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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.

 

Introducing The Thematic Leaders

Introducing The Thematic Leaders

 

Several weeks ago began the arduous task of recasting our investment themes, shrinking them down to 10 from the prior 17 in the process. This has resulted in a more streamlined and cohesive investment mosaic. As part of that recasting, we’ve also established a full complement of thematic positions, adding ones, such as Chipotle Mexican Grill (CMG) and Altria (MO) in themes that have been underrepresented on the Select List. The result is a stronghold of thematic positions with each crystalizing and embodying their respective thematic tailwinds.

This culmination of these efforts is leading us to christen those 10 new Buy or rechristened Buy positions as what are calling The Thematic Leaders:

  1. Aging of the Population – AMN Healthcare (AMN)
  2. Clean Living – Chipotle Mexican Grill (CMG)
  3. Digital Lifestyle – Netflix (NFLX)
  4. Digital Infrastructure –  Dycom Industries (DY)
  5. Disruptive Innovators – Universal Display (OLED)
  6. Guilty Pleasure – Altria (MO)
  7. Living the Life – Del Frisco’s Restaurant Group (DFRG)
  8. Middle-Class Squeeze – Costco Wholesale (COST)
  9. Rise of the New Middle-Class – Alibaba (BABA)
  10. Safety & Security – Axon Enterprises (AAXN)

 

By now you’ve probably heard me or Tematica’s Chief Macro Strategist Lenore Hawkins mention how Amazon (AMZN) is the poster child of thematic investing given that it touches on nearly all of the 10 investing themes. That’s true, and that is why we are adding Amazon to the Thematic Leaders in the 11th slot. Not quite a baker’s dozen, but 11 strong thematic positions.

One question that you’ll likely have, and it’s a logical and fare one, is what does this mean for the Select List?

We wouldn’t give up on companies like Apple (AAPL), Alphabet (GOOGL), Disney (DIS), McCormick & Co. (MKC) and several other well-positioned thematic businesses that are on the Select List. So, we are keeping both with the Thematic Leaders as the ones that offer the most compelling risk-to-reward tradeoff and the greater benefit from the thematic tailwinds. When we have to make an adjustment to the list of Thematic Leaders, a company may be moved to the Select List in a move that resembles a move to a Hold from a Buy as it is replaced with a company that offers better thematic prospects and share price appreciation. Unlike Wall Street research, however, our Hold means keeping the position in intact to capture any and all additional upside.

Another way to look at it, is if asked today, which are the best thematically positioned stocks to buy today, we’d point to the Thematic Leaders list, while the Select List includes those companies that still have strong tailwinds behind their business model but for one reason or another might not be where we’d deploy additional capital. A great example is Netflix vs. Apple, both are riding the Digital Lifestyle tailwind, but at the current share price, Netflix offers far greater upside than Apple shares, which are hovering near our $225 price target.

After Apple’s Apple Watch and iPhone event last week, which in several respects underwhelmed relative to expectations despite setting up an iPhone portfolio at various price points, odds are the iPhone upgrade cycle won’t accelerate until the one for 5G. The question is will that be in 2019 or 2020? Given that 5G networks will begin next year, odds are we only see modest 5G smartphone volumes industry-wide in 2019 with accelerating volumes in 2020. Given Apple’s history, it likely means we should expect a 5G iPhone in 2020. Between now and then there are several looming positives, including its growing Services business and the much discussed but yet to be formally announced streaming video business. I continue to suspect the latter will be subscription based.  That timing fits with our long-term investing style, and as I’ve said before, we’re patient investors so I see no need to jettison AAPL shares at this time.

The bottom line is given the upside to be had, Netflix shares are on the Thematic Leaders list, while Apple shares remain on the Select List. The incremental adoption by Apple of the organic light emitting diode display technology in two of its three new iPhone models bodes rather well for shares of Universal Display (OLED), which have a $150 price target.

Other questions…

Will we revisit companies on the Select List? Absolutely. As we are seeing with Apple’s Services business as well as moves by companies like PepsiCo (PEP) and Coca-Cola (KO) that are tapping acquisitions to ride our Clean Living investing tailwind, businesses can morph over time. In some cases, it means the addition of a thematic tailwind or two can jumpstart a company’s business, while in other cases, like with Disney’s pending launch of its own streaming service, it can lead to a makeover in how investors should value its business(es).

Will companies fall off the Select List?

Sadly, yes, it will happen from time to time. When that does happen it will be due to changes in the company’s business such that its no longer riding a thematic tailwind or other circumstances emerge that make the risk to reward tradeoff untenable. One such example was had when we removed shares of Digital Infrastructure company USA Technologies (USAT) from the Select List to the uncertainties that could arise from a Board investigation into the company’s accounting practices and missed 10-K filing date.

For the full list of both the Thematic Leaders and the Select List, click here

To recap, I see this as an evolution of what we’ve been doing that more fully reflects the power of all of our investing themes. In many ways, we’re just getting started and this is the next step…. Hang on, I think you’ll love the ride as team Tematica and I continue to bring insight through our Thematic Signals, our Cocktail Investing podcast and Lenore’s Weekly Wrap.

 

 

Adding more Del Frisco’s to our plate following several bullish data points

Adding more Del Frisco’s to our plate following several bullish data points

Key points inside this issue

  • We are scaling into shares of Del Frisco’s Restaurant Group (DFRG) following several bullish data points from last week. Our price target for DFRG shares remains $14.
  • Our price target on Amazon (AMZN) remains $2,250
  • Our price target on United Parcel Service (UPS) shares remains $130
  • Our price target on Chipotle Mexican Grill (CMG) shares remains $550
  • Our price target on Costco Wholesale (COST) remains $250
  • I am reviewing our current price target of $130 for shares of McCormick & Co.
  • Last week’s podcast – Lithium Ion Batteries: The Enabler of the Digital Lifestyle
  • Last week’s Thematic Signals

Last Friday we received a number of positive data points for restaurant spending, which coupled with the latest US Department of Agriculture report on falling beef prices has me using the recent weakness in our Del Frisco’s Restaurant Group (DFRG) shares to improve our cost basis. Since adding DFRG shares to the portfolio, they’ve fallen nearly 10% since the end of August and just over 3% since we added them to our holdings despite favorable economic and industry reports. Part of that downward pressure came from Stephens throwing in the towel on its bullish stance on the shares last Wednesday. It would appear that Stephens jumped the gun given the favorable data that emerged later in the week.

Let’s review all of those data points…

 

August Retail Sales

The August Retail Sales report saw its headline figure come in at +0.1% month over month missing expectations of +0.4% and marked the slowest gain since February suggesting persistently high gas prices could be taking a bite out of consumer spending. With prospects for higher gas prices ahead following last week’s greater than expected crude inventory drawdown reported by the Department of Energy and the greater than expected jump in Total Consumer Credit for January, it would appear that Middle-Class Squeeze consumers slowed their spending in August vs. July. Hat tip to Tematica’s Chief Macro Strategist, Lenore Hawkins, and her coverage of those data points in last Friday’s Weekly Wrap. If I’m reading it, so should you.

Turning to the year over year view, August retail sales rose 6.2%, led by a more than 20% increase in gas station sales due to the aforementioned gas prices, and continued gains in Nonstore retailers (+10.4%) and food services & drinking places (+10.1%). Over the last three months, these last two categories are up 9.9% and 9.5% year over year, even as gas station sales are up nearly 21% by comparison. Those figures bode extremely well for our Digital Lifestyle positions in Amazon (AMZN) and United Parcel Service (UPS), our Clean Living holding that is Chipotle Mexican Grill (CMG) and Del Frisco’s Restaurant Group, a Living the Life company.

The report also offered confirming context for our shares in Costco Wholesale (COST) as its August same-store sales handily beat those contained in the August Retail Sales report. Also inside this latest missive from the U.S. Department of Commerce, grocery store sales rose 4.3% year over year in August, which keeps me bullish on our shares of McCormick & Co. (MKC) even as they hover over our current $130 price target.

In terms of areas reporting declines in August Retail Sales Report, we continue to see pressure at Sporting goods, hobby, musical instrument, & bookstores (-3.9%) and Department Stores (-0.7%), continuing the trend of the last few months. With Amazon continuing to flex its business model as well as its own line of private label products, including fashion, sportswear, and apparel, as well as continued digital commerce gains at Walmart (WMT) and its Bonobos brand, we see these retail categories remaining challenged in the coming months.

 

August restaurant data from TDN2K

On Friday we also received figures from TDn2K’s Black Box Intelligence that showed August same-store restaurant sales rose +1.8%, the best highest since 2015. TDn2K’s data is based on weekly sales from over 30,000 locations representing more than 170 brands and nearly $70 billion in annual sales. More positives for our positions in Chipotle and Del Frisco’s. I’ll tuck this data point away as well as the July and eventual September one to compare them against same-store sales quarterly results for out two restaurant holdings.

 

US Department of Agriculture

The most recent data published on Friday by the US Department of Agriculture showed cow prices were down 13.6% year over year in July, continuing the trend of double-digit year over year declines that began this past May. I see this as confirmation of deflationary beef prices that bode well for both margins and EPS gains at both Del Frisco’s and to a lesser extent Chipotle.

Later this week, I’ll look for further confirmation of beef deflation leverage when Darden Restaurants (DRI), the parent of Capitol Grill reports its quarterly earnings.

 

Scaling into Del Frisco’s shares

The net result of these three Friday data points has me adding to our Del Frisco’s Restaurant Group shares at current levels. If our Chipotle shares were lower than our entry point, I’d be doing the same, but they aren’t – if they do fall below the $473 layer, all things being equal I’d look to repeat today’s actions but with CMG shares.

  • We are scaling into shares of Del Frisco’s Restaurant Group (DFRG) following several bullish data points from last week. Our price target for DFRG shares remains $14.
UPDATE: Boosting our Costco Warehouse price target… again

UPDATE: Boosting our Costco Warehouse price target… again

Key points inside this issue:

  • We are boosting our price target on Costco Wholesale (COST) shares to $250 from $230.

 

Last Thursday night, Costco Wholesale (COST) once again shared blow away same-store-sales results this time for the month of August, which reflects the Middle-Class Squeeze tailwind as well as Costco’s positioning to ride our Digital Lifestyle investing theme as well. All told, sales for the period rose 12.2% to $11.0 billion, which capped the company’s August quarter with $43.4 billion, a 5.0% increase vs. the year-ago quarter, which was rather impressive given the year-ago quarter contained an extra week compared to this year. On a same-store sales basis, and stripping out foreign exchange and gas prices, Costco’s overall August sales climbed 8.0% year over year and 7.2% year over for the quarter.

Also impressive was the continued gains, both during August and the overall August quarter, for Costco’s e-commerce business, which was up 24.5% and more than 26%, respectively, when excluding the impact of gas and foreign currency.

And lest you think I forgot, Costco exited August with 762 active warehouse locations, up from 741 exiting a year ago, which bodes and 750 exiting its May 2018 quarter. The greater number of warehouse locations implies greater membership fees and higher membership fee income, which is not only a key differentiator vs. other retailers but also a prime driver of Costco’s EPS.

With consumers feeling the pinch of higher debt levels and inflation, with wage growth only now starting to move, I continue to see Costco extremely well positioned as we move into the seasonally strong shopping season that is the last four months of the year. As the company continues to ride these two thematic tailwinds, I see further upside ahead in the coming months and am boosting our COST price target to $250 from $230. A portion of that increase reflects the move up in EPS expectations over the last 90 days due to the robust same-store sales reports and increases in open warehouse locations, with the balance tied to multiple expansion as Costco continues to shake out Amazon concerns and deliver results that are the envy of the vast majority of brick & mortar retailers. Even as this price target is boosted, we would not chase COST shares at the current share price, but rather sit back and enjoy the ride.

  • We are boosting our price target on Costco Wholesale (COST) shares to $250 from $230.

 

WEEKLY ISSUE: Taking Positions Off the Board and Reallocating Into Existing Positions

WEEKLY ISSUE: Taking Positions Off the Board and Reallocating Into Existing Positions

Key points from this issue

  • We are exiting the shares of Paccar (PCAR), which had an essentially neutral impact on the Select List;
  • We are exiting the shares of Rockwell Automation (ROK), which were a drag of more than 11% on the Select List;
  • We are exiting the shares of GSV Capital (GSVC), which in full returned a modest decline since we added the shares back in April.
  • We are scaling into shares of Applied Materials (AMAT) at current levels and keeping our long-term price target of $70 intact.
  • We are scaling into shares of Netflix (NFLX) at current levels and keeping our long-term price target of $500 in place.

 

After the S&P 500 hit an all-time high yesterday, if the stock market finishes higher today it will mean the current bull market will be 3,453 days old, which will make it the longest on record by most definitions. For those market history buffs, as of last night’s market close, it tied the one that ran from October 1990 to March 2000.

Even as the S&P 500 hit an all-time high yesterday thus far in 2018 it’s up 7.1%. By comparison, we have a number of positions on the Tematica Investing Select List that are up considerably more. Among them are Amazon (AMZN), Apple (AAPL), Costco Wholesale (COST), ETFMG Prime Cyber Security ETF (HACK), Habit Restaurant (HABT), McCormick & Co. (MKC), and USA Technologies (USAT). Not that I’m prone to bragging, rather I’m offering a gentle reminder of the power to be had with thematic investing vs. the herd and sector-based investing.

Over the last few weeks, I’ve been recasting our investing themes, which in some cases has given rise to a new theme like Digital Infrastructure, combined a few prior themes into the more cohesive Digital Lifestyle and Middle-Class Squeeze ones, and expanded the scope of our Clean Living theme. In the next few weeks, I’ll finish the task at hand as well as ensure we have a stock recommendation for each of what will be our 10 investment themes.

As part of that effort, I’m re-classifying USA Technologies (USAT) shares as part of our Digital Infrastructure investing theme. The shares join Dycom Industries (DY) in this theme.

 

Pruning PCAR, ROK and GSVC shares

Once we pass the approaching Labor Day holiday, we will be off to the races with the usual end of the year sprint. For that reason, we’re going to take what is normally the last two relatively quiet weeks of August to do some pruning. This will go hand in hand with the ongoing investment theme reconstitution that will eliminate the stand-alone Economic Acceleration/Deceleration and Tooling & Re-tooling investment themes. As such, we’re saying goodbye to shares of Paccar (PCAR) and Rockwell Collins (ROK). We’ll also shed the shares of GSV Capital (GSVC), which are going to be largely driven by share price movements in Spotify (SPOT) and Dropbox (DBX). As the lock-up period with both of those newly public companies come and go, I’ll look to revisit both of them with an eye to our Digital Lifestyle and Digital Infrastructure investing themes.

  • We are exiting the shares of Paccar (PCAR), which had an essentially neutral impact on the Select List;
  • We are exiting the shares of Rockwell Automation (ROK), which were a drag of more than 11% on the Select List;
  • We are exiting the shares of GSV Capital (GSVC), which in full returned a modest decline since we added the shares back in April.

 

Scaling into Applied Materials and Netflix shares

We’ll use a portion of that returned capital to scale into shares of Applied Materials (AMAT), which approached their 52-week low late last week following the company’s quarterly earnings report that included an earnings beat but served up a softer than expected outlook.

Applied’s guidance called for sales of $3.85-$4.15 billion vs. analyst consensus outlook of $4.45 billion. On the company’s earnings conference call, CEO Gary Dickerson confirmed worries that slower smartphone growth could cause chipmakers to rein in capital spending and reduce demand for chipmaking equipment in the near- term. That’s the bad news, the good news is Applied sees double-digit growth in 2019 for each of its businesses and remains comfortable with its 2020 EPS forecast of $5.08.

From my perspective, I continue to see the several aspects of our Disruptive Innovators investing theme – augmented and virtual reality, 5G, artificial intelligence, Big Data and others – as well as growing storage and memory demands for connected devices driving semiconductor capital equipment demands. There is also the rising install base of semiconductor capital equipment inside China, and with Apple turning to China suppliers over Taiwanese ones to contain costs it likely means a rebound in China demand when the current US-China trade imbroglio ends.

As we wait for that, I suspect Applied will continue to use its stock buyback program During its recently closed quarter, Applied repurchased $1.25 billion or 25 million shares of stock and the company has about $5 billion remaining in buyback authorization. Applied’s next quarterly dividend of $0.20 per share will be paid on Sept. 13 to shareholders of record on Aug. 23.

  • We are scaling into shares of Applied Materials (AMAT) at current levels and keeping our long-term price target remains $70 intact.

Turning to Netflix (NFLX) shares, they are down some just under 20% from where I first added them to the Select List several weeks ago. My thesis on the shares remains unchanged, and I continue to see its streaming video service and original content as one of the cornerstones of our Digital Lifestyle investing theme. Adding to the shares at current levels will serve to reduce our cost basis from just under $420 to just under $380.

  • We are scaling into shares of Netflix (NFLX) at current levels and keeping our long-term price target of $500 in place.

 

 

Weekly Issue: Booking a Tasty Gain in this Guilty Pleasure Stock

Weekly Issue: Booking a Tasty Gain in this Guilty Pleasure Stock

Key points inside this issue

  • Earnings continue to roll in as trade tensions remain and economic data is in conflict.
  • We are selling half the position in Habit Restaurant (HABT) shares on the Tematica Investing Select List, booking a hefty win in the process, and boosting our price target on the remaining shares to $16 from $12.
  • Our price target on Costco Wholesale (COST) shares remains $230
  • Our price target on United Parcel Service (UPS) shares remains $130.

 

We are now more than one-third of the way through the September quarter, and firmly into the month of August, a time that is traditionally one of the slowest times of the year. Corporate earnings for the June quarter continue to come in and the United States has reimposed sanctions on Iran with additional measures potentially later this year as the Trump administration looks to pressure the Tehran regime to negotiate or step aside.

In response to President Trump instructing U.S. Trade Representative Lighthizer to consider raising proposed tariffs on $200 billion in Chinese goods to 25% from 10%, the Chinese government on Friday shared a list of 5,207 U.S. products (meat, coffee, nuts, alcoholic drinks, minerals, chemicals, leather products, wood products, machinery, furniture and auto parts) on which it would impose tariffs between 5% to 25% if the U.S. followed through on proposed tariffs.

The stock market’s performance this week suggests it is shrugging off some of these geopolitical concerns, however, the longer they play out the more likely we are to see them have an impact to earnings expectations. The word “tariff” was mentioned 290 times in S&P 500 conference calls in the first quarter. So far this quarter that number is up to 609, and we have yet to finish the current season. We take this to mean that while many are hopeful when it comes to trade, companies are factoring potential pain into their planning. This could set the stage for a stronger finish to the year if the president is able to deliver on trade. We’ll continue to watch the developments and position the our holdings in the Tematica Select list accordingly.

As we move through the dog days of summer, I’ll continue to chew through the data and heed the messages from all the thematic signals that are around us each and every week.

 

Taking some profits in Habit after a smoking run

Even ahead of last week’s better than expected June quarter results, our shares of Habit Restaurant (HABT) have been rocking and rolling as they climbed just shy of 60% since we added them to the Tematica Investing Select List in early May.

Helping pop the shares over the last few days, Wall Street analysts boosted their forecasts for Habit following strong top and bottom line June quarter results that were driven by several pricing factors and better-than-expected volume, and an outlook that was ahead of expectations. On the pricing front, there were two items worth mentioning. First was the 3.9% increase taken in mid-May to offset California labor pressures, followed by the premium pricing associated with third-party delivery with the likes of DoorDash. As Habit rolls out third-party delivery in other locations and with other partners, such as Seamless with whom it is currently in testing, we are likely to see further pricing benefits that should drop to the bottom line.

Underlying this, our core thesis for the company, which centers on Habit’s geographic expansion outside of its core California market, remains intact. During the June quarter, it opened seven new company-operated restaurants, three of which were drive-thrus. While there were no new East Coast locations during the quarter, Habit remains committed to opening a total of 30 new locations in 2018 with 20% of them on the East Coast — one of which will be right near Tematica in Northern Virginia! Franchisees will add an additional seven to nine locations in 2018, with recently opened ones including Seattle and the second location in China.

In response, we are going to do two things. First, I am boosting our price target for HABT shares to $16, which offers modest upside from the current share price. As we do this, we will prudently book some of those hefty profits to be had given the move in the shares over the last three months, which has them in overbought territory. We will do this by selling half the HABT position on the Tematica Investing Select List, and keep the other half intact to capture the incremental upside. I’ll also continue to monitor the company to gauge its progress relative to revised expectations to determine if another beat is in the cards.

  • We are selling half the position in Habit Restaurant (HABT) shares on the Tematica Investing Select List, booking a hefty win in the process, and boosting our price target on the remaining shares to $16 from $12.

Costco shares get another boost

I recently boosted our price target on Costco Wholesale (COST) shares to $230 from $220. Over the last few weeks the shares have climbed, bringing their return on the Tematica Investing Select List to more than 40%. Yesterday a similar move was had at Telsey Advisory Group (TAG), which raised its COST price target to $230 from $220. The similarities don’t end there as TAG also sees Costco to be a share gainer that should see double-digit growth in earnings per share this year. I’ve said it before, and odds are I’ll say it again, I love it when the herd comes around to our way of thinking.

Later this week, we should receive Costco’s July same-store sales metrics, which should confirm continued wallet share gains but also update us as to the number of open warehouse locations. As a reminder, more open warehouses drive the high margin membership fee income that is a key driver of Costco’s EPS.

  • Our price target on Costco Wholesale (COST) shares remains $230

 

UPS keeps on trucking

Quarter to date, our shares of United Parcel Service (UPS) have soared 13%, bringing the return for us to more than 18%. In my view, the company is clearly benefiting from the improving economy and consumer spending, particularly that associated with our Digital LifeStyle investing theme. As we head into the thick of Back to School spending, let’s remember that UPS is well positioned to benefit not only from Amazon’s (AMZN) Prime Day 2018 but also march toward the year-end holiday spending bonanza that spans from Halloween through New Year’s. Over the last several years, we’ve seen digital shopping win a growing piece of consumer wallets and I see no reason why that won’t continue yet again this year.

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

 

WEEKLY ISSUE: Confirming Thematic Data Points Continue to Pour In

WEEKLY ISSUE: Confirming Thematic Data Points Continue to Pour In

Key points inside this issue:

  • Oh how the stock market has diverged over the last week
  • Ahead of Apple’s (AAPL) upcoming annual product refresh, we are boosting our price target to $225 from $210 for the shares.
  • Our price target on Amazon (AMZN) shares remains $2,250.00
  • Our price target on Costco Wholesale (COST) remains $230.00
  • Our price target on Nokia (NOK) shares remains $8.50
  • Our price target on AXT Inc. (AXTI) shares remains $11.50
  • Our price target on Dycom (DY) shares remains $125.00
  • Here come earnings from Habit Restaurant (HABT)

 

Oh how the stock market has diverged over the last week

Last week the divergence we saw in the major domestic stock market indices continued as both the Dow Jones Industrial Average and the S&P 500 powered higher while the Nasdaq Composite Index and the small-cap heavy Russell 2000 retreated. The technology-heavy Nasdaq moved lower following drops in Facebook (FB) and Twitter (TWTR) late last week, while the Russell’s move lower likely reflecting potential progress on trade following a positive meeting between the US and EU.

In recent weeks, we’ve shared our view that 2Q 2018 earnings season would likely lead to the resetting of earnings expectations, and it appears that is indeed happening. The stock market, however, didn’t expect that resetting to happen with Facebook, Twitter, Netflix (NFLX) and other high fliers. We also shared how that resetting could lead to some downward pressure in the overall market, so we’re not surprised by how it is digesting these realizations.

Also weighing on the market is the realization the 2Q 2018 GDP figure of 4.1%, which was propped up by government spending and some pull forward in demand ahead of tariff phase-ins, is not likely to repeat itself in the current quarter. As we noted above, there was some progress on trade between the US and EU last week — more of an agreement to work on an agreement — and there are still tariffs with Canada, Mexico, and China to face. And as much as we would like to see last week’s progress as hopeful, we’ve heard from a number of companies about how under the current environment higher input costs will weigh on margins and profits in the back half of the year. The response has companies boosting prices to pass along those increased costs, which could either sap demand or stoke inflation concerns.

We saw that rather clearly in the IHS Markit Flash US PMI for July last week. The headline flash PMI index clocked in at 55.9, a three-month low with the manufacturing component at a two month higher while services slipped month over month. One of the key takeaways was summed up by Chris Williamson, Chief Business Economist at IHS Markit who said, “…the July flash PMI is in line with the average for the second quarter and indicative of the economy growing at an annualized rate of approximately 3%.” The same flash report also showed a steep increase in prices with survey respondents citing the impact of tariffs, but also supply chain delays, which in our experience tends to be a harbinger of further price increases.

Because we’re still in the thick of earnings, we’ll continue to assess the situation as more company commentary becomes available and what it means for profits in the coming quarters. Odds are, however, the Fed, is seeing the above and will remain on a path to boost interest rates in the coming months. We’ll get more on that later today when the Fed exits its latest FOMC policy meeting. Barring a meaningful pick up in wage growth it could lead to more restrained consumer spending. We see that as positives for incremental consumer wallet share gains at Amazon (AMZN) and Costco Wholesale (COST) as we head into the seasonally strong shopping season.

  • Our price target on Amazon (AMZN) shares remains $2,250.00
  • Our price target on Costco Wholesale (COST) remains $230.00

 

Apple delivers and boosting our price target in response

We are boosting our price target on Apple (AAPL) shares to $225 from $210. This boost follows last night’s solid June quarter results and guidance, which topped expectations as investors and consumer prepare for the latest iteration of iPhone and other Apple products to hit shelves in the coming months. Here are some of the highlights from Apple’s June quarter:

  • Reported EPS of $2.34 vs. the consensus forecast of $2.18 on revenue of $53.265 billion vs. the expected $52.43 billion.
  • Year over year revenue grew 17% with led by double-digit increases at iPhone, Services and Other while Mac and iPad revenue declined vs. year-ago levels.

Moreover, the company forecasted September quarter revenue to grow double digits sequentially with prospects for an improving gross margin profile. That combination is leading Wall Street to take its EPS expectations higher, and I suspect we will see a number of price target increases this morning.

As exciting as this is — as well as proof positive the Apple model is not broken as some doomsayers would suggest — in several weeks Apple will take the wraps off its revitalized Fall 2018 new product lineup that is expected to have a number of new models across iPhones and iPads. Some products, like iPads, are expected to get new features such as FaceID, while the iPhone X lineup should expand to larger screen sizes as well as lower cost models utilizing an LCD screen instead of an organic light emitting diode (OLED) one. I see the Apple enthusiasm once again cresting higher as that date approaches.

Now let’s break down the quarter’s results:

iPhone revenue grew 20% year over year to $29.9 billion despite tepid smartphone industry dynamics. During the quarter Apple sold 41.3 million iPhones, which paired with the 19% year over year improvement in average selling price (ASP) to $724 vs. $606 in the year-ago quarter drove the revenue improvement. That surge in ASP reflects ongoing demand from the company’s premium iPhone products – iPhone X, iPhone 8 and iPhone 8+.

The Services business grew 30% year over year to $9.5 billion, roughly 18% of overall Apple revenue vs. 16% in the year-ago quarter. The total number of paid subscriptions rose 30 million sequentially to hit 300 million, up from 185 million exiting the June 2017 quarter. I see this as a positive given the subscription nature of iCloud, Apple Music, Apple Care, Texture and other offerings that drive not only cash flow but revenue predictability. During the earnings call, Apple tipped that it has over 50 million Apple Music listeners “when you add our paid subscribers and the folks in the trial…”

As the Services business continues to grow across the expanding Apple device install base, accounting for a greater portion of revenue and profits, odds are investors will begin to re-think how they value Apple shares, especially as the company’s dependence on iPhone sales is lessened at least somewhat. That will be especially true as Apple tips its original content plans, from both a programming perspective as well as pricing and subscription plan one.

Other products grew 37% vs. the year-ago quarter driven by wearables (Apple Watch, Air Pods, Beats) to account for 7% of overall revenue for the quarter.

For the September quarter, Apple guided revenue to $60-$62 billion with gross margin between 38.0-38.5% (vs. 38.3% in the June quarter). That double-digit sequential revenue improvement looks strong heading into the Fall unveiling of new devices, including multiple iPhone models, which as I mentioned earlier is expected to include a larger screen sized iPhone X model as well as a new iPhone X model and a lower priced one with an LCD screen. That implies a rebound in unit volume growth tied with favorable ASPs to drive iPhone revenue growth in the coming quarters. Of course, I continue to see the next major upgrade cycle tied to 5G, which increasingly looks to go live in North America during 2019 and outside the US thereafter.

Investor confidence in new products and Apple’s new product pipeline should be bolstered by the growth in R&D spending that has now outpaced revenue growth in 24 of the last 25 quarters. Historically speaking, when this has happened in the past, it was a forbearer of Apple unveiling a number of new products, including a new product category or two. While it would be easy to read into the possibilities of potential products as 5G goes mainstream, we’ll continue to focus on the near-term upgrades to be had in a few month’s time and what it means for Apple’s businesses.

Exiting the quarter, Apple’s balance sheet had a net cash position of $129 billion even after retiring some 112 million shares during the quarter. On a dollar basis that was $20.7 billion spent on share repurchases during the quarter, including the last part $10 billion of its prior authorization. That leaves roughly $90 billion under its current $100 billion authorization and we continue to see the company supporting the shares with that mechanism.

Finally, last night Apple’s board of directors has declared a cash dividend of $0.73 per share of the Company’s common stock. The dividend is payable on August 16, 2018, to shareholders of record as of the close of business on August 13, 2018.

In sum, it was a stronger than expected quarter that showed Apple’s various strategies bearing fruit with more to come as it updates existing products and introduces new ones as well as new services. If there was one disappointment in the earnings release and conference call it was the lack of discussion around 5G and original content efforts, but my thinking on that is good things come to those who wait.

  • Ahead of Apple’s (AAPL) upcoming annual product refresh, we are boosting our price target to $225 from $210 for the shares.

 

Nokia scores the biggest 5G contract win thus far

Earlier this week, T-Mobile (TMUS) named Nokia (NOK) as a supplier for $3.5 billion in 5G network gear, making this the largest 5G deal thus far. This is clear confirmation of the coming network upgrade cycle that bodes well for not only Nokia’s infrastructure business but will expand the addressable market for its licensing business as well.

Nokia’s deal with T-Mobile US is multi-year in nature, which means the $3.5 million will be spread out over eight-plus quarters. To put some perspective around the size of that one contract, over the last two quarters, Nokia’s infrastructure business has been averaging a little over $5 billion per quarter.  In our view, this speaks to the diverse nature of the customer base across not only the US but the EU, Africa, and Asia.

The thing is, 5G networks will be coming to each of those geographies over the coming years, and for those further out deployments, mobile carriers will be adding incremental 4G LTE capacity.  In other words, we are at the beginning of the 5G buildout, and it may seem like it has taken longer than expected to emerge, the data points from smartphone components to network builds suggest 2019 will be the beginning of a multiyear upcycle in mobile infrastructure demand.

And a quick reminder, we see the coming 5G buildout and the necessary smartphones and other devices driving demand for AXT Inc.’s (AXTI) compound semiconductor substrates. Those shares have been bouncing around like ping-pong balls of late, but we’ll continue to focus on the long-term drivers such as 5G and the eventual smartphone upgrade cycle.

And I would be remiss if I didn’t touch on Dycom Industries (DY) as well. To me, this T-Mobile US news says it is serious about building out its 5G network, and I strongly suspect both AT&T (T) as well as Verizon (VZ) will be sharing their own buildout plans in the coming days and weeks. These carriers are all about one-upping each other be it on data plan pricing or how good their networks are. As AT&T and Verizon fight back, it’s a solid reminder of the activity to be had for Dycom’s specialty contracting business.

  • Our price target on Nokia (NOK) shares remains $8.50
  • Our price target on AXT Inc. (AXTI) shares remains $11.50
  • Our price target on Dycom (DY) shares remains $125.00

 

Here come earnings from Habit

Quickly turning to Habit Restaurants (HABT), the company will report its quarterly earnings after today’s market close. Consensus expectations are looking for EPS of $0.03 on revenue of roughly $100 million for the June quarter. Ahead of that report, Wall Street is coming around to the Habit story. On Monday, investment firm Wedbush bumped up their price target to $15 from $12 and upped their rating to Outperform from Buy. Yes, I am wondering where they’ve been for the last 30% plus rally in HABT shares…

The gist of the upgrade reflects the positive impact to be had from recent price increases as well as premium pricing associated with delivery. Those are certainly positive drivers for revenue and margins, however, I continue to see the bigger thesis centering on the company’s geographic expansion. That expansion means more burgers and shakes being sold in more locations, drive-thru, and delivery. In other words, it’s the platform that allows for these other margin improving activities. This means I’ll be watching the company’s capital spending plans for the coming quarters.

As tends to be the case, I’ll be reassessing our $11.50 price target with tonight’s earnings report given the shares have sailed right through it over the last few days.

  • Heading into tonight’s earnings report, our price target on Habit Restaurant (HABT) shares remains $11.50.

 

Weekly Issue: Amazon Prime Day, Netflix Earnings, Controversy at Farmland Partners and June Retail Sales

Weekly Issue: Amazon Prime Day, Netflix Earnings, Controversy at Farmland Partners and June Retail Sales

Key points from this week’s issue:

  • Amazon (AMZN): What to watch as Amazon Prime Day 2018 comes and goes; Following the strong run in Amazon (AMZN) shares over the last several weeks, our $1,900 price target is under review.
  • Habit Restaurants (HABT): Our price target on Habit shares remains $11.50
  • Costco (COST): We are once again boosting our price target on Costco Wholesale (COST) shares to $230 from $220.
  • Netflix (NFLX): Despite 2Q 2018 earnings results, I continue to see Netflix shares rising further in the coming quarters as investors become increasingly comfortable with the company’s ability to deliver compelling content that will attract net new users, driving cash flow and bottom line profits. Our NFLX price target remains $525.
  • Farmland Partners (FPI): While credibility questions will keep Farmland in the penalty box in the short term, we continue to favor the longer-term business fundamentals. Our price target on FPI shares remains $12.

 

 

Catching up with the stock market

Last week we saw a change in the domestic stock market. After being led by the technology-heavy Nasdaq Composite Index and the small-cap-laden Russell 2000 during much of 2Q 2018, last week we saw the Dow Jones Industrial Average take the pole position, handily beating the other three major market indices. As all investors know, individual stocks, as well as the overall market, fluctuate week to week, but with just over two weeks under our belt in the current quarter, all four major market indices have moved higher, shrugging off trade concerns at least for now.

Of course, those mini market rallies occurred in the calm period before the 2Q 2018 earnings storm, which kicks off in earnest tomorrow when more than 84 companies will issue their report card for the quarter. Last week’s initial earnings reports for 2Q 2018 were positive for the market as was the latest Small Business Optimism Index reported by the NFIB. Despite those positive NFIB findings, which marked the sixth highest reading in the survey’s 45-year history, business owners continue to have challenges finding qualified workers. The challenge to fill open positions is not only a headwind for growth, but also increases the prospects for wage inflation.

For context, that NFIB survey reading matched the record high set in November 2000, which helps explain the survey’s findings for more companies planning to increase compensation. That adds to the findings from the June PPI report that showed headline inflation rising to 3.4% year over year and the 2.9% year-over-year increase in the June CPI report, all of which gives the Fed ample room to continue increasing interest rates in the coming months. Granted, a portion of that inflation is due to the impact of higher oil prices, but also higher metal and other commodity costs in anticipation of tariffs being installed are contributing. Again, these data points give the Fed the cover fire it will need when it comes to raising interest rates, which at the margin means borrowing costs will inch their way higher. Here’s the thing — all of that data reflects the time-period before the tariffs.

The focus over the next few weeks will be on corporate earnings, particularly how they stack up against expectations calling for more than 20% year-over-year EPS growth for the S&P 500 companies in the back half of 2018. So far, in aggregate, the reports we’ve received give little reason to worry, but to be fair we’ve only had a few dozen in recent weeks, with several hundred to be had. But… ah you knew there was a but coming… with companies like truck freight company JB Hunt blowing the doors off expectations but keeping its full-year 2018 guidance intact… a flag is raised. Another flag raised in the earnings results thus far was the consecutive slowdown in loan growth seen at JPMorgan Chase (JPM), Citigroup (C), PNC (PMC) and Wells Fargo (WFC), which came down to 2.1% year-over-year on an aggregate basis from 3% in the March quarter.

If earnings expectations come up short, we will likely see the market trade-off. How much depends on the discrepancy between reality and projections. Also, keep in mind, the current market multiple is ahead of the market’s historical average, and a resetting of EPS expectations could trigger something similar in the market multiple. What this means is at least as we go through the next few weeks there is a greater risk to be had in the market. As we move into the back half of the September quarter, if Trump can show some progress on the trade front we could have a market rally toward the end of the year. Needless to say, I’ll continue to keep one eye on all of this while the other ferrets out signals for our thematic investing lens.

 

It’s that Prime Day time of year

As I write this, we have passed the 24-hour mark in what is one of if not the largest self-created holidays. Better known as Amazon (AMZN) Prime Day, this made-up holiday strategically falls during one of the seasonally slowest times of the year for retailers. For those uninitiated with the day, or those who have not seen the litany of websites touting the evolving number of deals and retail steals being served up by Amazon throughout the day, Prime Day is roughly a day and a half push by Amazon to goose it sales by serving up compelling offerings and enticing non-Prime members to become ones. To put some context around it, Coresight Research forecasts Prime Day 2018 will generate $3.4 billion in sales in 36 hours — roughly 6% of the $58.06 billion Amazon is expected to report in revenue for the entire September quarter.

What separates this year’s Prime Day from prior ones isn’t the prospect for record-breaking sales, but rather the increased arsenal of private label products had by Amazon. Over the last few quarters, Amazon has expanded its reach into private label apparel and athletic wear as well as others like shoes and jewelry. All told, Amazon now sells more than 70 of its own brands, which it can price aggressively on Prime Day helping it win incremental consumer wallet share. Prime Day is also a deal bonanza for Amazon’s own line of electronic devices, ranging from FireTV products to Kindle e-readers and Echo powered digital assistants. The thing with each of those devices is they help remove friction to other Amazon products, such as its streaming TV and music services, Audible and of course its digital book service.

Unlike last year, this year’s Prime Day started off with a hitch in that soon after it began shoppers were met with the company’s standard error page because it was overwhelmed with deal seekers. Not a bad problem and certainly a great marketing story, but it raises the question as to whether Amazon will hit that $3.4 billion figure.

To me, the allure of Prime Day is the inherent stickiness it brings to Amazon as the best deals are offered only to Prime members, which historically has made converts of the previously unsubscribed. Those new additions pay their annual fee and that drives cash flow during a seasonally slow time of year for the company, while also expanding the base of users as we head into the year-end holiday shopping season before too long. Very smart, Amazon. But then again, I have long said Amazon is a company that knows how to reduce if not remove transaction friction. Two-day free Prime delivery, Amazon Alexa and Echo devices, Kindle digital downloads, and Amazon Pay are just some of the examples to be had.

Thus far in 2018, Amazon shares are up more than 58%, making them one of the best performers on the Tematica Investing Select List – hardly surprising given the number of thematic tailwinds pushing on its businesses. Even before we got to Prime Day, we’ve seen Amazon expanding its reach on a geographic and product basis, winning new business for its Amazon Web Services unit along the way. More recently, Amazon is angling to disrupt the pharmacy business with its acquisition of online pharmacy PillPack, a move that has already taken a bite out of CVS Health (CVS) and Walgreen Boots Alliance (WAB) shares. Odds are there will be more to come from Amazon on the healthcare front, and it has the potential to add to its business in a meaningful way as it once again looks to reduce transaction friction.So, what am I looking for from Amazon coming out of Prime Day 2018? Aside from maybe a few of mine own purchases, like a new Echo Spot for my desk, on the company data front, I am going to be looking for the reported number of new Prime subscribers Amazon adds to the fold. Sticking with that, I’m even more interested in the number of non-US Prime subscribers it adds, given the efforts by Amazon of late to bring 2-day Prime delivery to parts of Europe. As we here in the US have learned, once you have Prime, there is no going back.

  • Following the strong run in Amazon (AMZN) shares over the last several weeks, our $1,900 price target is under review.

 

June Retail Sales Report is good for Habit Restaurant and Costco shares

Inside this week’s June Retail Sales Report there were several reasons for investors to take a bullish stance on consumer spending in light of the headline increase of 0.5% month-over-month. On a year-over-year basis, the June figure was an impressive 6.6%, but to get to the heart of it we need to exclude several line items that include “motor vehicles & parts” and “gas stations.” In doing so, we find June retail sales rose 6.4% year-over-year, which continues the acceleration that began in May. The strong retail sales numbers likely means upward revisions to second-quarter GDP expectations by the Atlanta Fed and N.Y. Fed. Despite the positive impact had on 2Q 2018 GDP, odds are this spending has only added to consumer debt levels which means more pressure on disposable income in the coming months as the Fed ticks interest rates higher.

Now let’s examine the meat of the June retail report and determine what it means for the Tematica Select List, in particular, our positions in Habit Restaurants Inc. (HABT) and Costco Wholesale (COST).

Digging into the report, we find retail sales at food services and drinking places rose 8.0% year-over-year in June — clearly the strongest increase over the last three months. How strong? Strong enough that it brought the quarter’s year-over-year increase to 6.1% for the category, more than double the year-over-year increase registered in the March quarter.

People clearly are back eating out and this was confirmed by the June findings from TDn2K’s Black Box Intelligence. Those findings showed that while overall restaurant sales rose 1.1% year over year in June, one of the stronger categories was the fast casual category, which benefitted from robust to-go sales. That restaurant category is the one in which Habit Restaurant competes, and the combination of these two June data points along with new store openings and higher prices increases our confidence in Habit’s second-quarter consensus revenue expectations.

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

Now let’s turn to Costco – earlier this month the warehouse retailer reported net sales of $13.55 billion for the retail month of June an increase of 11.7% from $12.13 billion last year. Compared to the June Retail Sales Report, we can easily say Costco continues to take consumer wallet share. Even after removing the influences of gas sales and foreign currency, Costco’s June sales in the US rose 7.7% year over year and not to be left out its e-commerce sales jumped nearly 28% year over year as well. Those are great metrics, but exiting June, Costco has 752 warehouse locations opened with plans to further expand its footprint in the coming months. New warehouses means new members, which should continue to drive the very profitable membership fee income in the coming months, a key driver of EPS for the company.

Over the last few weeks, COST shares have been a strong performer. After several months in which it has clearly taken consumer wallet share and continued to expand its physical locations, I’m boosting our price target on COST shares to $230 from $220, which offers roughly 7% upside from current levels before factoring in the dividend. Subscribers should not commit fresh capital at current levels but should continue to enjoy the additional melt up to be had in the shares.

  • We are once again boosting our price target on Costco Wholesale (COST) shares to $230 from $220.

 

What to make of earnings from Netflix

Last week we added shares of Netflix (NFLX) to the Tematica Investing Select List given its leading position in streaming as well as original content, which makes it a natural for our newly recasted Digital Lifestyle investing theme, and robust upside in the share price even after climbing nearly 100% so far in 2018. As a reminder, our price target for NFLX is $525.

Earlier this week, Netflix reported its June quarter results and I had the pleasure of appearing on Cheddar to discuss the results as they hit the tape. What we learned was even though the company delivered better than expected EPS for the quarter, it missed on two key fronts for the quarter – revenue and subscriber growth. The company also lowered the bar on September quarter expectations. While NFLX shares plunged in

While NFLX shares plunged in after-market trading immediately after its earnings were announced on Monday, sliding down some 14%, yesterday the shares rallied back some to closed down a little more than 5% at the end of Tuesday’s trading session. Trading volume in NFLX shares was nearly 6x its normal levels, as the shares received several rating upgrades as well as a few downgrades and a few price target changes.

Here’s the thing, even though the company fell short of new subscriber targets for the quarter, it still grew its membership by more than 5 million in the quarter to hit 130 million memberships, an increase of 26% year over year. Combined with a 14% increase in average sales price, revenue in the quarter grew 43% year over year. Tight expense control led to the company’s operating margin to reach 11.8% in 2Q 2018, up from 4.6% in the year-ago quarter.

In recent quarters, the number of Netflix’s international subscribers outgrew the number of domestic ones, and that has a two-fold impact on the business. First, the company’s exposure to non-US currencies has grown to just over half of its streaming revenue and the strengthening dollar during 2Q 2018 weighed on the company’s international results. With its content production in 80 countries and expanding, Netflix will move more of its operating costs to non-US dollar currencies to put a more natural hedging strategy in place. Second, continued growth in its international markets means continuing to develop and acquire programming for those markets, which was confirmed by the company’s comments that its content cash spending will be weighted to the second half of this year.

From my perspective, the Netflix story is very much intact and the drivers we outlined have not changed in a week’s time. I continue to see Netflix shares rising further in the coming quarters as investors become increasingly comfortable with the company’s ability to deliver compelling content that will attract net new users, driving cash flow and bottom line profits.

  • Despite Netflix’s (NFLX) 2Q 2018 earnings results, I continue to see Netflix shares rising further in the coming quarters as investors become increasingly comfortable with the company’s ability to deliver compelling content that will attract net new users, driving cash flow and bottom line profits. Our NFLX price target remains $525.

 

 

Checking in on Farmland Partners

Last week we saw some wide swings in shares of Farmland Partners (FPI), and given its lack of analyst coverage I wanted to tackle this head-on. Before we get underway, let’s remember that Farmland Partners is a REIT that invests in farmland and looks to increase rents over time, which means paying close attention to farmer income and trends in certain agricultural prices such as corn, wheat and soybeans.

So what happened?

Two things really. First, a bearish opinion piece on FPI shares ran on Seeking Alpha last week, which accused FPI of “artificially increasing revenues by making loans to related-party tenants who round-trip the cash back to FPI as rent; 310% of 2017 earnings could be made-up.” Also according to the article FPI “has not disclosed that most of its loans have been made to two members of the management team” and it has “significantly overpaid for properties.”

As one might suspect, that article hit FPI shares hard to the gut, dropping them some 38%. Odds are that article caught ample attention, something it was designed to do. Soon thereafter, Farmland Partners responded with the following data:

  • The total notes and interest receivable under the Company’s loan program was $11.6 million, or 1.0% of the Company’s total assets, as of March 31, 2018.
  • The program generated $0.5 million in net revenues, or 1.1% of total revenue, in the year ended December 31, 2017.
  • The program is directed at farmers, including, as previously disclosed, tenants. It was publicly announced in August 2015, and included in the Company’s public disclosures since then. None of the borrowers under the program as of March 31, 2018 were related parties, or have other business relationships with the Company, other than as borrowers and, in some cases, tenants.

Those clarifications helped prop FPI shares up, but odds are it will take more work on the part of Farmland’s management team to fully reverse the drop in the shares.

In over two decades of investing, I’ve seen my fair share of bears extrapolate from a few, or less than few, data points to make a sweeping case against a company. When that happens, it tends to be short-lived with the effect fleeting as the company delivers in the ensuing quarters. Given the long-term prospects we discussed when we added FPI shares to the Select List, I’m rather confident over the long-term. In the short-term, the real issue we have to contend with is falling commodity prices and that brings us to our second topic of conversation.

As trade and tariffs have continued to escalate, we’ve seen corn, wheat and soybean prices come under pressure. Because these are key drivers of farmer income, we can understand FPI shares coming under some pressure. However, here’s the thing –  on the podcast, Lenore and I recently spoke with Sal Gilbertie of commodity trading firm Teucrium Trading, and he pointed out that not only are these commodity prices below production costs, something that historically is short-lived, but the demographic and production dynamics make the recent moves unsustainable. In short, China’s share of the global population is multiples ahead of its portion of the world’s arable land, which means that China will be forced to import corn, wheat and soybeans to not only feed its people but to feed its livestock as well. While China may be able to import from others, given the US is among the top exporters for those commodities, that can only last for a period of time.

Longer-term, the rising new middle class in China, India and other parts of greater Asia will continue to drive incremental demand for these commodities, which in the long-term view bodes well for FPI shares.

What I found rather interesting in Farmland’s press release was the following –  “We are evaluating what avenues are available to the Company and its stockholders to remedy the damage inflicted.” Looks like there could be some continued drama to be had.

  • While credibility questions will keep Farmland Partners (FPI) in the penalty box in the short term, we continue to favor the longer-term business fundamentals. Our price target on FPI shares remains $12.

 

WEEKLY ISSUE: Trade Concerns and Tariffs Continue to Hold Center Stage

WEEKLY ISSUE: Trade Concerns and Tariffs Continue to Hold Center Stage

Key Points From This Week’s Issue

  • News from Harley Davidson (HOG) and Universal Stainless & Alloy Products Inc. (USAP) confirm tariffs and rising costs will be a hotbed of conversation in the upcoming earnings season.
  • That conversation is likely to lead to a major re-think on earnings growth expectations for the back half of 2018.
  • We are closing out our position in Corning (GLW) shares;
  • We are closing out our position in LSI Industries (LYTS) shares;
  • We are closing out our position in shares of Universal Display (OLED).

 

Trade concerns and tariffs taking center stage

As we saw in Monday’s stock market, where the four major U.S. market indices fell from 1.3% to 2.1%, trade wars and escalating tariffs increasingly are on the minds of investors. Something that at first was thought would be short-lived has grown into something far more pronounced and widespread, with tariffs potentially being exchanged among the U.S., China, the European Union, Mexico and Canada.

In last week’s issue of Tematica Investing, shared how the Tematica Investing Select List has a number of domestically focused business, such as Costco Wholesale (COST), Habit Restaurants (HABT) and recently added Farmland Partners (FPI) to name a few. While the majority of stocks on the Select List traded down with the market, those domestic-focused ones are, generally speaking, higher week over week. Hardly a surprise as that escalating tariff talk is leading investors to safer stocks like a horse to water.

I cautioned this would likely be a longer than expected road to trade renegotiations, with more than a helping of uncertainty along the way that would likely see the stock market gyrate like a roller coaster. That’s exactly what we’ve been seeing these last few weeks, and like any good roller coaster, there tends to be an unexpected drop that scares its riders. For us as investors that could be the upcoming June quarter earnings season.

As we prepare to exit the current quarter, there tend to be a handful or more of companies that report their quarterly results. These tend to offer some insight into what we’re likely going to hear over the ensuing months. In my view, the growing question in investors’ minds is likely to center on the potential impact in the second half of 2018 from these tariffs if they are enacted for something longer than a short period.

Remember that earlier this year, investors were expecting earnings to rise as the benefits of tax reform were thought to jumpstart the economy. While GDP expectations for the current quarter have climbed, the growing concern of late is the cost side of the equation for both companies and consumers. We saw this rear its head during first-quarter earnings season and the widening of inflationary pressures is likely to make this a key topic in the back half of 2018, especially as interest costs for businesses and consumers creep higher.

 

Harley Davidson spills the tariff beans

Well, we didn’t need to wait too long to hear companies talk on those tariff and inflation cost concerns. Earlier this week Harley-Davidson Inc. (HOG) shared that its motorcycle business will be whacked by President Trump’s decision to impose a new 25% tariff on steel imports from the EU and a 10% tariff on imported aluminum.

For Harley-Davidson, its duty paid on imported steel and aluminum from the EU will be 31%, up from 6%. The impact is not small potatoes, considering that the EU has been Harley’s second-largest market, accounting for roughly 16% of total sales last year. On an annualized basis, the company estimates the new tariffs will translate into $90 million to $100 million in incremental costs. That would be a big hit to the company’s overall operating profit, as its annualized March quarter operating income was $254.3 million. With news like that it’s a wonder that HOG shares are down only 6.5% or so this week.

Meanwhile, Universal Stainless & Alloy Products Inc. (USAP), a company that makes semi-finished and finished specialty steel products that include stainless steel, tool steel and aircraft-quality low-alloy steels, announced this week it would increase prices on all specialty and premium products by 3% to 7%. Universal Steel also said all current material and energy surcharges will remain in effect.

 

What does it mean for earnings in the 2Q 2018 quarterly reporting season?

What these two companies have done is set the stage for what we’re likely to hear in the coming weeks about challenges from prolonged tariffs and the need to boost prices to contend with rising input costs, which we’ve been tracking in the monthly economic data. In our view here at team Tematica, this combination is likely to make for a challenging June quarter earnings season, which kicks off in just a few weeks, as costs and trade take over the spotlight from tax cuts and buybacks.

Here’s the thing – even as trade and tariff talk has taken center stage, we have yet to see any meaningful change to the 2018 consensus earnings forecast for the S&P 500 this year, which currently sits around $160.85 per share, up roughly 12% year over year. With up to $50 billion in additional tariffs being placed on Chinese goods after July 6, continued tariff retaliation by China and others could lead to a major reset of earnings expectations in the back half of 2018.

If we get more comments like those from Harley Davidson and Universal Stainless, and odds are that we will, we could very well see those results and comments lead to expectation changes that run the risk of weighing on the market.  We could see management teams offer “everything and the kitchen sink” explanations should they rejigger their outlooks to factor in potential tariff implications, and their words are likely to be met with a “shoot first, ask questions later” mentality by investors. That’s especially likely with the CNN Money Fear & Greed Index back in the Fear zone from Greed just a week ago.

I’m not the only one paying attention to this, as it was reported that Federal Reserve Chairman Jay Powell remarked that some business had put plans to hire or invest on hold because of trade worries and that “those concerns seem to be rising.”

Now there is a silver lining of sorts. Given the upsizing of corporate buyback programs over the last few months due in part to tax reform, any potential pullback in the stock market could be muted as companies scoop up shares and pave the way for further EPS growth as they shrink their share count.

I’ll continue to be vigilant with the Select List in the coming days so we’ll be at the ready to make moves as needed.

 

Doing some further Select List pruning

As we get ready for the 2Q 2018 earnings season that will commence with some fervor after the July 4th holiday, I’m going to take out the pruning shears and put them to work on the Tematica Investing Select List. As I mentioned above, odds are we will see some unexpected cautionary tales to be had in the coming weeks, and my thinking is that we should get ahead of it, remove some of the weaker positions and return some capital to subscribers that we can put to work during 3Q 2018. With that in mind, I am removing Corning (GLW), LSI Industries (LYTS), and Universal Display (OLED) from the Select List. in closing out these positions, I recognize they’ve been a drag on the Select List’s performance of late but we’ll also likely eliminate any further weight on the rest of the Select List.

  • We are closing out our position in Corning (GLW) shares;
  • We are closing out our position in LSI Industries (LYTS) shares;
  • We are closing out our position in shares of Universal Display (OLED).

 

Weekly Issue: Many Confirming Data Points from Retail Sales Report

Weekly Issue: Many Confirming Data Points from Retail Sales Report

 

KEY POINTS FROM THIS ISSUE:

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

 

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

April Retail Sales – the data and comments

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

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

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

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

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

 

April retail sales confirms our bullish stance on Costco

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

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

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

 

Two favorable data points for recently added Habit Restaurant shares

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

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

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

 

Gearing up for earnings from Applied Materials

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

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

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

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

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

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

 

Tim Cook confirms Apple’s move into original content

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

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

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

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