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

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

 

Our Latest Thoughts on Trump Tariffs

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

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

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

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

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

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

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

 

 

Getting back to the Tematica Investing Select List

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

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

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

 

Amazon (AMZN),  Connected Society

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

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

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

 

Starbucks (SBUX), Guilty Pleasure

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

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

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

 

Disney (DIS), Content is King

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

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

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

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

 

United Parcel Service, Connected Society

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

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

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

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

 

 

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

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

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

 

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

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

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

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

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

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

 

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

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

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

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

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

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

 

Waiting on Applied Materials Earnings Announcement

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

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

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

 

 

Should We Be Concerned About UPS Amid Amazon Announcement?

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

 

 

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

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

 

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

WEEKLY ISSUE: The Shakeout from Market Volatility on the Select List

WEEKLY ISSUE: The Shakeout from Market Volatility on the Select List

 

 

It’s Wednesday, February 7, and the stock market is coming off one of its wild rides it has seen in the last few days. I shared my thoughts on the what’s and why’s behind that yesterday with subscribers as well as with Charles Payne, the host of Making Money with Charles Payne on Fox Business – if you missed that, you can watch it here.

As investors digest the realization the Fed could boost interest rates more than it has telegraphed – something very different than we’ve experienced in the last several years – the domestic stock market appears to be finding its footing as gains over the last few days are being recouped. Lending a helping hand is the corporate bond market, which, in contrast to the turbulent moves of late in the domestic stock market, signals that credit investors remain comfortable with corporate credit fundamentals, the outlook for earnings and the ability for companies to absorb higher interest rates.

My perspective is this expectation reset for domestic stocks follows a rapid ascent over the last few months, and it’s removed some of the froth from the market as valuations levels have drifted back to earth from the rare air they recently inhabited.

 

Among Opportunity This New Market Dynamic Brings, There Have Been Casualties

While this offers some new opportunities for both new positions on the Tematica Investing Select List as well as the opportunity to scale into some positions at better prices once the sharp swings in stocks have abated some, it also means there have been some casualties.

We were stopped out of our shares in Cashless Consumption investment theme company, USA Technologies (USAT) when our $7.50 stop loss was triggered yesterday. While the shares snapped back along with the market rally yesterday, we were none the less stopped out, with the overall position returning more than 65% since we added them to the Select List last April. For those keeping track, that compares to the 15.3% return in the S&P 500 at the same time so, yeah, we’re not exactly broken up over things. We will put USAT shares on the Tematica Contender List and look to revisit them after the company reports earnings tomorrow (Thursday, Feb. 8).

That’s the second Select List position to have been stopped out in the last several days. The other was AXT Inc. (AXTI) last week, and as a reminder that position returned almost 27% vs. a 15% move in the S&P 500. Again, not too shabby!

The last week has brought a meaningful dip in shares of Costco Wholesale (COST). On recent episodes of our Cocktail Investing Podcast, Tematica Chief Macro Strategist Lenore Hawkins and I have discussed the lack of pronounced wage gains for nonsupervisory workers (82% of the US workforce) paired with rising credit card and other debt. That combination likely means we haven’t seen the last of the Cash-Strapped Consumer investment theme — of the key thematic tailwinds we see behind Costco’s business. While COST shares are still up more than 15% since being added to the Select List, we see the recent 5% drop in the shares as an opportunity for those who remained on the sidelines before the company reports its quarterly earnings in early March.

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

 

 

Remaining Patient on AMAT, OLED and AAPL

Two other names on the Tematica Investing Select List have fallen hard of late, in part due to the market’s gyrations, but also over lingering Apple (AAPL) and other smartphone-related concerns. We are referring to Disruptive Technologies investment theme companies Applied Materials (AMAT) and Universal Display (OLED). As we shared last week, it increasingly looks that Apple’s smartphone volumes, especially for the higher priced, higher margin iPhone X won’t be cut as hard as had been rumored. Moreover, current chatter suggests Apple will once again introduce three new iPhone models this year, two of which are slated to utilize organic light emitting diode displays.

Odds are iPhone projections will take time to move from chatter to belief to fact. In the meantime, we are seeing other smartphone vendors adopt organic light emitting diode displays, and as we saw at CES 201 TV adoption is going into full swing this year. That ramping demand also bodes for Applied Materials (AMAT), which is also benefitting from capital spending plans in China and elsewhere as chip manufacturers contend with rising demand across a growing array of connected devices and data centers.

  • Our price target on Apple (AAPL) remains $200
  • Our price target on Universal Display (OLED) remains $225
  • Our price target on Applied Materials (AMAT) remains $70

 

The 5G Network Buildout is Gaining Momentum – Good News for NOK and DY

This past week beleaguered mobile carrier, Sprint (S), threw its hat into the 5G network ring announcing that it will join AT&T (T), Verizon (VZ), and T-Mobile USA (TMUS) in launching a commercial 5G network in 2019. That was news was a solid boost to our Nokia (NOK) shares, which rose 15% last week. The company remains poised to see a pick-up in infrastructure demand as well as IP licensing for 5G technology, and I’ll continue to watch network launch details as well as commentary from Contender List resident Dycom Industries (DY), whose business focuses on the actual construction of such networks.

Several months ago, I shared that we tend to see a pack mentality with the mobile carriers and new technologies – once one makes a move, the others tend to follow rather than risk a customer base that thinks they are behind the curve. In today’s increasingly Connected Society that chews increasingly on data and streaming services, that thought can be a deathblow to a company’s customer count.

  • Our price target on Nokia (NOK) shares remains $8.50
  • I continue to evaluate upgrading Dycom (DY) shares to the Select List, but I am inclined to wait until we pass the winter season given the impact of weather on the company’s construction business.

 

Disney Offers Some Hope for Its ESPN Unit

Last night Disney (DIS) announced its December quarter results while the overall tone was positive, the stand out item to me was the announcement of the new ESPN streaming service being introduced in the next few months that has a price tag of $4.99 a month. For that, ESPN+ customers will get “thousands” of live events, including pro baseball, hockey and soccer, as well as tennis, boxing, golf and college sports not available on ESPN’s traditional TV networks. Alongside the service, Disney will unveil a new, streamlined version of the ESPN app, which is slated to include greater levels of customization.

In my view, all of this lays the groundwork for Disney’s eventual launch of its own Disney streaming content service in 2019, but it also looks to change the conversation around ESPN proper, a business that continues to lose subscribers. Not surprising, given that Comcast (CMCA) continues to report cable TV subscriber defections. One of the key components to watch will be the shake-out of the rights to stream live games from the major professional leagues — the NFL, Major League Baseball, the NBA. Currently, ESPN is on the hook for about $4 billion a year in rights fees to those three leagues alone — not to mention the rights fees committed to college athletics. Those deals, however, include only the rights to broadcast those games on cable networks or on the ESPN app to customers that can prove they have a cable subscription, not cord-cutters. So the question will be how quick will customers jump on board to pay $5 a month for lower-level games, or will they be able to cut deals with the major professional sports leagues to include some of their games as well.

Nevertheless, I continue to see all of these developments as Disney moving its content business in step with our Connected Society investing theme, which should be an additive element to the Content is King investment theme tailwind Disney continues to ride. With that in mind, we are seeing rave reviews for the next Marvel movie – The Black Panther – that will be released on Feb. 16. The company’s more robust 2018 movie slate kicks off in earnest a few months later.

  • We will continue to be patient investors with Disney, and our price target on the shares remains $125

 

 

 

Kicking the tires on Rite Aid shares

Kicking the tires on Rite Aid shares

There are several facets to our Aging of the Population investment theme, ranging from the obvious — assisted living, pharmaceuticals, financial services and vitamins and supplements — to the not so obvious such as online shopping, disruptive technology and artificial intelligence which can help maintain independence as the physical realities of an aging body take hold.

We as a people are also living longer, and statistics tabulated by Milliman show an encouraging pattern of increased life expectancy which will trigger increased consumption patterns in the population for medical services and pharmaceuticals. This should be a positive tailwind to pharmacy companies, such as CVS Health (CVS), Walgreen Boots (WBA) and Rite Aid (RAD) that are also pivoting their businesses toward health and wellness offerings. This tailwind also bodes well for the pharmacy businesses at Tematica Select List holding Costco Wholesale (COST) and other companies, like Kroger (KR) and other grocery chains, that have pharmacies.

Looking back over 2017, it was a painful year for Rite Aid, as its shares fell around 75%. Part of that reflects regulators blocking the acquisition of Rite Aid by Walgreens Boots Alliance for some $9.4 billion. After attempts to structure a deal that would placate regulators, this past September the two companies announced that Rite Aid would instead sell off more than 1,900 stores and three distribution centers to Walgreens for $4.375 billion in cash. Rite Aid is in the process of transferring those stores and facilities over to Walgreens, a process that’s expected to span through most of 2018. In exchange, Rite Aid will be receiving an influx of cash, which it has earmarked to primarily reduce the outstanding debt on its balance sheet. That debt reduction should drive a favorable decline in interest expense, enabling the company to drop more to its bottom line in the coming quarters.

Current Wall Street expectations call for Rite Aid to post losses of $0.06 per share in 2018 and $0.03 per share in 2019. Those consensus figures are tallied from six active analysts following Rite Aid and their consensus price target is $2.07, with a consensus view of “Hold.”

As I mentioned above, we here at Tematica see the aging of the U.S. population unfolding as more baby boomers pass 70 years of age, making it a multi-year tailwind to the pharmacy business, particularly as people are living longer. That’s not to say it will be easy peasy for Rite Aid considering the pharmacy businesses at CVS Health, Walgreens, Walmart (WMT), Kroger (KR), Costco Wholesale and others. Note, we haven’t even mentioned the rumblings of bricks and mortar crusher Amazon’s (AMZN) potential entry into the category.

I’m not going to sugar coat it, folks. What all of this tells me is Rite Aid is a turnaround story, and expectations are low, which also makes it a “show-me story.”

The hope/opportunity is that the Rite Aid management team is able to transform the company quicker than expected by leveraging the 20.7 million customers in its loyalty program, improving its offerings and shrinking its operating costs as it looks to offset reimbursement pressure. Management has already identified some $96 million in administrative cost savings, and I suspect there could be more savings to be had in the coming quarters as Rite Aid continues to right size itself.

I also see the company’s predominantly domestic footprint making it a solid beneficiary in terms of tax reform. As I shared in yesterday’s weekly issue of Tematica Investing, tax reform related EPS benefits are arguably all over the map, but Rite Aid should see some lift to its 2018 EPS forecast – the question is how much? More than likely this combination will lead to better-than-expected EPS performance over the coming quarters, and with the current low expectations that would likely move RAD shares, especially if its analyst following became either more bullish or less bearish on the company.

The question is one of magnitude in terms of tax reform benefits vs. expectations, and for that reason, I’m inclined to hold off on adding RAD shares to the Select List until we have some clarity on this key issue, especially since Rite Aid has been received income tax benefits in recent quarters. With the company’s next earnings report likely to occur in early April, we can look at results from CVS Health and Walgreens to get a handle on the potential tax reform impact to be had at Rite Aid. CVS shared that as a result of tax reform it sees its effective tax rate to run near 27% this year, which should increase its cash flow by roughly $1.2 billion, but Walgreen’s recent guidance did not factor in any impact from tax legislation.

Not very helpful, and rather than jump the gun on this, I’ll continue to assess the potential benefit on Rite Aid’s business and what it could mean for its shares. Until that clarity arrives, I’m adding Rite Aid shares to the Tematica Contender List as part of our Aging of the Population investment theme.

Barnes & Noble: Certain stocks  are cheap for a reason

Barnes & Noble: Certain stocks  are cheap for a reason

Over the last few weeks, we’ve been kicking the tires on several new positions for the Tematica Research Select List and recently added both United Rental (URI) and Vulcan Materials (VMC) to the Contender List. While it’s always exciting to add new positions, we have to remember that even with a stock market that is melting up like the one we are currently seeing, we still need to understand the business dynamics at play for the company behind the shares. Are we seeing thematic tailwinds or headwinds, and are there any catalysts to be had that will alter the winds that are blowing or intensify the force of those winds?

A great example can be found in book and gift retailer Barnes & Noble (BKS), which is attempting to pivot its business model headwind with a new line of stores that have an expanded café as it faces the realities of today’s online world, what we call our Connected Society investment theme. The gist of these new stores is the café will draw people in, but the crux of the issue is will it get people to shop for something more than a cup of coffee or a convenient snack?

Whenever possible, I find a boots on the ground approach, roll up your sleeves and check it out approach is called for. And that’s exactly what I did.

The new Barnes & Noble stores are an interesting concept and I’ve visited one of the few locations that is open in the Washington, DC metro area. It’s a wide-open space, the food is good and the menu includes a variety of soft and adult beverages. For mobile workers looking for a place to hole up, this will give Starbucks (SBUX), Panera Bread (PNRA) and others like them a run for their money.

Back to the question from above —  is sitting in the café likely to alter the changing behavior that is buying books and other things online?

I can say that I, and a score of others, were showrooming the newer books and truth be told I even hunted around for a few copies of the book I co-wrote with Tematica’s Chief Macro Strategist Lenore Hawkins – Cocktail Investing: Distilling Everyday Noise into Clear Investment Signals. For those looking for a copy, I’d recommend buying it online as you’ll get a far better price. No surprise, as that is one of the reasons consumers are flocking to digital commerce — the ability to easily price compare and stretch those disposable spending dollars.

Back to my Barnes & Noble visit . . . did the vast majority of people buy books, that is plunk down cash, card or even smartphone and buy a book or two, a calendar, or some other gift idea?

During the several times I have been there, both during the 2017 holiday shopping season and after, the overwhelming answer was “no.”

And then there was the other shoe to drop.

Barnes & Noble recently shared its holiday sales for the nine-week holiday period ending December 30, 2017, and it was not good. Not good at all. In fact, it was just painful and rather revealing. Year over year for the period, total sales were $953 million, declining 6.4%, and comparable store sales also declined 6.4% for the holiday period. Now, this next piece of data is particularly revealing – during the holiday period, Barnes & Noble’s online sales declined 4.5% year over year.

We all know that brick & mortar retail is having a challenging time as it squares off against Select List holding Amazon (AMZN) ups the ante, and Walmart (WMT) is pulling out the stops – acquisitions, repositioning Sam’s Clubs into distribution centers, and new digital offerings – to compete. But Barnes & Noble is seeing its online business contract at a time when consumers are increasingly shifting their buying preference to this modality. We saw this in spades this holiday shopping season and in the December Retail Sales report released on Friday that showed Non-store retail sales rose 12.7% year over year and 11.0% for the last three months of the year vs. the same period in 2016. For context during those two periods, retail sales rose 5.6% and 5.9% year over year, respectively.

From my eyes, it sure seems Barnes & Noble is fighting the same headwinds it has been over the last few years, and at least thus far, it’s strategies to right itself have not been paying off.

Now let’s add some perspective, for the company’s last three quarters it generated bottom line losses and for what should be its seasonally strongest quarter it’s business contracted, both in-store and online. Making matters even worse, the last two reported quarters missed expectations by a decent margin. Put it all together, and it says the company’s business continues to, put it politely, be challenged and there is not a lot of confidence to be had right now in the management team.

This is a reason to pass on BKS shares. Plain and simple. No matter how tempting they might look.

Some investors may be tempted by the current dividend yield that clocks in at more than 11%. That’s a heady dividend yield and one that is bound to catch eyes, but again let’s remember that recent string of bottom line losses and the fact the company’s current quarterly dividend runs just shy of $11 million per quarter vs. the $11.3 million in cash it had on its books exiting October. The issue may not be with the current dividend, but if the headwinds plaguing the company continue, odds are people will begin to question the company’s ability to maintain the current quarterly dividend of $0.15 per share without dipping into other borrowings on its balance sheet.

I’d rather stick with our Amazon shares and the Costco Wholesale (COST) shares on the Select List, especially as Costco continues to deliver robust same-store sales growth figures each month.

  • Our price target on Amazon (AMZN) shares remains $1,400
  • Our price target on Costco Wholesale (COST) shares remains $200
The November retail sales report is great news for the Tematica Investing Select List

The November retail sales report is great news for the Tematica Investing Select List

Today we received a better than expected print for the November Retail Sales report, which rose 0.8% month over month compared to the 0.3% expected increase. Viewed on a year over year basis, the headline November figure, which includes retail and food sales, climbed 5.8%. Backing out food, motor vehicles and parts, retail sales in the month soared 6.3% year over year. While we’re going to focus on the retail aspect of the report, we’d note the downtick in food sales bodes rather well for our position in McCormick & Co. (MKC) shares.

In a nutshell, the overall November report was rather bullish for a number of Connected Society and Cash-Strapped Consumer positions on the Tematica Investing Select List as well as several others. With that said, let’s get to the nitty-gritty…

The three standouts in the November retail data were:

  • Gasoline Stations (up 12.2%)
  • Building Materials (up 10.7% year over year)
  • Nonstore Retailers (up10.4% year over year)

The fact that Building Materials and Nonstore Retailers were stalwarts was not a surprise, given post-hurricane building efforts and the digital shopping data for the Thanksgiving – Cyber Monday holiday shopping period. We see these data points as rather confirming and positive for our positions in LSI Industries (LYTS), Amazon (AMZN), and United Parcel Service (UPS) and to a lesser extent Alphabet (GOOGL) shares.

The 3.6% year over year increase in general merchandise stores is, in our view, another reason to expect an upbeat earnings report from Costco Wholesale (COST) after today’s market close. As a reminder, with the shares bumping up against our $190 price target, we are in the process of reviewing additional upside. Today’s earnings report will be a factor in that analysis.

Despite the favorable November results for Sporting good, book and music stores (up 2.9% year over year), it wasn’t enough to bring the trailing 3-month total into the black. We continue to see a tough road ahead for these categories in the traditional brick & mortar environment as they feel the one-two punch of not only our Connected Society investment theme, but also Amazon flexing its muscles in an effort into private label products such as exercise and sports apparel.

Finally, electronics & appliance stores experienced a 6.4% bump year over year, clearly the strongest period in the trailing three-month period. While some of this is likely due to post-hurricane rebuilding efforts, we would note Apple’s (AAPL) iPhone X went on sale early in November and electronics was a big contributor to the holiday shopping spend.

  • Our price target on McCormick & Co.  (MKC) shares is $110
  • Our price target on LSI Industries (LYTS) shares is $10
  • Our price target on Amazon (AMZN) shares is $1,400
  • Our price target on United Parcel Service (UPS) shares is $130
  • Our price target on Alphabet (GOOGL) shares is $1,150
  • Our $190 price target for Costco Wholesale (COST) shares is under review.
  • Our price target on Apple (AAPL) shares is $200.
United Natural Foods Reports In-line Quarterly Results, Still Riding the Fresh & Natural Wave

United Natural Foods Reports In-line Quarterly Results, Still Riding the Fresh & Natural Wave

Last night Food with Integrity company United Natural Foods (UNFI) reported in-line quarterly earnings of $0.50 per share on revenue that rose 11.7% year over year to hit $2.29 billion. Despite that double-digit revenue growth, revenue for the quarter fell short of expectations by $50 million — not a big deal in our view, but we suspect some will look past the double-digit growth and focus on this being the second consecutive quarter where revenue fell just shy of expectations. To us that shortfall is overshadowed by the more than 16% increase in earnings before interest tax & depreciation (EBITDA) and the 12% increase in net income — we always like to see profits growing faster than revenue as it denotes margin expansion.

Given the continued deflationary environment the food and grocery industry is contending with, all in all, we were rather pleased with United Natural’s quarterly results as it continues to benefit from shifting consumers preferences and reap the benefits from cost savings initiatives and synergies with companies acquired in the last year. With those deflationary pressures poised to continue, the company is undertaking another initiative that will shed roughly 265 jobs in the current quarter, with benefits to be had in following ones. This latest effort is expected to result in pre-tax charges of $3.5-$4 million.

Even after this new initiative the company guided 2017 in line with expectations:

  • fiscal 2017 revenue between $9.38-$9.46 billion, an increase of approximately 10.7%-11.7% over fiscal 2016, and consensus expectations of $9.4 billion;
  • adjusted EPS in the range of $2.53 to $2.58 vs. the current consensus forecast of $2.54 per share.

Stepping back, we continue to see consumer shifting preferences to fresh, organic and natural products. Last week, grocery chain Kroger (KR) commented that it continues to “focus on the areas of highest growth like natural and organic products” and we’ve seen companies like Costco Wholesale (COST) continue to expand their fresh and natural offering to boost basket size and shrink time between visits. Against that backdrop that is not occurring at just Kroger and Costco, we continue to like United Natural’s strategy to expand its footprint, including its UNFI Next program that looks for new products and emerging brands and its e-commerce platform.

  • Our price target on UNFI shares remains $60, which offers more than 30% upside from current levels. As such we are keeping our Buy rating intact.

 

 

What Now After Being Stopped Out of Costco Shares?

What Now After Being Stopped Out of Costco Shares?

On Friday afternoon we were stopped out of Costco Wholesale (COST) shares on the Tematica Select List when they briefly dipped below our $170 stop loss. Even though it was for the briefest of moments, the $169.90 low for the day means that protective measure was triggered following quarterly earnings that missed expectations Thursday night. Recall we sold half the position for a gain of more than 14 percent before dividends, and when paired with the stopping out of the remainder of the position, the blended return before dividends on the Tematica Select was 14 percent vs. a 9.8 percent move in the S&P 500 over the same time frame.

 

The Catalyst Behind the Dip in the Share Price

While Costco’s revenue for the quarter was a whisper below expectation, earnings for the quarter were impacted by gross margin pressure primarily due to lower gas profitability vs. a year ago. You’ve probably noticed that gas prices have undergone a large double-digit increase since last year, and even Costco is not immune. In our view, this highlights the company’s thin retail margin structure, which can create earnings volatility from time to time.

While many focused on the earnings miss, we have been far more focused on Costco’s announced membership price increase that will bring its primary membership to $60 from $55 and its Executive Memberships in the US and Canada to $120 from $110. We see those $5 and $10 increases as not egregious, especially when compared to the $100 increase in the annual fee for American Express’s (AXP) Platinum Card that kicks in later this year, and suspect the vast majority of Costco members won’t blink at the price hike.

From an investor perspective, we like the announced price hikes because it translates into higher membership fees, which account for roughly 75 percent of overall operating income and help stabilize quarterly retail margin swings. Paired with more warehouse locations as Costco continues to grow its footprint and as Cash-strapped Consumer turn increasingly to Costco for fresh foods as well as bulk items, we continue to see solid revenue and earnings growth ahead. Exiting its most recent quarter, Costco had 728 warehouses, up from 698 in the year-ago quarter, with plans to add another 29 locations during 2017.

Again, we were stopped out of the position on Friday, but given the business model dynamics and Costco continuing to benefit from the Cash-strapped Consumer tailwind, we’re inclined to revisit the shares in the coming weeks with an eye toward getting them back on the Tematica Select List at better prices.