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Previewing AT&T (T) Earnings and Watching Capital Spending Levels for Dycom (DY)

Previewing AT&T (T) Earnings and Watching Capital Spending Levels for Dycom (DY)

After today’s market close when Connected Society company AT&T (T) reports its 1Q 2017 results we will get the first of our Tematica Select List earnings for this week. This Thursday we’ll get quarterly results from both Amazon (AMZN) and Alphabet (GOOGL) with several more to follow next week.

Getting back to AT&T, consensus expectations call for the company to deliver EPS of $0.74 on revenue of $40.57 billion for the March quarter. As we have come to appreciate, these days forward guidance is as important as the rear view mirror look at the recently completed quarter; missing either can pressure shares, and mission both only magnifies that pressure. For the current (June 2017) quarter, consensus expectations are looking for AT&T to earn between $0.72—$0.79 on revenue of $40.2-$41.3 billion.

Setting the state for AT&T’s results, last week Verizon (VZ) issued its March quarter results that saw both its revenue and earnings miss expectations. Buried in the results, we found decreased overage revenue, lower postpaid customers and continued promotional activity led to a year on year revenue delicate for Verizon Wireless. The culprits were the shift to unlimited plans and growing emphasis on price plans that likely led to customer switching during the quarter.

If AT&T were still a mobile-centric company, we’d be inclined to re-think our investment in the shares, but it’s not. Rather, as we’ve discussed over the last several months, given the pending merger with Time Warner (TWX), AT&T is a company in transition from being a mobile carrier to a content-led, mobile delivery company. As we’ve seen in the past, consumers will go where the content is (aka Content is King investment theme), and that means AT&T’s content portfolio provides a competitive moat around its mobile business. In many ways, this is what Comcast (CMCSA) established in buying NBC Universal — a content moat around its broadband business… the difference is tied to the rise of smartphones, tablets and other mobile content consumption devices that have consumers chewing content anywhere and everywhere, and not wanting to be tied down to do so.

For that reason, we are not surprised by Comcast launching Xfinity Mobile, nor were we shocked to hear Verizon is “open” to M&A talks with Comcast, Disney (DIS) and CBS (CBS) per CEO Lowell McAdam. In our view, Verizon runs the risk of becoming a delivery pipe only company, and while some may point to the acquisitions of AOL and Yahoo, we’d respond by saying that both companies were in troubled waters and hardly must-have properties.

With AT&T’s earnings, should we see some weakness on the mobile side of the business we’re inclined to let the stock settle and round out the position size as we wait for what is an increasingly likely merger with Time Warner.

 

We’re Also on the Look Out for Datapoints Confirming Our Position in Dycom (DY)

As we listen to the call and dig through the results, we’ll also keep an eye on AT&T’s capital spending plans for 2017 and outer years, given it is Dycom’s (DY) largest customers (another position in our Tematica Select List). As we digest that forecast and layer it on top of Verizon’s expected total capital spending plan of $16.8-$17.5 billion this year, we’ll look to either boost our price target on Dycom or revise our rating given we now have just over 8 percent upside to our $115 price target.

 

Tematica Select List Bottomline on AT&T (T) and Dycom (DY)
  • Our price target on AT&T (T) shares remains $45; should the shares remain under $40 following tonight’s earnings, we’ll look to scale into the position and improve our cost basis.
  • Heading into AT&T’s earnings call, our price target on Dycom (DY) shares remains $115, which offers less than 10 percent upside. This earnings season, we’ll review customer capital spending plans to determine addition upside to that target, but for now given the pronounced move in DY shares, up more than 18 percent in the last month, we’d hold off committing fresh capital at current levels.

 

 

Quick Thoughts on Alphabet and McCormick Shares

Quick Thoughts on Alphabet and McCormick Shares

Alphabet Gets Dinged, But Is Already Responding to Advertiser Concerns

The last few days have seen a rating downgrade on Asset-lite Business Model company Alphabet (GOOGL) and its shares to Market Perform from Outperform by Bank of Montreal and a new Hold rating at Loop Capital. Despite the accelerating shift toward digital commerce and streaming content that is benefitting several of Alphabet’s businesses, the shares are caught in a push-pull over the recent snafu that placed ads next to what have been described as “offensive and extremist content on YouTube.”

We certainly understand that reputation is a key element at consumer branded companies — from restaurants to personal care products and all those in between. As we said previously, we expect there will be some blowback on Alphabet’s advertising revenue stream, and some estimates put that figure between $750 million – $1.5 billion, but the fact of the matter is that it all comes down how much time elapses before those consumer branded companies return —they will come back, they always come back to Google.

The good news is Alphabet has improved its ability to flag offending videos on YouTube and has the ability to disable ads. The company is going one step further and is introducing a new system that, “lets outside firms verify ad quality standards on its video service, while expanding its definitions of offensive content.”  These new decisions, as well as Alphabet’s stepped up action come at a crucial time, given that Newfronts (which is the time when digital ad platforms pitch their tools and inventory) starts May 1. In our view, Alphabet needs to win back advertisers’ trust and we’re hearing some advertisers that recently pulled their spending, like Johnson & Johnson (JNJ), are already reversing their decision.

The bottom line is while the recent advertising boycott is likely to cause some short-term revenue pain that is likely to be a positive for our Connected Society position in Facebook (FB) shares, the longer-term implications are likely to be positive for Alphabet as these new measures win back companies and provide assurances that their brands are safe on YouTube and other Alphabet properties.

  • While we see potential upside to our $900 price target, we would caution subscribers to wait for the advertising boycott news to be priced into the shares, something that is not likely to happen fully until Alphabet reports its quarterly earnings on April 27. 

 

 

As expected, McCormick Reaffirms Long-Term Guidance, But Its 2H 2017 That Matters

Earlier this morning, ahead of today’s investor day, Rise & Fall of the Middle-Class investment theme company McCormick & Co. (MKC) reiterated its long-term constant currency objectives calling for both annual sales growth of 4 to 6 percent and EPS growth of 9 to 11 percent. Coming off of the company’s recent quarterly earnings, this reiteration comes as little surprise. What will be far more insightful will be management laying out its agenda to cut $400 million in costs between 2016 and 2019, not to mention more details on how it aims to deliver double digits earnings growth year over year in the back half of this year following its recent quarterly earnings cadence reset.

We continue to like the company’s business, which is benefitting from shifting consumer preferences for eating at home and eating food that is good for you as well as rising disposable incomes in the emerging economy. There is little question the company is a shrewd operator that is able to drive costs savings and other synergies from acquired companies. We also like the company’s increasing dividend policy, which tends to result in a step up function in the share price.

  • With just over 12 percent upside to our $110 price target, we need greater comfort the company can deliver on earnings expectations for the second half of the year or see the shares retreat to the $95 level before rounding out the position size in the portfolio. 
  • For now, we continue to rate MKC shares a Hold.

 

 

 

Assessing the Market as We Get Ready for 1Q17 Earnings Deluge

Assessing the Market as We Get Ready for 1Q17 Earnings Deluge

Despite yesterday’s move higher in the stock market, March to date has seen the Dow Jones Industrial Average move modestly lower with a larger decline in the Russell 2000. Only the Nasdaq Composite Index has climbed higher in March, bringing its year to date return to more than 9 percent, making it the best performing index thus far in 2017. By comparison, the Dow is up 4.75 percent, the S&P 500 up 5.35 percent and the small-cap heavy Russell 2000 up just 0.75 percent year to date.

So what’s caused the move lower in the stock market during March, bucking the upward trend the market enjoyed since Election Day 2016?

Despite the favorable soft data like consumer confidence and sentiment readings, investors are waking to the growing disconnect between post-election expectations and the likely reality between domestic economic growth and earnings prospects. Fueling the realization is the move lower in 1Q 2017 earnings expectations for the S&P 500, per data from FactSet, as well as several snafus in Washington, including the pulling of the vote for the GOP healthcare plan. These have raised questions about the timing and impact of President Trump’s stimulative policies that include infrastructure spending and tax reform.

We’ve been steadfast in our view that the earliest Trump’s policies could possibly impact the US economy was late 2017, with a more dramatic impact in 2018. On a side note, we agree with others that would have preferred to have team Trump focus on infrastructure spending and tax reform ahead of the Affordable Care Act. As we see it, focusing on infrastructure spending combined with corporate tax reform first would have boosted confidence and sentiment while potentially waking the economy from its 1.6 to 2.6 percent annual real GDP range over the last five years sooner. We’d argue too that that would have likely added to Trump’s political war chest for when it came time to tackle the Affordable Care Act. Oh well.

 

Evolution of Atlanta Fed GDPNow real GDP forecast for 2017: Q1

 

So here we are and the enthusiasm for the Trump Trade is being unraveled as growth slows once again. As depicted above, the most recent forecast for 1Q 2017 GDP from the AtlantaFed’s GDPNow sits at 1.0 percent compared to 1.9 percent for 4Q 2016 and 3.5 percent in 3Q 2016. Even a grade school student understands the slowing nature of that GDP trajectory. Despite all the upbeat confidence and sentiment indicators, the vector and velocity of GDP forecast revisions and push outs in the team Trump timing has led to to the downward move in S&P 500 EPS expectations for the current quarter and 2017 in full.

With Americans missing bank cards payments at the highest levels since July 2013, the delinquency rate for subprime auto loans hitting the highest level in at least seven years and real wage growth continuing to be elusive, the outlook for consumer spending looks questionable. Factor in the aging of the population, which will have additional implications, and it looks like the consumer-led US economy is facing more than a few headwinds to growth in the coming quarters. These same factors don’t bode very well for the already struggling brick & mortar retailers like Macy’s, Sears, JC Penney, Payless and others.

Now here’s the thing, currently, the S&P 500 is trading at 18x 2017 expectations —expectations that are more than likely to be revised down than up as the outlook for U.S. economic growth in the coming quarters is revisited. In three days, we close the books on 1Q 2017 and before too long it means we’ll be hip deep in corporate earnings reports. If what we’ve seen recently from Nike, FedEx, General Mills, Kroger and Target is the norm in the coming weeks, it means we’re more likely to see earnings expectations revised even lower for the coming year.

While it’s too early to say 2017 expectations will be revised as steeply as they were in 2016, (which started the year off with the expectation of a 7.6 percent increase year over year but ended with only a 0.5 percent increase following 4Q 2016 reporting), but any additional downward revisions will either serve to make the market even more expensive than it currently is or lead to a resumption of the recent downward move in the market. Either way, odds are there is a greater risk to the downside than the upside for the market in the coming weeks.

Buckle up; it’s bound to get a little bouncy.

WEEKLY ISSUE: Getting prepared before the velocity of earnings reports kicks into higher gear

WEEKLY ISSUE: Getting prepared before the velocity of earnings reports kicks into higher gear

With three trading days left to go in the quarter, we wanted to share some quick thoughts on several Tematica Select List positions, especially those like AMN Healthcare (AMN) and Alphabet (GOOGL), both of which received much attention last week that weighed on the shares of both companies. Even though all the major market indices fell last week, it wasn’t all bad news for the Tematica Select List as International Flavors & Fragrances (IFF) continued it move higher as did Facebook (FB) and several others.

As we shared in this week’s Monday Morning Kickoff and on last week’s Cocktail Investing Podcast, investors are giving the market a re-think as they juxtapose the speed of the economy and prospects for earnings growth near-term. While some shares on the Tematica Select List have come under some pressure, as we noted above, the thematic tailwinds that are powering the businesses behind these companies remain intact. As we get ready for the soon to be upon March quarter earnings season, we’ll be mindful of expectations as we watch for negative earnings pre-announcements. With the deluge of earnings coming at us, we’ll be revisiting stop loss levels in the coming days, and intend to make any and all adjustments before the velocity of earnings reports kicks into higher gear.

We’ve got a full review of the Tematica Select List, so we’ll keep the preamble to a minimum and get to it . . .

Alphabet (GOOGL) 
Asset-lite Business Models

GOOGL shares fell more than 1.0 percent over last week following the decision by a handful of high-profile consumer brands like Verizon (VZ) and our own AT&T (T) to pull advertising from Google’s YouTube over offensive content. While Alphabet doesn’t break out YouTube’s financial performance, this concern over “brand safety” could be a bump in the road for the business as advertisers look to other outlets, from Facebook (FB) to more traditional broadcast and cable TV. Much like fake news, we see this as a temporary set back for Alphabet and suspect before too long Alphabet will put protocols in place for such offensive content.

Also last week it was reported that Alphabet submitted a bid against Amazon and Facebook to stream Thursday Night Football games next season on YouTube. Given the aforementioned YouTube advertising issue, a win here would help smooth over advertisers in our view and Alphabet certainly has the balance sheet to compete.

The accelerating shift toward digital advertising and shopping bodes very well for Alphabet’s core search and advertising business, while the same for streaming bodes well for YouTube. Those drivers have Alphabet tracking to grow earnings more than 17 percent in 2018 vs. 2017 and the shares are trading at 22x consensus 2018 expectations that sit at $38.92 per share, essentially a PEG ratio of 1.25.

  • Our price target on GOOGL remains $975 and the rating is a Buy at current levels.

 

Amazon (AMZN)
Connected Society

Shares of Amazon rose 1.5%, but year to date are up more than 14 percent. Last week brought a number of announcements that, from out vantage point, confirm the company’s position in our increasingly Connected Society and Amazon’s plans to expand its footprint:

  • Amazon acquired all of Souq.com, a Dubai-based online retailer to better position itself in the young and tech-savvy Middle East markets of Kuwait, Saudi Arabia and the United Arab Emirates.
  • Amazon is reportedly partnering with the German logistics company DHL to leverage its Cincinnati/Northern Kentucky Airport to build out its upcoming Prime Air cargo hub operation. We see this as the latest step in Amazon looking to shrink time to customer as part of its growing Fulfilled By Amazon offering. The partnership also reportedly includes the introduction of AmazonFresh food deliveries in Germany starting next month, which also serves to extend service offering deeper into the eurozone.
  • Amazon is also seeking approval from India’s Trade Ministry to invest about $500 million in a grocery venture.
  • For those concerned that Amazon may be putting too much on its plate, it’s being reported that Amazon has postponed a much expected launch into Southeast Asia from 1Q 2017 to sometime later this year.

The common thread among these items is that Amazon continues to expand its footprint, which augurs for continued growth in the coming quarters. Stepping back and looking at the company’s competitive positions that are poised to benefit from their respective tailwinds — the shift to digital consumption (shopping, content streaming, grocery) and Cloud adoption — and are poised for additional share gains, we see favorable revenue and profit growth over the long term.

  • For now, we are keeping our $975 price target intact as well as our Buy rating. As we have said before, Amazon is a stock to own, not trade.

 

AMN Healthcare (AMN)
Aging of the Population

Shares of this workforce management company that serves the health-care industry, and nursing primarily, dropped last week on concerns over the repeal and replacement of the Affordable Care Act. With Republicans pulling the GOP health plan vote last week, and President Trump clearly signaling that he will be moving on with his agenda, we see the pressure that led to the sharp pullback in AMN shares last week abating as the Affordable Care Act remains intact.

We continue to be fans of the pain point that is the healthcare worker shortage, particularly for nurses, that is powering AMN’s business as the domestic population continues to skew older placing greater demands on healthcare.

  • With the rebound in the share price over the last few days, we now have roughly 14 percent upside to our $47 price target, which has us keeping our Buy rating for now. 
  • As the shares approach $43, we would be less inclined to commit fresh capital to the position. 

 

Applied Materials (AMAT)
Disruptive Technologies

Just over a month ago, we added shares of Applied Materials, a leading nano-manufacturing equipment, service, and software provider to the semiconductor, flat panel display (FPD), and solar industries, to the Tematica Select List, with a 12-18-month price target of $47. Recent bullish commentary in Barron’s underscores our bullish view on the company and its shares as it benefits form several multi-year tailwinds that include not only ramping industry capacity for organic light emitting diodes, but also 3D NAND flash and the industry need to add DRAM capacity.

  • We have ample upside to our $47 price target and we’d look to scale into our position on share price weakness below $33, as long as the current outlook remains intact, or on signs the ramp in semi-cap and display equipment is ramping stronger than expected.

 

AT&T (T)
Connected Society

Year to date, AT&T shares have traded sideways, as we wait for more details on the pending merger with Time Warner (TWX). Chatter in and around Washington seems to suggest that President Trump has softened his opposition to the combination of the two companies as it looks to get regulatory approval before the end of the year. This week there is a pending decision to be had in Washington that will create a nationwide publish safety network dubbed FirstNet. That special meeting will be held Wednesday (March 29), and the growing consensus is the ensuing vote is likely to pave the way for AT&T to be awarded with a 25-year deal to build and maintain the much-anticipated nationwide public-safety broadband network. We’ll be looking for the outcome next week, which would be a nice positive for the company’s business and our shares.

  • As more clarity on the merger with Time Warner develops, we are likely to revisit our current $44 price target. 
  • All things being equal we are likely to add to the position below $40.

 

CalAmp (CAMP)
Connected Society

This wireless solutions company competes in the developing Internet of Things market, better known as telematics, and resonates with our Connected Society investing theme. CAMP shares fell just under 2 percent over the last week. Year to date, the shares are up more than 15 percent. Given growing investor concern over growth, we suspect more short-termed investors were taking profits last week given the CAMP story is one weighted toward the back half of the year given the looming electronic logging device (ELD) mandate.

Building off its relationship with Caterpillar (CAT), CalAmp recently introduced AssetOutlook, a telematics application designed to optimize construction operations for off-road equipment and on-road vehicles. CalAmp also recently announced its entrance into the cold-chain and supply-chain visibility markets, an area forecasted to reach $5.4 billion in size by 2021.

  • With ample multi-year growth prospects on the horizon, we continue to rate the shares a Buy with a $20 price target.

 

Dycom Industries (DY)
Connected Society

Year to date, Dycom shares are up more than 15 percent vs. 5.35 percent for the S&P 500. Given the strong move in the shares year to date we suspect some profit-taking has been taking place over the last several days. With the expected win by Dycom customer AT&T (T) this week for a 25-year deal to build and maintain the much-anticipated nationwide public-safety broadband network, we are likely to see some lift in DY. Longer-term as Dycom’s customers deploy both next-generation solutions as well as add incremental capacity to existing networks, we remain bullish on the name.

One risk we have to watch for given the nature of Dycom’s business is disruption due to weather; thus far the company has benefited from mild winter weather, but we now need to account for the recent storm, Stella, that hit the Northeast.

  • Our price target is $115, which offers potential upside of more than 25 percent from current levels and has us rating the shares a Buy.

 

 

Facebook (FB)
Connected Society

Our Facebook shares continued to move higher last week, ensuring its place as the best-performing position on the Tematica Select List thus far in 2017. While we currently have another 9 percent to our $155 price target, there are reasons to think there could be additional upside potential as the company continues to expand the reach of its platforms (Facebook, Instagram, WhatsApp) and their monetization.

Last week Facebook shared that Instagram’s advertising base topped 1 million businesses, which comes at a time when Google is received advertising blowback given some of its content. While that is likely to be a short-term disruption, we see incremental wins by Facebook across its various platforms. On the news front, Facebook is one of several firms hoping to stream Thursday Night Football games next season — this would be a big win for the company, but it is going up against Amazon and Google. We’ll continue to watch for more details.

The next known catalyst for FB shares will be the F8 Annual Developer Conference on Apr. 18, at which we should learn above new product features as well as the recently launched Facebook 360. This event is likely to be a week or two before the company reports 1Q 2017 earnings.

  • For now, our price target remains $155 and our rating a Buy, but should the shares cross $142, we would not add further to the position

 

 

International Flavors & Fragrances (IFF) 
Rise & Fall of the Middle Class

Having climbed more than 11 percent, IFF shares have been a solid performer year to date. Last week the company gave an upbeat presentation at the CAGE Conference 2017 and the positive reception that drove the shares higher also meant we are encroaching on our $145 price target.

With roughly 10 percent upside to that level, we’re not inclined to add fresh capital to the position at or near current levels. As we do this, we recognize new product categories, such as dairy, that aided Coca-Cola (KO) during the December quarter, as well as alternative sweetener demand by beverage companies ranging from Coca-Cola to PepsiCo (PEP) and Dr. Pepper Snapple (DPS), bode well for the flavors business in the coming quarters. The same is true with candy companies looking to cut back sugar, but preserve taste. Even longer term, the outlook remains bright for this market as the Freedonia Group’s forecast calls for global demand for flavors and fragrances to reach $26.3 billion by 2020, which would be a 21 percent increase from $21.7 billion in 2015.

 

  • As new data becomes available, we’ll continue to evaluate potential upside to our $145 price target. 

 

McCormick & Co. (MKC)
Rise & Fall of the Middle Class

Yesterday as part of reporting better than expected February quarter results and reaffirming it full year guidance, McCormick reshuffled EPS expectations for the balance of the year. The company cut expectations for the current quarter due to continued currency headwinds, a higher than usual tax rate and ramping marketing costs for newer products.

As we expected, MKC shares came under some pressure yesterday, but held off reaching the $95 level at which we’d be more inclined to scale into the position. Also as expected, the double-digit earnings growth in the back half of the year was a central topic on the earnings conference call. Our confidence in the company’s ability to deliver centers on its ability to extract price increase outside of the US later this quarter that will have a full impact in the back half of the year following US price increase in January as well headway on its $100 million in targeted cost savings and additional share buybacks.

  • Looking at the bigger picture, consumers continue to eschew restaurants and are shifting their palates to healthier meals, all of which plays into McCormick’s hands. 
  • Our price target on the shares is $110, which offers just under 12 percent upside from current levels. 
  • Again, we’d be more inclined to scale into the shares closer to $95.

 

Nuance Communications (NUAN)
Disruptive Technology

Nuance shares were rose more than 1 percent over the last week and year to date are up more than 13 percent. As the shares moved higher, we continued to get more proof points for voice digital assistants from Marriott (MAR), which is testing Apple’s (AAPL) Siri and Amazon’s Alexa technology to decide which it will use to control devices in its hotel rooms. Also too, Starbucks (SBUX) now allows for mobile orders via Ford (F) vehicles equipped with its SYNC3 voice-activated technology as well as Amazon’s Echo devices.

While we tend to focus on home and car voice applications, we’d remind you that healthcare is a burgeoning market for voice digital assistants and plays into Nuance’s strengths, as does mobile. We view the growing adoption and deployment of VDAs in other applications (smartphone, auto, home, etc.) lending credence to Tractica’s forecast for unique active consumer VDA users to grow from 390 million in 2015 to a whopping 1.8 billion worldwide by the end of 2021. During the same period, unique active enterprise VDA users are expected to rise from 155 million to 843 million.

As that market heats up, it isn’t lost on us that Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), Samsung and Huawei are likely to acquire voice-technology companies to improve their capabilities in this area. We can also add IBM (IBM) to that list as it moves toward “human-like accuracy” for speech recognition.

 

  • Against that backdrop, our rating on NUAN shares is Buy and our price target continues to be $21

 

PureFunds ISE Cyber Security ETF (HACK)
Safety & Security

In our view, cyber security should be a part of everyone’s portfolio, especially when we consider that losses from cyber theft, espionage, disruption, and destruction are now spoken of in the trillions of dollars. The global market for cybersecurity, which was only $3.5 billion in 2004, will this year reach $170 billion with the federal government alone will spend $18 billion on cybersecurity. Add these data points to the recent re-introduction of the Developing and Growing the Internet of Things (DIGIT) Act, which shows Congress has estimated that more than 50 billion devices will be connected by 2020, and we are easily reminded that cyber security remains a growth industry.

Our view remains that cybersecurity is a growing issue for individuals, companies and other institutions as connective technologies move past smartphone and other maturing platforms into new areas such as the IoT. The issue is cyber security companies are very much like game console companies — who has the latest offering that is attracting customers? By investing in HACK shares, we get a diversified offering that allows us to catch the rising tide of cyber and related attacks.

 

  • Our price target on HACK shares is $35

 

Starbucks Corp. (SBUX)
Rise & Fall of the Middle Class

Starbucks recently held its annual shareholder meeting at which new CEO Kevin Johnson reiterated the strategy to create new occasions for customer visits, including its new Starbucks Mercado lunch items. We see this building on the company’s food offering, which to date has largely focused on breakfast items. The company is also looking to capitalize on our Food with Integrity investing theme by bringing a line of iced teas to market this summer that have no artificial flavors or sweeteners, as well as gluten-free and vegan food options. With the gluten-free food market expected to grow at an annual rate of roughly 12 percent through 2021, according to global research group Technavio, as investors we applaud Starbucks move to tap into this tailwind. We’d also add this move with iced teas also confirms our position in International Flavors & Fragrances (IFF) as we’re pretty sure Starbucks and others don’t want to sacrifice taste while making these healthy changes.

Amid all of that, Starbucks continues to expand its global footprint as it continues to play the long game, particular in China where it aims to double its store count to 5,000 by 2021. In sum, these initiatives have the company targeting “annual high-single digit unit growth, mid-single digit same store sales growth and EPS growth of 15 to 20 percent.”

The trick in this continued expansion will be ensuring product quality and the consumer experience as the company grows past its 25,000 plus location footprint. We certainly believe the company has watched McDonald’s (MCD) struggle with these issues across its near 37,0000 restaurant locations across the globe and has learned from those mistakes.

While we continue to monitor the company’s top line growth prospects, we’ll also be watching key cost inputs like coffee, which is up 9.7 percent year over year, as well as those for milk (up roughly 7 percent year over year), wheat and other key ingredients. When faced with sustained cost increases Starbucks has tended to implement modest hikes, and while we’ve not heard of any such increases thus far in 2017, we’ll be keeping our ears open. While painful for consumers, these price increases tend to benefit margins when coffee, milk and other input costs fall.

 

  • Our price target on SBUX shares remains $74, which offers 29 percent upside from current levels even before we factor in the quarterly dividend and keeps the shares in the Buy zone. 

 

United Natural Foods (UNFI)
Foods with Integrity

United Natural Foods is a specialty food distributor, which is benefiting from our Food with Integrity tailwind as consumers increasingly look for non-GMO, natural and organic food products, as well as those tied to other lifestyle choices such as gluten-free and paleo. UNFI shares flip-flopped once again last week falling just under 3 percent, but still remain well above their recent post-earnings lows.

According to a study that was recently published in the Journal of the American Medical Association, diet indeed plays a major role in increasing a person’s risk of dying from heart disease, stroke or diabetes — collectively referred to as “cardio-metabolic killers.” In a nutshell, it suggests that in order to lower the risk of dying from a cardio-metabolic disease, Americans likely have to do more than just eat more healthy foods — they have to eat less unhealthy foods as well. We see this as helping explain the shifting consumer preference toward natural and organic products that should continue to drive organic revenues and faster-growing EBITDA at United Natural as it focuses on cost controls.

 

  • Our price target on UNFI shares is $60.

 

 

United Parcel Service (UPS)
Connected Society

Year to date, UPS shares are down more than 7 percent, but are up modestly since we added them to the Tematica Select List in late February. Despite that performance, we continue to favor the shares as the “missing link” in the accelerating shift toward digital commerce. We see this in aggregate each month in the Retail Sales report, but we are also seeing the toll this shift is taking on brick & mortar retailers through a growing combination of store closures and bankruptcies. As those retailers grapple with that shifting landscape, a growing number of them are focusing on direct to consumer via online and mobile platforms, which means more packages needing to be shipped to more people that buying more products online. The bottom line is those packages still need to get to the buyers or the intended recipients, which bodes well for UPS shares. From time to time, there UPS shares get knocked around on chatter than Amazon (AMZN) is building its own logistics business, but that is related to its Fulfilled By Amazon offering and the need to compress shipping as Amazon offers more products under its Prime umbrella. We rather doubt that Amazon is interested in fully replicating UPS’s entire hub and spoke delivery system far and wide across the country.

Given the magnitude of this shopping transformation, we will continue to be patient with UPS shares, especially when there is a holiday shopping lull.

  • Our price target remains $122, which keeps the shares with a Buy rating. 
  • As we are being patient, we’ll be more than happy to collect the current $0.83 per share quarterly dividend, which offers a dividend yield of 3.2 percent at the current share price, and helps support the share price.

 

Universal Display (OLED)
Disruptive Technologies

Shares of this materials and IP licensing company that serves the organic light emitting diode (OLED) display industry climbed nearly 4 percent over the last week, bringing our return to 60 percent since last October. Currently, OLED industry capacity is limited, but adoption by Apple (AAPL) and other smartphone manufacturers, TV vendors and the automotive industry is leading to a pronounced pick-up in this area, which bodes well for Universal’s materials and intellectual property business over the coming quarters. The biggest risk with Universal Display, in our view, is timing associated with new industry capacity coming on stream. Given, however, that our time horizon spans the next few years we are inclined to be patient investors with OLED shares.

  • Our price target is $100, which offers sufficient upside from current levels to warrant a Buy rating.

 

 

Walt Disney (DIS)
Content is King

Disney shares rose just shy of 1 percent last week, bringing the year-to-date return to more than 8 percent and leaving roughly 10 percent upside to our $125 price target. There were two key pieces of news last week, the first of which was the record box office performance of Beauty and the Beast last weekend. We see this offering a number of positives for Disney’s other businesses, just the way Star Wars, Marvel and Pixar films have in the past and should in the coming months.

Also last week was the news over the extension of Chairman & CEO Bog Iger’s contract to July 2019, which should quell concerns over management succession planning at least for the near term. While the bears are likely to pick at ESPN, the reality is we are now in spring break season, which bodes well for Disney’s park business.

As a reminder, Disney recently announced it was boosting ticket prices, which we may cringe at as consumers, but love as shareholders. Combined with leveraging its Frozen and Star Wars content at the parks over the coming years, we see Disney providing new reasons to revisit these destinations.

As we move past March and April, the next catalyst we see for the shares will be several box office films being released  by Disney — Guardians of the Galaxy 2 (May 5), Pirates of the Caribbean: Dead Men Tell No Tales (May 26), Cars 3 (June 16) and Spider-Man: Homecoming (July 7). Those rapid fire releases, likely bode well for this Content is King company across several of its businesses in the second half of 2017.

  • Our price target on DIS shares remains $125.

 

 

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

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

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

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

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

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

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

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

 

 

The Market Climbs Higher, But Look at These Two Charts and It’s Ruh-Roh Time

The Market Climbs Higher, But Look at These Two Charts and It’s Ruh-Roh Time

As the stock market continued to get further and further out over its ski tips last week, as investors we have a split mind on the current state of things. On the one hand, we’re certainly enjoying the higher stock prices. On the other hand, we are mindful of the increasingly stretched market valuation. One of the common mistakes see with investors is they all too easily enjoy the gains, but tend not to be mindful of the risks that could wash those gains away.

Over the last few weeks, we here at Tematica have been pointing out the growing disconnect between the stock market’s valuation and the current economic environment. We have a snootful of data points that underscore our cautious stance in this week’s Monday Morning Kickoff, but we wanted to share two charts from our weekend reading that caught our cautious eye.

There have been some who call into question the use of Robert Schiller’s Cyclically Adjusted Price to Earnings (CAPE) ratio, but Tematica’s Chief Macro Strategist Lenore Hawkins does a pretty good job handling that criticism. Exiting last week the CAPE to GDP growth of 19.77 has far surpassed the 1999 peak and all points back to at least 1950. As we like to say when looking at data, context and perspective are key to truly understanding what it is we’re looking out. So here’s that context and perspective for the current CAPE to GDP reading —  it is over three times the average for the last 66 years. Going back to 1900, the only time today’s ratio was eclipsed was in 1933 and that reflected the Great Depression when GDP has been running at close to zero for nearly a decade.

Students of CAPE will point out that in order for the CAPE to GDP to fall back to more normalized levels, we either need to see a dramatic increase in GDP (not likely in the near-term) or we need to see a pullback in the CAPE. Here’s the thing, as Michael Lebowitz of 720 Capital points out, “if we assume a generous 3% GDP growth rate, CAPE needs to fall to 18.71 or 35 percent  from current levels to reach its long-term average versus GDP growth.” Based on the data we’re seeing, there is a rather high probability 2017 GDP is more likely to be closer to 2.5 percent than 3.0 percent per The Wall Street Journal’s Economic Forecasting Survey of more than 60 economists, which means to hit normalized levels, the CAPE would need to fall further than 35 percent.

As you ponder that and think on why it has us a tad cautious, here’s more food for thought:

 

 

Coming into 2017, forecasts called for the S&P 500 group of companies to grow their collective earnings more than 12 percent year over year, marking one of the strongest years of expected growth in some time. Granted energy companies are likely to be more of a contributor than detractor to earnings growth this year, but we as can be seen by the graph above, earnings expectations for the S&P 500 are already coming down for the current quarter. Those revisions now have year over year EPS growth for the collective at up just over 10 percent.

Are we getting data that shows the current quarter isn’t likely to break out of the low-gear GDP we’ve been seeing for most of the last few years?

Yep.

Are earnings expectations for 2Q-4Q 2017 still calling for 8.5 to 12.5 percent earnings growth year over year?

Yep.

Is it increasingly likely that President Trump’s fiscal policies won’t have a dramatic impact until late 2017 and more likely 2018?

Yep and yep.

The bottom line is we have the stock market melting higher, pulling a Stretch Armstrong-like move in terms of valuation even though earnings expectations for 2017 are starting to get trimmed back.

Yep, you can color us cautious at least for the near-term. While we continue to use our thematic foresight to ferret our companies poised to ride several of our thematic tailwinds, the current market dynamic has us being far more selective.

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What Now After Being Stopped Out of Costco Shares?

What Now After Being Stopped Out of Costco Shares?

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

 

The Catalyst Behind the Dip in the Share Price

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

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

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

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

Costco Shares Fall, But Was It All Bad News For This Cash-Strapped Consumer Play?

Costco Shares Fall, But Was It All Bad News For This Cash-Strapped Consumer Play?

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

We’ve seen such thin margins before when examining brick & mortar retailers across the board from Macy’s (M) and Kohl’s (KSS) to Kroger (KR). It makes for a challenging business, but when it comes to Costco, there’s a key differentiator above and beyond its offering of bulk products.

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

From an investor perspective, we like the announced price hikes because it translates into higher membership fees, which account for roughly 75 percent of overall operating income and help stabilize quarterly retail margin swings. Paired with more warehouse locations as Costco continues to grow its footprint and as Cash-strapped Consumer turn increasingly to Costco for fresh foods as well as bulk items, we continue to see solid revenue and earnings growth ahead. Exiting its most recent quarter, Costco had 728 warehouses, up from 698 in the year-ago quarter, with plans to add another 29 locations during 2017. More locations with more members paying more in membership fees equal more operating income to be had in the coming quarters. As any student taking Financial Statement Analysis knows, operating income is one of the key determinants of Net Income and EPS generation

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

For those looking for more insight on the bulk product and warehouse club industry, but with a hefty dose of our Connected Society investing theme be sure to check out our most recent podcast where we talk with the CEO of Boxed.

Prepping for Dycom’s Earnings This Week

Prepping for Dycom’s Earnings This Week

While we are finally starting to see the pace of corporate earnings reports subside, there are still a number of stragglers on the Tematica Select List. One of those is Dycom Industries (DY), which will report its quarterly results on Wednesday (Mar. 1) before the market open. Consensus expectations call for this communications heavy specialty contractor and Connected Society company to deliver EPS of $0.69 on revenue of $661.8 million and guide the current quarter to EPS of $1.09-$1.18 on revenue of $708-$725 million.

We’ve noted that as Dycom customers have been reporting and sharing their 2017 capital spending plans over the last few weeks, the combined 2017 capital spending plans for Dycom’s core customers — AT&T (T), Verizon (VZ), CenturyLink (CTL) and Comcast (CMCSA) — for broadband and wireless will be up modestly year over year with a greater portion of spending on network capacity and new technologies (5G, Gigabit fiber). We continue to see Dycom as a prime beneficiary of that wireless and wireline capital spending.

As we noted earlier today, this week the 2017 iteration of Mobile World Congress is being held and its one of the major wireless trade shows of the year. We expect a number of announcements to be had, some of which should shed light on expected 5G deployments. We see those items as filling in between the lines for Dycom’s core customers, many of which continue to build out existing 4G LTE networks as they begin to test their 5G offerings.

As we get ready for Dycom’s earnings and follow on management comments during the follow-up conference call, we are inclined to sit tight and be patient with the position given our view that, worst case, it’s only a matter of time for next-generation network technologies to be deployed. Keep in mind, in order for them to be deployed, they first have to be constructed.

  • We continue to rate DY shares a Buy with a $110 price target.
Musings on Apple’s “Record” December Quarter

Musings on Apple’s “Record” December Quarter

Last night Tematica Research Chief Investment Officer Chris Versace appeared on CGTN America’s Global Business program to talk about Apple’s (AAPL) December quarter earnings and several other topics. As CEO Tim Cook put it, “We sold more iPhones than ever before and set all-time revenue records for iPhone, Services, Mac and Apple Watch…” which enabled the company to deliver better than expected revenue and earnings per share relative to Wall Street consensus expectations.

While Cook boasted of strong Apple Watch growth, iPhone shipments were up 5 percent year over year, hardly the robust growth levels we’ve seen in the past. Meanwhile, the Mac business — the next largest one next to the iPhone at just over 9 percent of total revenue — saw volumes rise 1 percent year over year, while iPad units fell 19 percent compared to the year-ago quarter. One bright spot in the company’s December quarter was Apple’s Services business, which rose 18 percent year over year and boasts more than 150 million paid customer subscriptions.

Circling back to that better than expected December quarter EPS, we’d be remiss if we didn’t point out Apple’s net income actually shrank year over year. If it weren’t for the company flexing its cash-rich balance sheet, which clocked in at $246.1 billion, to shrink the share count during 2017 Apple’s reported EPS would have been flat to down year over year instead of being reported up just under 10 percent. Coming into 2017, Apple has nearly $50 billion remaining on its current capital return program, which means more share repurchase activity is possible in the coming quarters.

One other sour point in the earnings report was Apple’s guidance for the current quarter, which fell shy of expectations. One particular call out was the impact of foreign currency, which is expected to be a ‘major negative’ as the company moves from the December to the March quarter.

The long and short of it is that while Apple CEO Tim Cook called it a record quarter, the reality is Apple’s financial performance remains closely linked to the iPhone, which still accounts for 70 percent of Apple’s overall business. To us here at Tematica this means until Apple can bring to market an exciting new product, or reenergize an existing one that can jumpstart growth, the company will be tied to the iPhone upgrade cycle. Expectations for the next iteration, the presumed iPhone 8, call for a new body, new display — hence  Disruptive Technology company Universal Display (OLED) being on the Tematica Select List — and a greater use of capacitive touch that should eliminate the current home button and bezel. But we’ll have to see if this new model on the 10th anniversary of the transformative device’s launch will capture the hearts of customers, as the last couple of models have only had a meh response.

Despite its current reliance on the iPhone, there are hopeful signs at Apple, such as the new AirPods that echo past design glory, an Apple TV business that has 150 million active subscriptions and a growing Services business. The issue is even if Apple doubled its service business in the coming year, it would still account for 15-20 percent of Apple’s overall revenue. Moreover, if that happened in the coming year it would likely mean the next iteration of the iPhone underwhelmed, something Apple is not likely to shoot for on the devices 10-year anniversary. Near-term, Apple is likely to remain a victim of its own success in creating one of the most loved and most used devices on the plant.

We’ll continue to keep tabs on this poster child company for our Connected Society investment theme company, but with no evident catalyst over the coming months, we’re inclined to be patient and pick off the AAPL shares at better prices.

 

Additional Thematic Data Points from Apple’s Earnings Announcement

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

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

We’ll continue to look analyze management commentary for more thematic data points as more companies report their December-quarter earnings over the next few weeks.