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Adding downside protection and naming a new Thematic Leader

Adding downside protection and naming a new Thematic Leader

Key points inside this issue

  • As more investors reassess coming growth expectations, we are adding ProShares Short S&P500 (SH) to hedge both the Thematic Leaders and the Select List. While not a thematic position but one that will limit near-term downside, we will evaluate this position on as needed basis in the coming weeks.
  • Calling Nokia up to the Thematic Leaders
  • Adding Skyworks Solutions to the Contender’s List
  • Cannabis rumors swirl around Altria

 

Adding some downside protection with SH shares

It’s not often we get a mid-week break for the stock market, and the reason behind yesterday’s stock market closure was a solemn one. It did offer a respite from the wild swing we saw in the market between Monday and Tuesday, which resulted in a demonstrable move lower for all the major market indices. As I shared on Monday, despite the seeming forward motion on US-China trade, there remains much work to be done and a number of headwinds that, as expected, are leading investors to question 2019 EPS growth prospects.

Yesterday, China’s Commerce Ministry released a statement calling trade talks between Presidents Xi and Trump at the G20 Summit in Argentina “very successful.” The statement said the Chinese and U.S. trade and economic delegations will “actively advance the work of consultation” in 90 days in accord with “a clear timetable” and “road map” but offered little concrete details. Odds are this will add to the uncertainty that led Monday’s rally to finish the day off its highs and helped drive the market lower on Tuesday.

In my view, this will keep the market on pins and needles as we digest the coming economic data points to be had that I shared on Monday as well as those for next week that include November reports for inflation, Retail Sales and Industrial Production. As more investors question earnings growth prospects vs. the current stock market multiple, the risk is we could see more downside, especially if those same investors suspect tariffs will indeed be eventually raised to 25% from 10% along with further interest rate hikes. A recent survey of 500 institutional investors by Natixis showed that 65% see a change coming, with the biggest threats being geopolitical tensions and rising interest rates. Between the wage data to be had in Friday’s Employment Report and next week’s PPI and CPI reports, we also run the risk of seeing potentially hawkish comments following today’s latest Fed Beige Book. That report showed tariff driven price increases have spread more broadly through the U.S. economy.

As we get these and other data points ahead of the Fed’s essentially baked in the cake rate hike on December 19, I’ll continue to heed the Thematic Signals we collect each week. Given the market mood, however, I’m adding some downside protection to help insulate subscriber assets in the near-term in the form of ProShares Short S&P500 (SH), an inverse ETF for the S&P 500.

  • As more investors reassess coming growth expectations, we are adding ProShares Short S&P500 (SH) to hedge both the Thematic Leaders and the Select List. While not a thematic position but one that will limit near-term downside, we will evaluate this position on as needed basis in the coming weeks.

 

Samsung set to bring 5G into the prime time

Amid the trade news between the United States and China out of the G-20 summit, there was other news that we’ve been waiting on patiently. Subscribers know that one of our core investment thesis for our positions in Dycom Industries (DY),  AXT Inc. (AXTI), Nokia (NOK) and to a lesser extent Applied Materials (AMAT) shares is the deployment of 5G networks and devices. In the last few months, we’ve heard of beta rollouts from both AT&T Inc. (T) and Verizon Communications Inc. (VZ) as well as fixed wireless testing that could be a replacement for broadband to the home. The thing that has been missing is the to-date elusive announcement on a 5G smartphone that will ride 5G networks and their data speeds, something that will make the speed of the current 4G LTE network look something out of the dial-up days. If you remember those days, you know what I’m talking about — all that’s missing is the wonky connect garble noise.

Let me rephrase: That announcement was elusive until this past Monday when Verizon shared that smartphone users in the United States will be able to use Verizon’s 5G wireless network in the first half of 2019 starting with devices from Samsung. While details of the devices were scant — no models or price points — it is expected that Samsung will be revealing a proof concept this week at the annual Qualcomm Inc. (QCOM) Snapdragon Summit in Maui, Hawaii. Given the location of the unveiling, it seems like a sure bet Qualcomm and its chipsets will be powering the device. No surprise, considering that Samsung long has been a core customer of Qualcomm.

The key point here is the largest smartphone company by volume will be debuting its first 5G market in the coming months.

 

Calling Nokia up to the Thematic Leaders

From our perspective, I see this development as confirming our view on a few levels. Operators are not ones to launch a network unless devices are available for them to monetize that network and all the investments that led to it. That’s a positive for Nokia as it confirms the pending multi-year upswing in 5G infrastructure demand is firmly in front of it, as is the opportunity for its IP licensing business. Second, given Verizon’s timetable of “the first half of 2019,” it means the supply chain soon will be firing up to deliver the components necessary for these devices, including the incremental number of RF (radio frequency) semiconductors needed for 5G. That means incremental wafer demand for AXT during what is a seasonally slow period for smartphones.

As a result, I am calling shares of Nokia up from the Select List to the Thematic Leaders to fill the Disruptive Innovatorsvoid. With Samsung, AT&T, and Verizon having now laid out a timetable for 5G deployments for both networks and devices, we now have a far firmer timetable for a pick up in demand for mobile infrastructure business as well as high margin licensing business. My price target on NOK shares remains $8.50.

  • We are adding Nokia (NOK) shares to the Thematic Leaders for our Disruptive Innovators investing theme. Our price target remains $8.50

 

Adding Skyworks Solutions to the Contender’s List

That incremental RF semiconductor demand for 5G I mentioned a few paragraphs above also means more power amplifiers, switches, filters and other components that will once again increase the dollar content per device for Skyworks Solutions (SWKS) and its competitors. We’ve owned SWKS shares before, and more recently they’ve been battered around as more signs of stalling smartphone demand have emerged leading suppliers to cut their forecasts.

I’ve no intention in jumping into that fray ahead of the seasonally slowest time of the year for smartphone demand – the first half of the calendar year. Rather, we’ll put a pin in SWKS shares, add them to the Contender List and look to revisit them as a Disruptive Innovator play as we either put the March quarter behind us or a new US-China trade deal is inked.

 

Cannabis rumors swirl around Altria

After we published Monday’s Tematica Investing issue, there was much chatter suggesting that Guilty Pleasure Thematic Leader Altria Group (MO) could be interested in acquiring Cronos Group (CRON), a Canadian cannabis company. That speculation sent CRON shares 11% higher on the day and also lifted MO.

As you know, I have held the view that Altria would look to diversify its business away from tobacco and ride the wave of cannabis legalization in the U.S. The key here is legalization across the entire U.S., which would ease manufacturing, distribution, sales and marketing efforts by Altria rather than being an ad-hoc effort. Until the federal ban is lifted, there are also issues with how a company such as Altria would deposit its revenue and profits.

For those looking at Cronos as a positive for Altria’s U.S. business, I think that is a bit presumptuous as the timing of U.S. cannabis legalization remains tenuous. A potential acquisition such as this, however, would give Altria a toehold in the cannabis space, which is legal in Canada, and allow it to learn the business and test market product for an eventual launch in the U.S. when the time is right.

For now, a potential acquisition of Cronos is just speculation, but in principle, it fits with our long-term view of where Altria is likely headed. Now we have to see what Altria does next.

 

 

WEEKLY ISSUE: The Cherry on Top of Apple’s Quarter Earnings Beat

WEEKLY ISSUE: The Cherry on Top of Apple’s Quarter Earnings Beat

 

Key Points from this Alert:

  • After March quarter earnings that shut down the doomsayers, an upsized capital return program and ahead of the upcoming WWDC 2018 event in June, our price target on Apple (AAPL) shares remains $200.
  • What’s the Fed likely to say later today?
  • We are scaling into AXT (AXTI) shares on the Tematica Investing Select List at current levels and keeping our long-term $11 price target intact.
  • We are also adding to our position in LSI Industries (LYTS) shares at current levels, and our price target remains $11.

 

Apple delivers for the March quarter and upsizes its capital return program

Last night in aftermarket trading, Apple (AAPL) shares popped more than 3% after closing the day more than 2% higher as Apple delivered a March quarter that was a sigh of relief to many investors. More specifically Apple served up results on the top and bottom line that were ahead of expectations, guided current quarter revenue ahead of expectations and upsized not only its share repurchase program, but its dividend as well. Heading into the earnings report, investors had become increasingly concerned over iPhone shipments for the quarter, particularly for the iPhone X, following recent comments on high-end smartphone demand from Taiwan Semiconductor (TSM), Samsung and others. That set a low sentiment bar, which the company once again walked over.

What Apple delivered included iPhone shipments modestly ahead of expectations – 52.2 million vs. 52.0 million – and an average selling price that fell $70 to $729. Down but certainly not the disaster that many had fretted for the iPhone X. iPad shipments were also stronger than expected and Apple continued to grow its Services business with Mac sales in line with analyst forecasts. Looking at the Services business, Apple is well on track to deliver on its $50 billion revenue target by 2021 and that’s before we factor in what’s to come from its recent acquisitions of Shazam and Texture as well as its burgeoning original content moves. In my view, that original content move, which replicates a strategy employed by Netflix (NFLX) and Amazon (AMZN), will make Apple’s already incredibly sticky devices even more so.

Think of it as Tematica’s Content is King investing theme meets Connected Society and Cashless Consumption… and yes, I need a better name for that three-pronged tailwind combination.

On the guidance, Apple put revenue ahead of consensus expectations and signaled a modest dip in gross margins due to the memory pricing environment. Even so, the sequential comparison for revenue equates to a quarter over quarter drop of 12.5%-15.5%, which likely reflects a mix shift in iPhones toward non-iPhone models. Pretty much as expected and far better than the doomsayers were predicting.

The bottom line on the March quarter results and June quarter outlook was investors fretted about the iPhone X to an extreme degree… an overreactive degree… forgetting the company has a portfolio of iPhone products as well as other products and services. Some may see the report as giving investors a sigh of relief, but I see it more as a reminder that investors should not count Apple out as we move into an increasingly digital lifestyle.

Is the company still primarily tied to the iPhone? Yes, but it is more than just the iPhone and that is something that will become more apparent in the coming year. We’re apt to see more of that in a month’s time at the company’s annual World-Wide Developer Conference, which several months later will be followed by what continues to sound like an iPhone product line up with refresh with several models at favorable price points.

The added cherry on top of the company’s meet to beat quarter and outlook was the incremental $100 billion share repurchase program and the 16% increase in the dividend. That dividend boost brings the company’s annual dividend to $2.92 per share, which equates to a dividend yield of 1.7%. Looking at dividend yields over the last few years applied to the new dividend supports our $200 price target for Apple shares.

  • After March quarter earnings and ahead of the upcoming WWDC 2018 event in June, our price target on Apple (AAPL) shares remains $200.

 

What’s the Fed likely to say later today?

While many were focused on Apple’s earnings, others, like myself, were also getting ready for the Fed’s latest monetary- policy meeting, which concludes today. Market watchers expect the FOMC to leave interest rates unchanged, but recent data (as well as some comments that company executives have made this earnings season) suggest that we’re seeing a pickup in U.S. inflation.

For example, Caterpillar (CAT) last week shared that its margins likely peaked during the first quarter due to rising commodity prices, most notably steel. Meanwhile, the April IHS Markit Flash U.S. Composite Purchasing Managers Index report last week showed that average prices for goods and services “increased solidly. The rate of input price inflation was the quickest since July 2013.”

And on the manufacturing side, the report noted that “price pressures within the factory sector intensified, with the rate of input-cost inflation picking up to the fastest since June 2011.” Markit also wrote that the services sector “witnessed its average cost burdens climbing month over month as well.”

We also learned just this week that the U.S. Personal Consumption Expenditures Price Index (which happens to be the Fed’s preferred inflation metric) rose 2.4% year over year. While that’s down a few ticks from February’s 2.7%, the PCE came in well above the Fed’s 2% inflation target for the second month in a row.

And lastly, the April ISM Manufacturing Index’s price component edged up to 79.3 from 78.1 in March, easily marking 2018’s highest level so far.

All of these figures have likely caught the Fed’s eyes and ears. Make no mistake about it — the central bank will review them with a fine-toothed comb. The FOMC came out of its last policy meeting rather divided as to the number of rate hikes it expects for 2018. Some FOMC members preferring the three hikes that markets widely expect, but others on the committee increasingly leaned toward four.

In the grand scheme of things, four vs. three rate hikes isn’t a “yuge deal” (as President Donald Trump would say). In fact, more investors are likely expecting the higher numbers of hikes given the recent inflationary economic data. But that’s just the investor base. Odds are that any language in the FOMC’s post-meeting communique that points to an upsized pace of rate hikes is bound to catch the mainstream media and others off-guard.

And one way or another, the Fed’s comments are bound to make the wage data that we’ll be getting in this Friday’s U.S. April jobs report a key focus. A hotter-than- expected headline number will boost the odds that we’ll see a fourth rate hike this year.

But between now and then, expect to see lower-than-usual trading volumes as investors wait to see the latest economic figures while also digesting this week’s litany of earnings reports. Things could get a little wonky, as investors reset expectations for corporate earnings and FOMC hikes, but I’ll continue to let our thematic tailwinds be our guide.

 

Scaling into AXTI (AXTI) shares …

Last week was a challenging one for shares of AXT Inc. (AXTI) and LSI Industries (LYTS), and while that is painful and frustrating in the near-term, I view this as an opportunity to scale deeper into both positions at better prices. The silver lining is this will improve our cost basis for the longer term.

With regard to AXT, the smartphone industry has been currently transfixed on comments from Taiwan Semiconductor (TSM), Samsung and SK Hynix that all warned on demand for high-end smartphones. As we saw last night, those comments were not necessarily indicative of Apple’s iPhone shipments for the March quarter and as I pointed out above Apple has a portfolio of smartphones and a growing services business. Also, given comments from mobile infrastructure company Ericsson (ERIC) and chip-supplier Qualcomm (QCOM), 5G smartphones should be hitting in 2019, which we see fostering the beginning of a major upgrade cycle for the iPhone and other vendors.

This is a great example of focusing on the long-term drivers rather than short-term share-price movement. Later this week two of AXT’s customers — Skyworks Solutions (SWKS) and Qorvo (QRVO) — will report their quarterly results. I expect those reports to reflect the short-term concerns as well as the longer-term opportunity as wireless connectivity continues to move past smartphones. With AXT’s substrates an essential building block for the RF semiconductors, let’s remain patient as I keep our long-term price target at $11, following the company’s first-quarter 2018 results that beat expectations but also call for sequential improvement in both revenue and earnings per share.

  • We are scaling into AXT (AXTI) shares on the Tematica Investing Select List at current levels and keeping our long-term $11 price target intact.

 

… and buying more shares of LSI Industries (LYTS) as well

Now let’s turn to LSI Industries. Concerns about a sudden management change last week, just days ahead of the company’s quarterly earnings report, led LYTS shares to plummet 20% but rebound a bit later in the week even as LSI reported March-quarter results that missed both top-line and bottom-line expectations. While the search for a new CEO is underway, what was said during the earnings conference call was favorable, in my opinion, and supports my thesis on the shares.

First, let’s tackle the elephant in the room that is the sudden CEO departure. As one might expect, such a late in the quarterly reporting game resignation is bound to jar investors, but the near 29% move lower over the ensuing few days was more than extreme. That said, a sudden CEO departure raises many questions, and when it’s in a market that has been registering Fear on the CNNMoney Fear & Greed Index, investors tend to a shoot first and ask questions later mentality.

What I saw on the earnings conference call was a calm management team that is looking for a next-generation CEO. What I mean by that is one that understands the changes that are happening in the lighting market with increasing connectivity in lighting systems and signage. This to me says the desired CEO will be one with a technology background vs. one with a legacy lighting background. Much the way the lighting technology being used is being disrupted with LEDs and soon OLEDs, LSI needs a forward-thinking CEO, not one that only thinks of traditional light bulbs.

Second, the company’s lighting business is nearing the end of its transition to light- emitting diodes (LEDs) from traditional lighting solutions. During the March quarter, LSI’s LED business grew 14% year over year to account for 92% of the segment vs. roughly 80% in the year-ago quarter. Despite that success, the legacy lighting business continues to decline, with sales of those products falling by more than 55% year over year in the March quarter.

With one more quarter left in its transition to LEDs, the weight of the legacy lighting business likely won’t be a factor much longer, and that should allow the power of the LED business to benefit the bottom line. The LED business is riding the combined tailwinds of both environmentally friendly green technology as well as the improving nonresidential landscape.

Alongside its earnings report, LSI’s Board of Directors declared a regular quarterly cash dividend of $0.05 per share that is payable May 15 to shareholders of record as of May 7. The annualized dividend equates to LYTS shares offering a dividend yield of 3.4% at recent levels, well above its historical range of 1.5%-2.5% over the 2015-2017 period. Applying those historical dividend yields to the current annualized dividend yields a share price between $8-$13. The stock market liked this as LYTS shares rallied some 10% over the last several days, but we still have ample upside to my long-term $11 price target.

This tells me that there is much further to go fro LYTS shares in the coming months as LSI finds a CEO and gets its story back on track. Let’s remain patient with this one.Helping with that patient attitude was yesterday’s March Construction Spending Report, which revealed private nonresidential construction rose 3.8% year over year for the month on a non-seasonally adjusted basis.

  • We are adding to our position in LSI Industries (LYTS) shares at current levels, and our price target remains $11.

 

 

SPECIAL ALERT – Adding Nokia shares to the Tematica Select List

SPECIAL ALERT – Adding Nokia shares to the Tematica Select List

 

  • We are issuing a Buy on  Nokia Corp. (NOK) shares with an $8.50 price target.

  • At this time, there is no recommended stop-loss level and we would look to scale into the shares aggressively near $5.50.

 

Yes, you are reading that correctly. After recently adding Nokia Corp. (NOK) shares to the Contender List, we are now adding them to the Tematica Select List given continued progress in its higher margin, intellectual property (IP) business, Nokia Technologies. We’ve seen the power of this Asset-Lite Business Model investment theme before with Qualcomm (QCOM) and InterDigital (IDCC) and it has the power to not only transform Nokia, but deliver EPS  upside relative to expectations.

To jog people’s memory, in the most recent quarter the Nokia Technologies division accounted for 7% of Nokia’s overall revenue, but delivered 37% of operating profit. To be clear, we like the operating leverage in this business. In the coming quarters, we also expect Nokia to benefit from continued wireless infrastructure buildout from both existing 3G and 4G networks as well as eventual deployments on 5G networks.

 

So why add NOK shares to the Select List now?

Early this morning it was announced Nokia won an arbitration battle against LG Electronics, which follows recent deals with Samsung, Apple (AAPL) and Xiaomi Electronics, a Chinese smartphone company. From LG Nokia will receive both a one-time payment, which was not disclosed, as well as recurring revenue that is expected to be in the realm of $275-$300 million. This is a meaningful bump to Nokia’s IP, which had sales of 616 million euros in the first half of 2017, and gives far more comfort in the likelihood of the company hitting 2018 EPS expectations of $0.37, up from this year’s consensus EPS of $0.30. Also too, as Nokia continues to stack up licensees, it becomes increasingly easier to win over its remaining IP targets.

Our price target on Nokia shares is $8.50, which equates to 23x expected 2018 EPS or 1.0 on a price to earnings growth ratio (PEG) basis using the company EPS growth over the 2016-2018 time frame. Given the degree of upside to be had, we are adding NOK shares to the Select List with Buy. At this time, there is no recommended stop-loss level and we would look to scale into the shares aggressively near $5.50.

Over the coming quarters, we expect to see more movement in the company’s wireless infrastructure business as 5G moves from testing and beta to deployment. With Nokia Technologies, the company has booked some impressive wins, and it can turn its attention to Huawei, which according to data compiled by IDC is now the third largest smartphone vendor behind Samsung and Apple. Also, as Apple brings augmented reality into the mainstream with its new iPhone models and does the same with health applications with Apple Watch, this opens the door for other technology licensing opportunities at Nokia given its portfolio of connected health, augment and virtual reality as well as other technologies. What this will require is patience with the shares, but given we are not only thematic investors but ones that have a longer than the herd time horizon that’s just fine with us.

 

 

Boosting Our Price Target on this Disruptive Technology Company Again

Boosting Our Price Target on this Disruptive Technology Company Again

Last night shares of Disruptive Technology company Universal Display (OLED) popped more than 10% in after-market trading as the company delivered substantially better than expected December quarter results and instituted a new dividend program. Granted the quarterly dividend of $0.03 per share equates to an extremely low dividend yield, but the program, which is expected to include regular quarterly dividend payments, is a signal that Universal sees enough cash generation to invest in the business and return capital to shareholders as the organic light emitting diode market expands.

 

Details Behind Universal Display’s Performance

For the quarter, Universal reported EPS of $0.55 per share, $0.14 ahead of consensus expectations on revenue that rose 20% year over year to $74.6 million, besting expectations of $69 million for the quarter. Breaking down the company’s revenue, licensing fees grew 27% year over year to $43.6 million (58% of revenue), material sales rose 5% to $29.2 million (39%) with the remainder generated by Universal’s contract research business (2%). Simply put, we see licensing business and materials business responding to the rising industry demand for organic light emitting diode displays, a phenomenon of which we are still in the early innings.

As expected, on the earnings call, Universal’s management team trotted out a number of examples of new products and market opportunities that are increasing demand for organic light emitting diode displays, which in turn drive demand for the company’s materials and licensing businesses. We see those examples, which included smartphones from ASUS and Huawei, TVs from Panasonic, LG, automotive lighting applications (tail lights, interior lighting, indicator lights and displays), augmented reality, virtual reality,  as solid reminders that organic light emitting diode display adoption spans far more than just Apple (AAPL) and the next generation iPhone.

If we were to be nit-picky, the only issue to be had with Universal’s earnings report was that management guided 2017 revenue in line with expectations. Coming into last night’s earnings report, consensus revenue for 2017 stood at $242.7 million across just over a handful of analysts and Universal’s guidance put revenue at $230-$250 million. Baked into that company guidance are two $45 million royalty payments from Samsung that land in the second and fourth quarter. In our view that guidance seems conservative, but we also recognize the biggest swing factor in the company’s revenue is not so much new capacity additions, but when that capacity moves past installation and testing, and into active production.

Given expanding capacity from a number of companies including Samsung, LG Display, AUO Optronics, Japan Display, Sharp and China BOE Technology, which is reflected in the order book at capital equipment company Applied Materials (AMAT) and its competitors, there is ample confirmation of expanding capacity over the next few years. Where it gets tricky is predicting the quarterly timing of productive capacity coming on stream. Given our long-term investment horizon, we’re inclined to sit back and be patient as the continued step up in capacity likely means an expanding business at Universal Display and boosting our price target on the shares along the way.

Earlier this week, shares of Applied Materials joined Universal Display shares on the Tematica Select List, and we continue to rate AMAT shares a Buy with a $47 price target.