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Boeing’s 737-Max issues highlight index construction issues

Boeing’s 737-Max issues highlight index construction issues

The latest flight tragedy involving Boeing’s (BA) 737-8 Max plane has reignited air travel safety concerns that could pressure Boeing’s business in the near-term. Demand for its aircraft has been and is expected to continue to be powered by international air travel, particularly out of Asia, which fits very well with our Rise of the New Middle-class investing theme. This means the recent drop in BA shares could present an opportunity for investors but depending on what we learn in the coming days we could see the shares trend lower. The issue plaguing the company and its shares is the crash of two 737-8 MAX planes in a relatively short time causing several countries and regions to ground those planes as the causes of the most recent crash are sought.

This has raised several questions for Boeing – How long will those planes be grounded? What does it mean for future 737 family orders and production levels that drive revenue, profits and earnings? The 737 family is an important one for Boeing, as it accounted for 80% of its aircraft backlog entering 2019 and 58% of its January order book. In the past Boeing has quickly dealt with situations such as these, and it has already announced an extensive change to the flight-control system in the 737 MAX aircraft.

Still, we are in a period of uncertainty for the shares, and uncertainty has never been a friend for the stock market or individual stocks. Now to see what comes next.

On a different note, the Boeing issue highlights a key difference in how the major market indices are constructed. These tend to be bench marks by which we and others judge their performance, but there are several differences and intricacies between them. For example, we know the Dow Jones Industrial Average is limited to just 30 stocks, while the S&P 500 is roughly 500 stocks spread across 11 sectors, yielding a more broad based view of the market. For that reason, the S&P 500 tends to be the benchmark of choice for most investors even though the media still tends to focus on the Down.

No matter how many constituents an index has, who the constituents are, and their weightings make all the difference. As we know, the Nasdaq Composite Index tends to be weighted toward technology stocks, while the Russell 2000 is focused on stocks with smaller market capitalizations. Inside the Dow, the weighting of BA shares is just under 10%, which makes it the largest holding inside the index. The next closest constituent is UnitedHealth Group (UNH) at 6.52%. This means moves higher or lower in Boeing shares can have a pronounced impact on the overall index. We’ve clearly seen that over the last few days as Boeing’s shares have fallen more than 10%  the Dow’s performance has been markedly different than the rest of the market indices as the Dow has less than 1% while the S&P 500 has risen nearly 2.5%

In examining the S&P 500, we see the reason for that different performance. While nearly 10% of the Dow is represented by Boeing shares, exposure inside the S&P 500 is far more limited at 0.9%. Even though that is more than 1/500thof the S&P it is far, far lower than the weighting contained inside the Dow. The point of this is that to truly understand the movements in the major market indices one needs to understand how these market indices are constructed.

One of the key parts of that understanding is knowing what the holdings and their weightings. This same understanding should also be applied to ETFs as well, especially ones that are based on passive indices. While two ETFs may appear to have a similar strategy and practically the same constituents, the weighting mechanisms between an equal weighted, market cap weighted or a capped market weight approach can produce different returns as well as generate different risk parameters.

As far as the constituents themselves, it goes without saying an investor should be more familiar with the constituents. In the case of Boeing, there are a number of ETFs that hold the shares, but one with sizable exposure is the ETFMG Drone Economy Strategy ETF (IFLY). That ETF, which looks to invest in drones, holds 4.96% of its assets in BA shares, it’s second largest holding. That ETF, which looks to invest in drones, holds 4.96% of its assets in BA shares, even though its revenues from drones and other autonomous systems are so small they aren’t even broken out by the company in SEC filings. We can debate the rationale behind Boeing being the second largest holding, but until the current situation at Boeing is resolved, odds are those shares will have a meaningful impact on both the Dow and IFLY shares.

Weekly Issue: Del Frisco’s Sends Strong Signals of Potential Take Over Bid

Weekly Issue: Del Frisco’s Sends Strong Signals of Potential Take Over Bid

Key points inside this issue

  • The stock market continues to move higher even as global growth slows and S&P 500 earnings prospects for the current quarter slump further.
  • Our long-term price target on Thematic King Amazon (AMZN) shares remains $2,250, which offers more than 35% upside following its December quarter earnings report.
  • As Living the Life Thematic Leader Del Frisco’s Restaurant Group (DFRG) gets serious with its strategic alternatives, our price target remains $14.
  • We are issuing a Buy on and adding the Del Frisco’s Restaurant Group (DFRG) September 20, 2019, 10.00 calls (DFRG 190920C00010000) that closed last night at 0.60 with a stop loss at 0.30.
  • On the housekeeping front, we were stopped out of the Nokia (NOK) July 2019 7.00 (NOK190719C00007000) calls last Friday (Feb. 1).

 

Stocks rebounded in a pronounced manner as we started off 2019, making it the best January showing since 1989. The data continues to point to a slowing global slowing economy, especially in China and in the eurozone with Italy in a recession and France not too far behind. The December-quarter concerns, however, have rolled back and propelled the market higher, especially during the last week of the month when the Fed signaled patience with its speed of further interest rate hikes. For the month in full, the S&P 500 finished up just shy of 8.0%, ahead of the Dow Jones Industrial Average’s 7.2% rise, but trailing the tech-heavy Nasdaq’s 9.7% surge.

On top of Friday’s blockbuster January Employment Report, a stronger-than-expected ISM Manufacturing Index reading for January came in, which showcased a rebound in new order activity. On the back of those two reports, the domestic stock market started February off in the green, as that data suggest the U.S. remains the brightest spot in the global economy. That view was supported by the January PMI data released Friday morning by IHS Markit, which showed the U.S. manufacturing economy picking up steam while that activity in the eurozone and Japan slowed, and China marked the second month in contraction territory.

 

Another positive inside the ISM Manufacturing Report was the month-over-month drop in the Prices component. Pairing that with falling prices in the eurozone data, it’s another reason the Federal Reserve can take its finger off the interest rate hike button for the time being. That patient stance, shared by the Fed this week after its latest FOMC meeting, has walked the dollar back some, but as we see in the chart below the greenback’s year-over-year strength will likely continue to be a headwind for companies during the first half of 2019.

 

The current mismatch between U.S. economic data and that for China has raised hopes for U.S.-China trade talks. Also lending a helping hand on that front were several positive tweets from President Trump exiting this week’s round of trade talks. I remain cautiously optimistic but will once again remind subscribers it’s the details that we’ll be focused on when they are released. 

As we move deeper into February, just over half of the S&P 500 companies have yet to report their quarterly results and given the slowing global economy and dollar headwinds we are likely to see further downward revisions to earnings expectations for the S&P 500 in the coming weeks. Along with the market’s push higher in January that has extended into February, should those revisions come to pass it means the market gets incrementally more expensive. This means we should continue to tread carefully in the near-term.

 

As we do this, known catalysts to watch in the coming weeks will be incremental developments on U.S.-China trade and potential moves by the European Central Bank. Following the weakening economic data in the eurozone, ECB President Mario Draghi said, “The European Central Bank is ready to use all its policy tools to support Europe’s softening economy, including by restarting a recently shelved bond-buying program.” There is also the possibility of another government shutdown should Congress fail to reach an agreement on immigration. Who said 2019 was likely to be boring?

 

Tematica Investing

As I have said numerous times, we do not buy the market, but rather invest in companies that are well positioned to capitalize on the tailwinds from our 10 investment themes. From time to time, we are given opportunities to scale into existing positions and in my view, we are seeing that now with Thematic King Amazon (AMZN). The reason for this latest bout of weakness in Amazon’s share price is management’s comments that it will once again investment more than Wall Street expected and the news over e-commerce regulations in India.

From time to time we’ve seen Amazon step up its investment spending and historically its been a great time to load up on the shares because those investments have paved the way for future growth. From opportunities in grocery, mobile payments, streaming video and gaming services, healthcare following its PillPack acquisition as well as expanding the scale and scope of its Amazon Prime service further in the US and abroad, there are ample thematic opportunities for the Amazon business. I also suspect that with FedEx (FDX) looking to collapse order times to under 24 hours for its retail partners, that Amazon too is working on growing its Prime Now offering at the same time.

Let’s turn to the new e-commerce regulations in India and their potential impact on Amazon. The issue is that while these new regulations permit full foreign ownership of ‘single brand’ retailers such as IKEA, restrictions are in place with ‘multibrand’ stores such as supermarkets from outside India. Odds are we will see a rebranding of sorts by the likes of Amazon, Walmart (WMT) and others that are looking to tap into this New Global Middle-Class market. Candidly, given Amazon’s growing private label business that spans apparel, furniture, food, electronics, and other categories, I’m not all that bothered by this. And let’s face it, not only are the folks at Amazon pretty smart, but we have yet to see a market that shuns two-day delivery. I doubt India and its growing middle-class will be the first.

The bottom line with this Thematic King is it is a stock to own as the company is poised to further disrupt other markets, sectors and other business models in the coming quarters.

  • Our long-term price target on Thematic King Amazon (AMZN) shares remains $2,250, which offers more than 35% upside following its December quarter earnings report.

 

 

Del Frisco’s gets serious about entertaining take out bids

After a few weeks of no big news from Living the Life company Del Frisco’s Restaurant Group Inc. (DFRG) after it pre-announced its fourth-quarter revenue in early January, we have a new development that in my view reinforces our belief that the company is putting itself up for sale. More specifically, Del Frisco’s announced on Monday that it has executed a cooperation agreement with its third-largest shareholder, Engaged Capital — the same shareholder that criticized the management team in late 2018 and suggested the company examine its strategic alternatives.

Included in the agreement is the appointment of Joe Reece not only to the Del Frisco’s board but also as the Chairman of the Transaction Committee that is overseeing the company’s previously announced review of strategic alternatives. There are other conditions with the cooperation agreement, but it is the naming of Reece and the comments contained inside the accompanying press release that gives us some insight into his background. The comments read in part:

Glenn W. Welling, the founder and Chief Investment Officer of Engaged Capital, said, “I am pleased to have reached this agreement as part of a constructive dialogue with Del Frisco’s. In addition to his decades of experience working inside boardrooms, Joe Reece brings exceptional experience in investment banking and the capital markets to Del Frisco’s which will be instrumental as the Board evaluates the various opportunities available to maximize value for all shareholders.”

 Joe Reece has over 30 years of experience as a business leader. His experience working with executives at corporations, financial sponsors, and institutional investors, as well as serving on several public company boards, will bring an added dimension to the Board.

Mr. Reece is the Founder and Chief Executive Officer of Helena Capital. Mr. Reece previously served as Executive Vice Chairman and Head of the Investment Bank for the Americas at UBS Group AG from 2017-2018 as well as serving on the board of UBS Securities, LLC.

 

More on Reece’s background is contained in the press release, but as the above excerpt notes, he has ample investment banking experience. In our view, the naming of Reece as chairman of the Del Frisco’s Transaction Committee means two things. First, the company is serious about examining alternatives to remaining a stand-alone company. Second, it is also serious about extracting the greatest value for its business and brands.

As shareholders, this news has increased my degree of confidence that a transaction, be it with private equity or a strategic partner, is likely to happen. As such, we will continue to keep DFRG shares as a Thematic Leader for the time being to capture these potential gains.

  • As Living the Life Thematic Leader Del Frisco’s Restaurant Group (DFRG) gets serious with its strategic alternatives, our price target remains $14.

 

Tematica Investing: Thematic Tailwinds for 2019 and Scaling into AXON

Tematica Investing: Thematic Tailwinds for 2019 and Scaling into AXON

 

Key Points Inside this Issue:

Last Friday’s favorable December Employment Report showed the domestic economy is not falling off a cliff and comments by Fed Chair Jay Powell reflected that the central bank will be patient with monetary policy as it watches how the economy performs. Those two things kicked the market off on its most recent three-day winning streak as of last night’s close. In many ways, Powell gave the market what it was looking for when he shared the Fed will remain data dependent when it looks at the economy and its next step with monetary policy.

Taking a few steps back, we’ve all experienced the market volatility over the last several weeks as it contends with a host of issues that we here at Tematica have laid out through much of the December quarter. These include:

  • U.S.-China trade issues
  • The slowing economy
  • A Fed that could boost rates twice in 2019 and continues to unwind its balance sheet
  • Brexit and political uncertainty in the Eurozone
  • And more recently the government shutdown.

These factors have led investors to question growth prospects for the global as well as the domestic economy and earnings in 2019.

Powell’s comments potentially take one of those issues off the table at least in the short-term. If the economy continues to deliver job creation as we saw in December, with some of the best year-over-year wage gains we’ve seen in years, before too long the Fed-related conversation could very well turn from two rate hikes to three.

Currently, that isn’t what the market is expecting.

The reason it isn’t is that outside of the December jobs report, data from ISM and IHS Markit continued to show a decelerating global and U.S. economy. With new orders and backlog levels falling, as well as pricing-related data, it likely means we won’t see a pronounced pickup in the January data. The JPMorgan Global Composite Output Index for December delivered its lowest reading since September 2016 due principally to the slowdown in the eurozone. Rates of expansion slowed in Germany (66-month low) and Spain (three-month low), while Italy stagnated. China, the UK, and Brazil all saw modest growth accelerations.

 

Despite the month over month declines in the December data for the US, it was the best performer on a relative basis even though the IHS Markit Composite PMI reading for the month hit a 15-month low. A more sobering view was shared by Chris Williamson, Chief Business Economist at IHS Markit who said:

“Manufacturers reported a weakened pace of expansion at the end of 2018, and grew less upbeat about prospects for 2019. Output and order books grew at the slowest rates for over a year and optimism about the outlook slumped to its gloomiest for over two years.”

That should give the Fed some room to hold off boosting rates, but it also confirms the economy is decelerating, which will likely have revenue and earnings guidance repercussions in the upcoming December-quarter earnings season.

There are several catalysts that could drive both the economy and the stock market higher in the coming months. These include a “good deal” resolution to the U.S.-China trade situation and forward movement in Washington on infrastructure spending. This week, the US and China have met on trade and it appears those conversations have paved the way for further discussions in the coming weeks. A modest positive that has helped drive the stock market higher this week, but thus far concrete details remain scant.

Such details are not likely to emerge for at least several weeks, which means the next major catalyst for the stock market will be the upcoming December quarter earnings season that begins in nine trading days.

 

Earnings expectations are being revised lower

Facing a number of risks and uncertainties over the last several weeks, investors have once again questioned growth prospects for both the economy and earnings growth for 2019. The following two charts – one of the Citibank Economic Surprise Index and one showing the aggregate profit margin for the S&P 500 companies – depict what investors are grappling with weaker than expected economic data at a time when corporate operating margins have hit the highest levels in over 20 years.

While expectations for growth in both the domestic economy and earnings for the S&P 500 have come in compared to forecasts from just a few months ago, the current view per The Wall Street Journal’s Economic Forecasting Survey calls for 2019 GDP near 2.3% (down from 3.0% in 2018) with the S&P 500 group of companies growing their collective EPS by 7.4% year over year in 2019.

 

Here’s the thing, in recent weeks, analysts lowered their earnings estimates for companies in the S&P 500 for the December quarter by roughly 4% to $40.93. The Q4 bottom-up EPS estimate (which is an aggregation of the median EPS estimates of all the companies in the index) dropped by 4.5% to $40.63. In the chart below, you can see this means quarter over quarter, December quarter earnings are expected to drop breaking the typical pattern of earnings growth into the last quarter of the year. What you can’t see is that marks the largest cut to quarterly S&P 500 EPS estimates in over a year.

 

 

Getting back to that 7.4% rate of earnings growth that is currently forecasted for 2019, I’d call out that it too has been revised down from 9% earlier in the December quarter. That new earnings forecast is a far cry from 21.7% in 2018, which was in part fueled by a stronger economy as well as the benefits of tax reform that was passed in late 2017. As we all know, there that was a one-time bump to corporate bottom lines that will not be repeated this year or in subsequent ones. The conundrum that investors are facing is with the market barometer that is the S&P 500 currently trading at 15.9x consensus 2018 EPS of $161.54, the factors listed above have investors asking what the right market multiple based on 2019’s consensus EPS of $173.45 should be?

And while most investors don’t “buy the market,” its valuation and earnings growth are a yardstick by which investors judge individual stocks.

 

Thematic tailwinds will continue to drive profits and stock prices

One of the key principles to valuing stocks is that companies delivering stronger EPS growth warrant a premium valuation. Of course, in today’s stock buyback rampant world, that means ferreting out those companies that are growing their net income. My preference has been to zero in on what is going on with a company’s operating profit and operating margins given that their vector and velocity are the prime drivers of earnings. That was especially needed last year given the widespread bottom-line benefits of tax reform.

At the heart of it, the question is what is driving the business?

As I’ve shared before, sector classifications don’t speak to that as they are a grouping of companies by certain characteristics rather than the catalysts that are driving their businesses. As we’ve seen before, some companies, such as Amazon (AMZN) or Apple (AAPL) capitalize on those catalysts, while others fail to do so in a timely manner if at all. Sears (SHLD), JC Penney (JCP) are easy call outs, but so are Toys R Us, Bon-Ton Stores, Sports Authority, Blue Apron (APRN), and Snap (SNAP) to name just over a handful.

Very different, and we can see the difference in comparing revenue and profit growth as well as stock prices. The ones that are performing are responding to the changing landscapes across the economic, demographic, psychographic, technological, regulatory and other playing fields they face. In short, they are riding the thematic tailwinds that we here at Tematica have identified. As a reminder those themes are:

 

As we move into 2019, I continue to see the tailwinds associated with those themes continuing to blow hard. Despite all the vain attempts to fight it temporarily, there is no slowing down the aging process. Consumers continue to flock to better for you alternatives, and as you’ll see below that has led Thematic Leader Chipotle Mexican Grill (CMG) to bring a new offering to market.

As we saw this past holiday shopping season, consumers are flocking more and more to digital shopping while hours spent streaming content continue to thwart broadcast TV and the box office. This year 5G networks and devices will become a reality as AT&T (T), Verizon (VZ) and others launch those commercial networks. The legalization of cannabis continues, and consumers continue to consume chocolate, alcohol and other Guilty Pleasures.

Whether you are Marriott International (MAR), Facebook (FB), British Airways or the Bridgeport School System, cyber threats continue to grow and as we saw last night during the presidential address and Democratic response, border security be it through a wall, technology or other means is a pain point that needs to be addressed. While the last two monthly Employment Reports have shown some of the best wage gains in years, Middle-class Squeeze consumers continue to face a combination of higher debt and interest rates as well as rising healthcare costs and the need to save for their golden years that will weigh on the ability to spend.

Like any set of winds, there will be times when some blow harder than others. For example, as we peer into the coming year the launch of 5G networks and gigabit ethernet will likely see the Digital Infrastructure tailwind accelerate in the first half of the year as network and data center operators utilize the services of companies like Thematic Leader Dycom Industries (DY) to build the physical networks. Some tailwinds, such as those associated with Aging of the Population, Clean Living and Middle-class Squeeze are likely to be more persistent over the coming year. Other tailwinds will gust hard at times almost seemingly out of nowhere reminding that they have been there all along. Given the nature of high profile cyber attacks and other threats, that’s likely to once again be the case with Safety & Security.

The bottom line is this – the impact to be had of the tailwinds associated with our 10 investment themes will continue to be felt in 2019. They will continue to influence consumer and business behavior, altering the playing field and forcing companies to either respond or not. The ones that are capitalizing on that changing playing field and are delivering pronounced profit growth are the ones investors should be focusing on.

 

TEMATICA INVESTING 

Scaling into AAXN, and updates on NFLX, CMG, and DFRG

As I discussed above, the December quarter was one of the most challenging periods for the stock market in some time. Even though we are just over a handful of days into 2019, we’re seeing the thematic tailwinds blow again on the Thematic Leaders with 9 of the 11 positions ahead of the S&P 500. Yes, we’re looking pretty good so far but it’s too early in the year to start patting our backs, especially with the upcoming earnings season. Odds are Apple’s (AAPL) negative preannouncement last week won’t be the only sign of misery to be had, and that’s why I’m keeping the ProShares Short S&P 500 ETF (SH) active for the time being. As I shared with you last week, while Apple and others are contending with a maturing smartphone market, I continue to like the long-term Digital Lifestyle aspects as it moves into streaming content and subscription-related businesses.

Of those 9 companies that are ahead of the S&P 500, as you can see in the table above, there are several that are significantly outperforming the market in the brief time that is 2019. These include Netflix (NFLX) shares, Axon Enterprises (AAXN), and Chipotle Mexican Grill (CMG)  as well as Del Frisco’s (DFRG).

After falling just over 28% in the December quarter as investors gave up on the FANG stocks, as of last night’s market close Netflix shares are up 20% so far for the new year. Spurring them along have been favorable comments and a few upgrades from the likes of Piper Jaffray, Barclays, Sun Trust, and several other investment banks. From my perspective, even though Netflix will face a more competitive landscape as AT&T (T), Disney (DIS), Hulu, Amazon (AMZN), Google (GOOGL), Facebook (FB), and Apple (AAPL), it has a substantial lead in the original content race over the likes of Facebook, Apple, Google and Amazon.

Candidly, only AT&T given its acquisition of Time Warner, and Disney, especially once it formally acquires with the movie, TV and other content from 21stCentury Fox (FOXA), will be streaming content contenders in the near term. And Disney is starting from scratch while AT&T lags meaningfully behind Netflix in terms of not only overall subscribers but domestic ones as well. For now, the digital streaming horse to play remains Netflix, especially as it brings more content to its service for both the US and international markets, which should drive its global subscriber base higher.

 

New bowls at Chipotle signal the Big Fix continues

Since its beginnings, Chipotle has been at the forefront of our Clean Living investing theme, but last week it took another step to attract those who are aiming to eat healthier when it introduced a line of Lifestyle Bowls. These included Keto, Paleo, Whole30, and Double Protein versions are only available through the company’s mobile app and the Chipotle website. Clearly, the new management team that arrived last year understands the powerful tailwind associated with our Digital Lifestyle investing theme. More on those new bowls can be found here, and we expect to hear more on the management team’s Big Fix initiatives when the company presents at the ICR Conference on Jan. 15.

 

Adding to Axon Enterprises as EPS expectations move higher

When we added shares of Axon Enterprises to the Thematic Leaders for the Safety & Security slot, we noted the company’s long reach into US police departments and other venues that should drive adoption of its newer Taser units but more importantly its body cameras and digital storage businesses. In the company’s November earnings report we saw that positive impact as its Axon Cloud revenue rose 47% year over year to $24 million, roughly $24 million or 23% of revenue vs. 18% in the year-ago quarter. Even better, the gross margin associated with that business has been running in the mid 70% range over the last few quarters, well above the corporate gross margin average of 36%-37%. Over the last 90 days, we’ve seen Wall Street boost its EPS forecasts for the company to $0.77 for 2018, up from $0.52, and to $0.92 for 2019 up from $0.73.

Even though we AAXN shares are on a roll thus far in 2019, the position is still in the red since joining the Thematic Leaders. Against the favorable tailwind of our Safety & Security investing theme and rising EPS expectations, we will scale into AAXN shares at current levels, which will drop our cost basis to around $61 from just under $73. Our $90 price target remains intact.

  • We are scaling into shares of Safety & Security Thematic Leader Axon Enterprises (AXON) at current levels, which will dramatically improve our cost basis. Our $90 price target remains intact.

 

Del Frisco’s shares jump on takeout speculation

Over the last few weeks, there has a sizable rebound in the shares of high-end restaurant name Del Frisco’s Restaurant Group. Ahead of the year-end 2018 holidays, the company’s board of directors was the recipient of activist investor action from Engaged Capital. During the holiday weeks, the company shared it has hired investment firm Piper Jaffray to “review and consider a full range of options focused on maximizing shareholder value, including a possible sale of the Company or any of its dining concepts.”

In other words, Del Frisco’s is putting itself in play. Often this can result in a company being taken out either by strategic investors, private equity or a combination of the two. There is also the chance a company going through this process is not acquired due primarily to a mismatch between the potential buyer(s) and the board on price as well as underlying financing.

From my perspective, 2018 was a challenging year for Del Frisco’s as it repositioned its branded portfolio. This included the sale of Sullivan’s Steakhouse and the acquisition of Barteca Restaurant Group, the parent of both Bartaco and Barcelona restaurants.

Transitions such as these can be challenging, and in some cases, the benefits of the transformation may take longer to emerge than planned. That said, given the data we’ve discussed previously on the recession-resistant nature of high-end dining, such as at Del Frisco’s core Double Eagle Steakhouse and Grille, we do think the company would be a feather in the cap for another restaurant group. As we noted when we added DFRG shares to the Thematic Leaders, there are very few standalone public steakhouse companies left — the vast majority of them have been scooped up by names such as Landry’s or Darden Restaurants (DRI).

From a fundamental perspective, the reasons why we are bullish on Del Frisco’s are the same ones that make it a takeout candidate. While we wait and see what emerges on the bid front, I’ll be looking over other positions to fill DFRG’s slot on the Thematic Leaders should a viable bid emerge.  Given the company’s restaurant portfolio, the continued spending on high-end dining and its recession-resistant nature, odds are rather high of that happening.

  • Our price target on Del Frisco’s Restaurant Group (DFRG) remains $14.

 

 

Weekly Issue: Looking Around the Bend of the Current Rebound Rally

Weekly Issue: Looking Around the Bend of the Current Rebound Rally

 

Stock futures are surging this morning in a move that has all the major domestic stock market indices pointing up between 1.5% for the S&P 500 to 2.2% for the Nasdaq Composite Index. This surge follows the G20 Summit meeting of President Trump and Chinese President Xi Jinping news that the US and China will hold off on additional tariffs on each other’s goods at the start of 2019 with trade talks to continue. What this means is for a period of time as the two countries look to hammer out a trade deal during the March quarter, the US will leave existing tariffs of 10% on more than $200 million worth of Chinese products in place rather than increase them to 25%.  If after 90 days the two countries are unable to reach an agreement, the tariff rate will be raised to 25% percent.

In my view, what we are seeing this morning is in our view similar to what we saw last week when Fed Chair Powell served up some dovish comments regarding the speed of interest rate hikes over the coming year – a sigh of relief in the stock market as expected drags on the economy may not be the headwinds previously expected. On the trade front, it’s that tariffs won’t escalate at the end of 2018 and at least for now it means one less negative revision to 2019 EPS expectations. In recent weeks, we’ve started to see the market price in the slowing economy and potential tariff hikes as 2019 EPS expectations for the S&P 500 slipped over the last two months from 10%+ EPS growth in 2019 to “just” 8.7% year over year. That’s down considerably from the now expected EPS growth of 21.6% this year vs. 2017, but we have to remember the benefit of tax reform will fade as it anniversaries. I expect this to ignite a question of what the appropriate market multiple should be for the 2019 rate of EPS growth as investors look past trade and the Fed in the coming weeks. More on that as it develops.

For now, I’ll take the positive performance these two events will have on the Thematic Leaders and the Select List; however, it should not be lost on us that issues remain. These include the slowing global economy that is allowing the Fed more breathing room in the pace of interest rate hikes as well as pending Brexit issues and the ongoing Italy-EU drama. New findings from Lending Tree (TREE) point to consumer debt hitting $4 trillion by the end of 2018, $1 trillion higher than less five years ago and at interest rates that are higher than five years ago. Talk about a confirming data point for our Middle-class Squeeze investing theme. And while oil prices have collapsed, offering a respite at the gas pump, we are seeing more signs of wage inflation that along with other input and freight costs will put a crimp in margins in the coming quarters. In other words, headwinds to the economy and corporate earnings persist.

On the US-China trade front, the new timeline equates to three months to negotiate a number of issues that have proved difficult in the past. These include forced technology transfer by U.S. companies doing business in China; intellectual-property protection that the U.S. wants China to strengthen; nontariff barriers that impede U.S. access to Chinese markets; and cyberespionage.

So, while the market gaps up today in its second sigh of relief in as many weeks, I’ll continue to be prudent with the portfolio and deploying capital in the near-term.  At the end of the day, what we need to see on the trade front is results – that better deal President Trump keeps talking about – rather than promises and platitudes. Until then, the existing tariffs will remain, and we run the risk of their eventual escalation if promises and platitudes do not progress into results.

 

The Stock Market Last Week

Last week we closed the books on November, and as we did that the stock market received a life preserver from Federal Reserve Chair Powell, which rescued them from turning in a largely across-the-board negative performance for the month. Powell’s comments eased the market’s concern over the pace of rate hikes in 2019 and the subsequent Fed November FOMC meeting minutes served to reaffirm that. As we shared Thursday, we see recent economic data, which has painted a picture of a slowing domestic as well as global economy, giving the Fed ample room to slow its pace of rate hikes. 

While expectations still call for a rate increase later this month, for 2019 the consensus is now looking for one to two hikes compared to the prior expectation of up to four. As we watch the velocity of the economy, we’ll also continue to watch the inflation front carefully given recent declines in the PCE Price Index on a year-over-year basis vs. wage growth and other areas that are ripe for inflation.

Despite Powell’s late-month “rescue,” quarter to date, the stock market is still well in the red no matter which major market index one chooses to look at. And as much as we like the action of the past week, the decline this quarter has erased much of the 2018 year-to-date gains. 

 

Holiday Shopping 2018 embraces the Digital Lifestyle

Also last week, we had the conclusion of the official kickoff to the 2018 holiday shopping season that spanned Thanksgiving to Cyber Monday, and in some cases “extended Tuesday.” The short version is consumers did open their wallets over those several days, but as expected, there was a pronounced shift to online and mobile shopping this year, while bricks-and-mortar traffic continued to suffer. 

According to ShopperTrak, shopper visits were down 1% for the two-day period compared to last year, with a 1.7% decline in traffic on Black Friday and versus 2017. Another firm, RetailNext, found traffic to U.S. stores fell between 5% and 9% during Thanksgiving and Black Friday compared with the same days last year. For the Thanksgiving to Sunday 2018 period, RetailNext’s traffic tally fell 6.6% year over year. 

Where were shoppers? Sitting at home or elsewhere as they shopped on their computers, tablets and increasingly their mobile devices. According to the National Retail Federation, 41.4 million people shopped only online from Thanksgiving Day to Cyber Monday. That’s 6.4 million more than the 34.7 million who shopped exclusively in stores. Thanksgiving 2018 was also the first day in 2018 to see $1 billion in sales from smartphones, according to Adobe, with shoppers spending 8% more online on Thursday compared with a year ago. Per Adobe, Black Friday online sales hit $6.22 billion, an increase of 23.7% from 2017, of which roughly 33% were made on smartphones, up from 29% in 2017.

The most popular day to shop online was Cyber Monday, cited by 67.4 million shoppers, followed by Black Friday with 65.2 million shoppers. On Cyber Monday alone, mobile transactions surged more than 55%, helping make the day the single largest online shopping day of all time in the United States at $7.9 billion, up 19% year over year. It also smashed the smartphone shopping record set on Thanksgiving as sales coming from smartphones hit $2 billion.

As Lenore Hawkins, Tematica’s Chief Macro Strategist, and I discussed on last week’s Cocktail Investing podcast, the holiday shopping happenings were very confirming for our Digital Lifestyle investing theme. It was also served to deliver positive data points for several positions on the Select List and the Thematic Leader that is Amazon (AMZN). These include United Parcel Service (UPS), which I have long viewed as a “second derivative” play on the shift to digital shopping, but also Costco Wholesale (COST) and Alphabet/Google (GOOGL). Let’s remember that while we love McCormick & Co. (MKC) for “season’s eatings” the same can be said for Costco given its food offering, both fresh and packaged, as well as its beer and wine selection. For Google, as more consumers shop online it means utilizing its search features that also drive its core advertising business.

As we inch toward the Christmas holiday, I expect more data points to emerge as well as more deals from brick & mortar retailers in a bid to capture what consumer spending they can. The risk I see for those is profitless sales given rising labor and freight costs but also the investments in digital commerce they have made to fend off Amazon. Sales are great, but it has to translate into profits, which are the mother’s milk of EPS, and that as we know is one of the core drivers to stock prices.

 

Marriott hack reminds of cyber spending needs

Also last week, we learned of one of the larger cyber attacks in recent history as Marriott (MAR) shared that up to 500 million guests saw their personal information ranging from passport numbers, travel details and payment card data hacked at its Starwood business. As I wrote in the Thematic Signal in which I discussed this attack, it is the latest reminder in the need for companies to continually beef up their cybersecurity, and this is a profound tailwind for our Safety & Security investing theme as well as the  ETFMG Prime Cyber Security ETF (HACK) shares that are on the Select List.

 

The Week Ahead

Today, we enter the final month of 2018, and given the performance of the stock market so far in the December quarter it could very well be a photo finish to determine how the market finishes for the year. Helping determine that will not only be the outcome of the weekend’s G-20 summit, but the start of November economic data that begins with today’s ISM Manufacturing Index and the IHS Markit PMI data, and ends the week with the monthly Employment Report. Inside those two reports, we here at Tematica be assessing the speed of the economy in terms of order growth and job creation, as well as inflation in the form of wage growth. These data points and the others to be had in the coming weeks will help firm up current quarter consensus GDP expectations of 2.6%, per The Wall Street Journal’s Economic Forecasting Survey that is based on more than 60 economists, vs. 3.5% in the September quarter.

Ahead of Wednesday’s testimony by Federal Reserve Chair Powell on “The Economic Outlook” before Congress’s Joint Economic Committee, we’ll have several Fed heads making the rounds and giving speeches. Odds are they will reinforce the comments made by Powell and the November Fed FOMC meeting minutes that we talked about above. During Powell’s testimony, we can expect investors to parse his words in order to have a clear sense as to what the Fed’s view is on the speed of the economy, inflation and the need to adjust monetary policy, in terms of both the speed of future rate hikes and unwinding its balance sheet. Based on what we learn, Powell’s comments could either lead the market higher or douse this week’s sharp move higher in the stock market with cold water.

On the earnings front this week, we have no Thematic Leaders or Select List companies reporting but I’ll be monitoring results from Toll Brothers (TOL), American Eagle (AEO), Lululemon Athletica (LULU), Broadcom (AVGO) and Kroger (KR), among others. Toll Brothers should help us understand the demand for higher-end homes, something to watch relating to our Living the Life investing theme, while American Eagle and lululemon’s comments will no doubt offer some insight to the holiday shopping season. With Broadcom, we’ll be looking at its demand outlook to get a better handle on smartphone demand as well as the timing of 5G infrastructure deployments that are part of our Disruptive Innovators investing theme. Finally, with Kroger, it’s all about our Clean Living investing theme and to what degree Kroger is capturing that tailwind.

 

Weekly Issue: We aren’t out of the woods just yet

Weekly Issue: We aren’t out of the woods just yet

Key Points from this Issue:

  • We are downgrading Universal Display (OLED) shares from the Thematic Leaders to the Select List and cutting our price target to $125 from $150. In the coming days, we will name a new Thematic Leader for our Disruptive Innovators investing theme.
  • Given the widespread pain the market endured in October, Thematic Leaders Chipotle Mexican Grill (CMG), Del Frisco’s (DFRG), Axon Enterprises (AXXN), Alibaba (BABA) and Netflix (NFLX) were hit hard; however, the hardest hit was Amazon (AMZN).

 

This week we closed the books on the month of October, and what a month it was for the stock market. In today’s short-term focused society, some will focus on the rebound over the last few days in the major domestic stock market indices, but even those cannot hide the fact that October was one of the most challenging months for stocks in recent memory. In short, the month of October wiped out most the market’s year to date gains as investors digested both September quarter earnings and updated guidance that spurred a re-think in top and bottom line expectations.

All told, the Dow Jones Industrial Average fell 5.1% for the month, making it the best performer of the major market indices. By comparison, the S&P 500 fell 6.9% in October led by declines in eight of its ten subgroups. The technology-heavy Nasdaq Composite Index dropped 9.2% and the small-cap focused Russell 2000 plummeted 10.9%. That marked the Nasdaq’s steepest monthly drop since it posted a 10.8% fall in November 2008. The month’s move pulled the Russell 2000 into negative territory year to date while for the same time period both the Dow and S&P 500 closed last night up around 1.5%.

We are just over halfway through the September quarter earnings season, which means there are ample companies left to report and issue updated guidance. Candidly, those reports could push or pull the market either higher or continue the October pain. There are still ample risks in the market to be had as the current earnings season winds down. These include the mid-term elections; Italy’s next round of budget talks with Brussels; upcoming Trump-China trade talks, which have led to another round of tariff preparations; and Fed rate hikes vs. the slowing speed of the global economy.

Despite the very recent rebound in the stock market, CNN’s Fear & Greed Index remains at Extreme Fear (7) as I write this – little changed from last week. What this likely means is we are seeing a nervous rebound in the market, and it will likely some positive reinforcement to make the late October rebound stick. As we navigate that pathway to the end of the year, we will also be entering the 2018 holiday shopping season, which per the National Retail Federation’s annual consumer spending survey should rise more than 4% year over year.

This combination of upcoming events and sentiment likely means we aren’t out of the woods just yet even though we are seeing a reprieve from the majority of October. As is shared below, next week has even more companies reporting than this week as well as the midterm elections. The strategy of sitting on the sidelines until the calmer waters emerge as stock prices come to us is what we’ll be doing. At the right time, we’ll be adding to existing positions on the Thematic Leaders and Thematic Select List as well as introducing new ones.

Speaking of the Thematic Leaders and the Select List, as the mood shifts from Halloween to the year-end shopping season,  we have several companies including Amazon (AMZN), United Parcel Service (UPS), Costco Wholesale (COST), Del Frisco’s Restaurant Group (DFRG), McCormick & Co. (MKC) and Apple (AAPL) among others that should benefit from that uptick in holiday spending as well as our Digital Lifestyle, Living the Life and Middle-class Squeeze investing themes in the next few months.

 

UPDATES TO The Thematic Leaders and Select List

Given the widespread pain the market endured in October, we were not immune to it with the Thematic Leaders or companies on the Tematica Select List. Given the volatility, investor’s nerves it was a time of shoot first, ask questions later with the market – as expected – trading day to day based on the most recent news. I expect this to continue at least for the next few weeks.

The hardest hit was Amazon, which despite simply destroying September quarter expectations served up what can only be called a conservative forecast for the current quarter. For those that didn’t tune in to the company’s related earnings conference call, Amazon management flat out admitted that it was being conservative because it is too hard to call the second half of the quarter, which is when it does the bulk of its business during the frenetic holiday shopping season. I have long said that Amazon shares are one to hold not trade, and with the move to expand its private label product, move into the online pharmacy space as well as continued growth at Amazon Web Services, we will do just that. That conservative guidance also hit United Parcel Service (UPS) shares, but we see that as a rising tide this holiday season as digital shopping continues to take consumer wallet share this holiday shopping season.

Both Chipotle Mexican Grill (CMG), Del Frisco’s (DFRG), Axon Enterprises (AXXN), Alibaba (BABA) and Netflix (NFLX) have also been hit hard, and I’m waiting for the market to stabilize before scaling into these Thematic Leader positions. As we’ve moved through the current earnings season, comments from Bloomin’ Brands (BLMN), Del Taco (TACO), Wingstop (WING), Habit Restaurant (HABT) and others, including Chipotle, have all pointed to the benefit of food deflation. Chipotle’s Big Fix continues with progress had in the September quarter and more to be had in the coming ones. Del Frisco’s will soon report its quarterly results and it too should benefit from a consumer with high sentiment and lower food costs.

With Axon, the shares remain trapped in the legal volley with Digital Ally (DGLY), but as I pointed out when we added it to the Leaders, Axon continues to expand its safety business with law enforcement and at some point, I suspect it will simply acquire Digital Ally given its $30 million market cap. Turning to Alibaba (BABA) and Netflix (NFLX), both have been hit hard by the downdraft in technology stocks, with Alibaba also serving as a proxy for the current US-China trade war. In my opinion, there is no slowing down the shift to digital streaming that is driving Netflix’s business and its proprietary content strategy is paying off, especially outside the US where it is garnering subscriber growth at price points that are above last year’s levels. This is one we will add to as things settle down.

The same is true with Alibaba – there is no slowing down the shift to the Digital Lifestyle inside of China, and as Alibaba’s other business turn from operating losses to operating profits, I expect a repeat of what we saw with Amazon shares. For now, however, the shares are likely to trade sideways until we see signs of positive developments on trade talks. Again, let’s hang tight and make our move when the time is right.

 

Downgrading Universal Display shares to the Select List

Last night Thematic Leader Universal Display (OLED) reported rather disappointing September quarter results that fell well short of expectations and guided the current quarter below expectations given that the expected rebound in organic light emitting diode materials sales wasn’t ramping as expected despite a number of new smartphones using organic light emitting diode displays. On the earnings call, the company pointed out the strides being had with the technology in other markets, such as TV and automotive that we’ve been discussing these last few months but at least for the near-term the volume application has been smartphones. In short, with that ramp failing to live up to expectations for the seasonally strongest part of the year for smartphones, it speaks volumes about what is in store for OLED shares.

By the numbers, Universal now expected 2018 revenue in the range of $240-$250, which implies $63-$73 million for the December quarter vs. $77.5 million for the September quarter and $88.3 million in the year-ago one. To frame it another way, that new revenue forecast of $240-$250 million compares to the company’s prior one of $315- $325 million and translates into a meaningful fall off vs. 2017 revenues of $335.6 million. A clear sign that the expected upkeep is not happening as fast as was expected by the Universal management team. Also, too, the first half of the calendar year tends to be a quiet one for new smartphone models hitting shelves. And yes, there will be tech and consumer product industry events like CES, CEBIT, and others in 2019 that will showcase new smartphone models, but candidly we see these new models with organic light emitting diode displays as becoming a show-me story given their premium price points. Even with Apple (AAPL) and its September quarter earnings last night, its iPhone volumes were flat year over year at 46.9 million units falling short of the 48.0 million consensus forecast.

In my view, all of this means the best case scenario in the near-term is OLED shares will be dead money. Odds are once Wall Street computes the new revenue numbers and margin impact, EPS numbers for the next few quarters will be taken down and will hang on the shares like an anchor. Given our cost basis in the shares near $101, and where the shares are likely to open up tomorrow – after market trading indicates $95-$100, down from last night’s closing price of $129.65 – we have modest downside ahead. Not bad, but again, near-term the shares are likely range bound.

Given our long-term investing style and the prospects in markets outside of the smartphone, we’re inclined to remain long-term investors. That said, given the near-term headwinds, we are demoting Universal Display shares from the Thematic Leaders to the Select List. Based on revised expectations, we are cutting our price target from $150 to $125, fully recognizing the shares are likely to rangebound for the next 1-2 quarters.

  • We are downgrading Universal Display (OLED) shares from the Thematic Leaders to the Select List and cutting our price target to $125 from $150. In the coming days, we will name a new Thematic Leader for our Disruptive Innovators investing theme.

 

Clean Living signals abound

As we hang tight, I will continue to pour through the latest thematic signals that we see day in, day out throughout the year, but I’ll also be collecting ones from the sea of earnings reports around us.

If I had just read that it would prompt me to wonder what some of the recent signals have been. As you know we post them on the Tematica Research website but during the earnings season, they can get a tad overwhelming, which is why on this week’s Cocktail Investing podcast, Lenore Hawkins (Tematica’s Chief Macro Strategist) and I ran through a number of them. I encourage you to give it a listen.

Some of the signals that stood out of late center on our Clean Living investing theme. Not only did Coca-Cola (KO) chalk up its September quarter performance to its water and non-sugary beverage businesses, but this week PepsiCo (PEP) acquired plant-based nutrition bar maker Health Warrior as it continues to move into good for you products. Mondelez International (MDLZ), the company behind my personal fav Oreos as well as other cookies and snacks is launching SnackFutures, a forward-thinking innovation hub that will focus on well-being snacks and ingredients. Yep, it too is embracing our Clean Living investing theme.

Stepping outside of the food aspect of Clean Living, there has been much talk in recent months about the banning of plastic straws. Now MasterCard (MA) is looking to go one further with as it looks to develop an alternative for those plastic debit and credit cards. Some 6 billion are pushed into consumer’s hands each year. The issue is that thin, durable card is also packed with a fair amount of technology that enables transactions to occur and do so securely. A looming intersection of our Clean Living, Digital Infrastructure and Safety & Security themes to watch.

 

Turning to next week

During the week, the Atlanta Fed published its initial GDP forecast of 2.6% for the current quarter, which is essentially in line with the same forecast provided by the NY Fed’s Nowcast, and a sharp step down from the initial GDP print of 3.5% for the September quarter. Following the October Employment Report due later this week, where wage growth is likely to be more on investor minds that job gains as they contemplate the velocity of the Fed’s interest rate hikes, next week brings several additional pieces of October data. These include the October ISM Services reading and the October PPI figure. Inside the former, we’ll be assessing jobs data as well as pricing data, comparing it vs. the prior months for hints pointing to a pickup in inflation. That will set the stage for the October PPI and given the growing number of companies that have announced price increases odds are we will some hotter pricing data and that could refocus the investor spotlight back on the Fed.

Next week also brings the September JOLTS report as well as the September Consumer Credit report. Inside those data points, we expect more data on the continued mismatch between employer needs and available worker skills that is expected to spur more competitive wages.  As we examine the latest credit data, we will keep in mind that smaller banks reporting higher credit card delinquency rates while Discover Financial (DFS) and Capital One (COF) have shared they have started dialing back credit spending limits. That could put an extra layer of hurt on Middle-class Squeeze consumers this holiday season.

Also, next week, the Fed has its next FOMC meeting, and while it’s not expected to boost rates at that meeting, we can expect much investor attention to be focused on subsequent Fed head comments as well as the eventual publication of the meeting’s minutes in the coming weeks ahead of the December meeting.

On the earnings front, following this week’s more than 1,000 earnings reports next week bring another 1,100 plus reports. What this means is more than half of the S&P 500 group of companies will have issued September quarter results and shared their revised guidance. As these reports are had, we can expect consensus expectations for those companies to be refined for the balance of the year. Thus far, roughly 63% of the companies that have issued EPS guidance for the current quarter have issued negative guidance, but we have yet to see any meaningful negative revisions overall EPS expectations for the S&P 500.

Outside the economic data and corporate earnings flow next week, we also have US midterm elections. While we wait for the outcome, we would note if the Republicans maintain control of the House and Senate, it likely means a path of less resistance for President Trump’s agenda for the coming two years. Should the Democrats gain ground, which has historically been the case following a Republican presidential win, it could very well mean an even more contentious 24 months are to be had in Washington with more gridlock than not. Should that be the case, expectations for much of anything getting done in Washington in the medium-term are likely to fall.

Yes, next week will be another busy one that could challenge the recent market rebound. We’ll continue to ferret out signals for our thematic lens as we remain investors focused on the long-term opportunities to be had with thematic investing.

 

 

 

 

WEEKLY ISSUE: Confirming Data Points for Apple and Universal Display

WEEKLY ISSUE: Confirming Data Points for Apple and Universal Display

Key points inside this issue:

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

 

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

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

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

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

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

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

Also found in the IHS Markit report:

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

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

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

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

 

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

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

 

Today is Fed Day

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

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

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

 

Favorable Apple and Universal Display News

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

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

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

 

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

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

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

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

So what are these moves really trying to accomplish?

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

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

 

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

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

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

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

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

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

 

WEEKLY ISSUE: 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: Trade Meetings and Earnings Reshape Market Outlook

Weekly Issue: Trade Meetings and Earnings Reshape Market Outlook

Key points from this issue:

  • Earnings from Boeing (BA) and General Motors (GM) signal markets will trade day-to-day as trade meetings and earnings season heat up.
  • Our price target on Dycom Industries (DY) shares remains $125
  • Our AXTI price target remains $11.
  • Our price target on Nokia (NOK) shares remains $8.50
  • Our long-term price target for Farmland Partners (FPI) shares remains $12.
  • As we head into the seasonally strong second half of the year for United Parcel Service (UPS), our price target on the shares remains $130.

 

This week we’ve moved into the meaty part of 2Q 2018 earnings season, and so far, we’ve seen a number of companies beat top and bottom line expectations. Some market observers will point out that some 20%-25% of the S&P 500 group of companies are in that boat, and are declaring “victory” for the market. With today’s earnings from Boeing (BA) that and General Motors (GM), the market is trending lower as Boeing’s outlook falls short of Wall Street expectations while GM cut its outlook due to higher commodity prices. As you probably guessed, one of the culprits for GM is higher aluminum and steel prices.

My take on that is with 75%-80% of the S&P 500 yet to report, that claim while it could prove to right, it also could be a bit premature. As I shared with Oliver Renick, host at the TD Ameritrade Network a few days ago, we’ve only started to see the impact of initial trade tariffs and if the international dance continues we could see far more tariff jawboning put into action.

Consider a tweet from President Trump this morning that suggests a tariff follow through is possible.

 

 

But last night Trump tweeted a path forward to eliminating tariffs and other trade barriers between the Eurozone and the US ahead of his meeting today with the European Commission President Jean-Claude Juncker today to discuss trade, including tariffs on autos.

It would appear Trump is attempting to keep his negotiating opponents off balance in the hopes of improving trade relations from a US perspective. But it also seems that others have read Trump’s Art of the Deal by now as according to EU trade commissioner Cecilia Malmstrom, the Commission is also preparing to introduce tariffs on $20 billion of U.S. goods if Washington imposes trade levies on imported cars.

While I would love to see some forward progress coming out of these talks, but just like with China the probability is rather low in my opinion. Much like with the China trade talks, things have escalated so that both sides will be looking to claim some victory to report back to their countrymen and women.  This likely means that as we migrate over the next few weeks of earnings, we will have to continue to watch trade developments, especially if more recent and wider spread tariffs wind up being enacted.

With more on the earnings and trade to be had in the coming days, we should be ready for day-to-day moves in the market, which will make it challenging for traders and options players. As they struggle, we’ll continue to take a longer-term focus, heeding the signals to be had with our thematic investing lens. Now, let’s get to some updates and other items…

 

Checking in on 5G spending from Verizon and AT&T

With both Verizon Communications (VZ) and AT&T (T) reporting June quarter results yesterday, I sifted through their comments on several fronts but especially on 5G given our positions in mobile infrastructure and licensing company Nokia (NOK), specialty contractor Dycom (DY) as well as compound semiconductor company AXT Inc. (AXTI). The nutshell take is things remain on track as both carriers look to launch commercial 5G networks in the coming quarters.

Verizon delivered solid quarterly results, buoyed by its core wireless business that added 531,000 net retail postpaid subscribers, which included 398,000 postpaid smartphone net adds. We’ve talked about how sticky mobile service is with consumers as smartphones are increasingly a life link for their connected lives so it comes as little surprise that Verizon’s customer loyalty remains strong with the quarter marking the fifth consecutive period of retail postpaid phone churn at 0.80 percent or better.

In terms of capital spending, a figure we want to watch as Verizon gets ready to launch its commercial 5G network, the company shared its 2018 spend will be at the lower end of its previously guided range of $17.0-$17.8 billion. Now here’s the thing, the mix of spending will favor 5G, which confirms the bullish comment and tone we shared last week from Ericsson (ERIC) on the North American 5G market.

With AT&T, its net capital spending in the June quarter slipped to $5.1 million, down from roughly $6 million in the March quarter but the company shared it will spend roughly $25 billion in all of 2018. Doing some quick math, we find this spending is weighted to the back half of 2018, which likely reflects investments in its 5G network as well as the new first responder network, FirstNet, it is building. During the earnings call, management shared the company now has 5G Evolution in more than 140 markets, covering nearly 100 million people with a theoretical peak speed of at least 400 megabits per second with plans to cover 400 plus markets by the end of this year. In terms of true 5G, trials are progressing and AT&T is tracking to launch service in parts of 12 markets by the end of this year.

That network spend and 5G buildout bodes well for both our Dycom shares.

  • Our price target on Dycom Industries (DY) shares remains $125

 

In addition, a few days ago mobile chip company Qualcomm (QCOM) shared that its 5G antennas are ready from prime time. More specifically, Qualcomm is shipping 5G antennas to its device partners that include Samsung, LG, Sony (SNE), HTC and Xiaomi among others for testing. Moreover, Qualcomm said it stands ready for “large-scale commercialization” which likely means 5G devices are just quarters away instead of years away.

We’d note those device partners of Qualcomm’s mentioned above have all announced plans to bring initial 5G powered phones to market during the first half of 2019. That means the supply chain will be readying power amplifiers and switches that will enable these devices to communicate with the 5G networks, which bodes well for incremental compound semiconductor substrate demand at AXT. Because 5G is being viewed as an “access technology” that will move mobile broadband past smartphones and similar devices, I continue to see this as a positive for the higher margin licensing business at Nokia as well.

As a reminder, AXT will report its quarterly results after tonight’s market close, and expectations for its June quarter are clocking in at $0.08 per in earnings on $26.1 million in revenue, up 60% and roughly 11% year over year.

  • Our AXTI price target remains $11.
  • Our price target on Nokia (NOK) shares remains $8.50

 

Farmland Partners fights back

A few weeks ago, we shared not only our long-term conviction for Farmland Partners (FPI) shares but also prospects for continued drama in the coming months. Well, let’s say we’re not disappointed as this morning the company filed a lawsuit in District Court, Denver County, Colorado against “Rota Fortunae” (a pseudonym) and other entities who worked with or for Rota Fortunae in conducting a “short and distort” scheme to profit from the sharp decline in Farmland’s stock price resulting from false and misleading posting on Seeking Alpha. Farmland is seeking damages and injunctive relief for defamation, defamation by libel per se, disparagement, intentional interference with prospective business relations, unjust enrichment, deceptive trade practices, and civil conspiracy.

Are we surprised? No, especially since the Farmland management team signaled it would be moving down this path. While this will likely result in some incremental noise, we’ll continue to focus on the business and the long-term drivers of the agricultural commodities that drive it.

  • Our long-term price target for Farmland Partners (FPI) shares remains $12.

 

Paccar delivers on the earnings front, boosts its dividend

Tuesday morning, heavy and medium duty truck company Paccar (PCAR) delivered strong June quarter results, beating on both the top and bottom line. For the quarter, Paccar reported earnings of $1.59 per share, $0.16 better than the $1.43 consensus on revenues that rose more than 24% year over to year to $5.47 billion, edging out the $5.39 billion that was expected. The strength in the quarter reflects not only rising production and delivery levels that reflect the pick up in truck orders over the last 6-9 months, but also the ripple effect had on the company’s high margin financing business. Also too, as truck up time increases as does the number of Paccar trucks in service, we’ve seen a nice pick up in the company’s Parts business that carries premium margins relative to the new truck one.

During the quarter, Paccar repurchased 1.21 million of its common shares for $77.2 million, completing its previously authorized $300 million share repurchase program. The Board of Directors approved an additional $300 million repurchase of outstanding common stock earlier this month and given the current share price that is below that average repurchase price we suspect this new program will be put to use quickly. Also during the quarter, Paccar boosted its quarterly dividend to $0.28 per share from $0.25, and management reminded investors of the company’s track record of delivering quarterly and special dividends in the range of 45-55% of net income.

Given 111% year over year growth in the new heavy truck orders throughout the U.S. and Canada during the first half of 2018, we continue to be bullish on PCAR shares as we head into the second half of 2018. Even so, we’ll continue to analyze the monthly truck order data as well as freight indicators and other barometers of domestic economic activity to assess the continued strength in new truck demand. In the coming months, we expect long-time followers of Paccar will begin to focus on the potential year-end special dividend the company has issued more often than not.

  • Our price target on Paccar (PCAR) shares remains $80.

 

A quick note on United Parcel Service earnings

Early this morning, United Parcel Service (UPS) beat estimates by a penny a share, with an adjusted quarterly profit of $1.94 per share. Revenue beat forecasts, as well, boosted by strong growth in online shopping – no surprise to us given our Digital Lifestyle investing theme. UPS will host a conference call this morning during which it will update its outlook for the back half of the year, and that should help quantify the year over year growth in Amazon’s (AMZN) Prime Day 2018 ahead of its earnings report later this week.

  • As we head into the seasonally strong second half of the year for United Parcel Service (UPS), our price target on the shares remains $130.

 

 

WEEKLY ISSUE: Amid an air of uncertainty we revisit a Cashless Consumption player

WEEKLY ISSUE: Amid an air of uncertainty we revisit a Cashless Consumption player

 

KEY POINTS FROM THIS ALERT

  • We are issuing a Buy on USA Technologies (USAT) shares and adding them back to the Tematica Investing Select List with a $12 price target.
  • Our price target on LSI Industries (LYTS) shares remains $11
  • Our price target on Paccar (PCAR) shares remains $85 and offers 25% upside from current levels.

 

Despite the swings up and down that we’ve seen in the stock market over the last several weeks, it might surprise you know the S&P 500, my preferred barometer of the domestic stock market, has moved down all of 1.4% over the last two months. As you know during those weeks we shed shares in both Universal Display (OLED), which have gone on to fall further, and Facebook (FB), while we added GSV Capital (GSVC) shares to the Tematica Investing Select List with a Buy rating and an $11 price target.

As I wrote this past weekend in the Toronto Sun – yes, we are spreading the thematic word to our northern neighbors – I expect the air of uncertainty of the last few weeks to result in lukewarm guidance. This will likely cause a rethink by investors given the herd’s expectation for more than 18% EPS growth by the S&P 500 this year. To say that’s aggressive even in the face of tax reform benefits to be had is an understatement. I suspect we’ll have several opportunities for the Select List in the coming weeks. In the meantime, buckle up for the fun begins early next week.

 

 

Facebook’s Zuckerberg in the hot seat

Yesterday, Facebook was a hot topic given CEO Mark Zuckerberg’s testimony to the Senate. As expected, Zuck offered up his mea culpa, once again promised to “do more” to address the company’s shortcomings when it comes to user data and privacy. While FB shares have traded higher, parsing Zuck’s comments to add more security personnel and do more, what it means is higher costs to eliminate existing and potential bad actors from its content partners. I made this point on the Intelligence Report with Trish Regain on Fox Business yesterday. This point was hammered home in this week’s Cocktail Investing podcast, in which I spoke with Interos Solutions Jennifer Bisceglie (Ep 59: Exposing the Supply Chain Security Nightmare).

Given the privacy concerns, we’re apt to see another drop in the company’s US user metrics as well as a dip in its revenue stream as advertisers backed away from Facebook. Here’s the thing, over the last 30-60 days, we’ve seen no meaningful change in revenue and EPS expectations for 1Q 2018 and 2Q 2018 for Facebook. When the company reports its quarterly results on April 25th, however, more than likely we will see some hit to its metrics and hear about the need to ramp spending in order to restore user trust. The company also needs to show the resiliency of its advertising dominated revenue stream.

What this means is just because Facebook shares have rebounded since we scuttled them a few weeks ago, there is another shoe to drop. My recommendation is we remain on the sidelines until we have a far better understanding of the financial implications to be had.

 

 

Adding back USA Technologies shares to the Select List

Last October we exited half of our position in Cashless Consumption play USA Technologies (USAT), with an 81% win, and were stopped out of the balance in February with a 67% gain. As a reminder, USA Technologies provides wireless networking, cashless transactions, asset monitoring, and other value-added services in the United States and internationally primarily through kiosks and unattended retail. All in all, the position was in USAT shares was a great investment in 2017 and early 2018, especially since the returns crushed the move in the S&P 500. I’ve kept tabs on the shares given the continued growth to be had in mobile payments and USA’s potential to be a takeout candidate.

Recently it was announced that mFoundry was getting acquired by Fidelity National Information Services (FIS), a banking and payment provider that works with some 14,000 banks worldwide, for $120 million. Monday night it was announced that point-of-sale system company VeriFone (PAY) is being acquired in a $3.4 billion deal led by private equity firm Francisco Partners and Canada’s British Columbia Investment Management Corp. Under the terms of the deal, VeriFone shareholders would receive $23.04 in cash for each share, representing a roughly 54% premium to the company’s Monday closing price of $15.

M&A activity and consolidation is a sign that an industry is beginning to mature, with larger players and financial players gobbling up technologies and products to round out their capabilities and offerings. I’ve long seen USA Technologies as company prominently riding our Cashless Consumption investing theme, but one that is bound to show up on M&A radar screens. With its revenue slated to reach roughly $175 million next year, up from $104 million in 2017, with positive EPS, this could happen sooner than previously expected.

I suspect two recent publications will help spur on this likelihood. First is “Intelligent Vending Machine Market – Global Industry Analysis, Size, Share, Trends, Growth and Forecast 2018 – 2025” — that calls for the global intelligent vending machine market to increase at a CAGR (compound annual growth rate) of 38.24% during the period 2017-2021. The second is a forecast published by Statista that shows more than 140% per annum growth for mobile point of sales to $1.3 trillion in 2022 up from $230.8 billion in 2017. Digging into this forecast, we see it reflects a combination of rising consumer adoption over the coming years as well as solid growth in transaction value per user.

On the merits of my original $12 price target, I see more than 35% upside in the shares on a fundamental basis. As mobile payments activity continues to grow, and USAT continues to expand its install base across vending, kiosk and other retail applications, I’ll look to revise my price target. Any additional upside to be had from a takeout offer, well that would just be gravy.

  • We are issuing a Buy on USA Technologies (USAT) shares and adding them back to the Tematica Investing Select List with a $12 price target.

 

 

Checking in on LSI Industries and Paccar

Each month there is a plethora of data released, some of it industry specific and some of it company specific. Recent industry data for both the construction and the truck industry are bullish for our positions in LSI Industries (LYTS) and Paccar (PCAR). Let me explain…

Year to date, shares of LSI Industries are up more than 15%, well ahead of the major market indices. I chalk this up to the favorable monthly data we’ve got in the form of the Architectural Billings Index (ABI) and construction data. In the February ABI reading marked the fifth consecutive monthly increase and the 11th monthly increase in the last 12 months. As a reminder, the ABI is a leading indicator of construction activity. Add to that the favorable February construction report that showed nonresidential construction rebounded in January following several weeks of severe cold and winter weather. As we finally put the winter weather behind us, I expect to see a pickup in nonresidential construction that reflects the ABI index. I see this as setting a favorable base for LSI’s lighting solutions, which is benefitting from the added tailwind associated with green construction that favors light-emitting diode solutions.

  • Our price target on LSI Industries (LYTS) shares remains $11

 

On a year to date basis, shares of heavy and medium duty truck company Paccar (PCAR) are down slightly, and we’re essentially flat form our mid-February addition to the Select List. Here too, the data has been more than favorable. Last week,

Late Wednesday, it was reported by FTR Transportation Intelligence that first-quarter 2018 orders for heavy-duty trucks came in at 133,900 — a 98% gain year over year and the highest level since 2006. Orders for medium-duty Class 5-7 trucks topped 84,700 for the first quarter, a 20.4% increase compared with the same period a year ago.

I expect this to lead to not only a favorable 1Q 2018 earnings report for Paccar but an upbeat outlook as well. During the upcoming earnings season, I’ll be looking for re-affirming comments for Paccar in the form of rising freight costs due to tight truck industry capacity at food and other consumer-related companies.

  • Our price target on Paccar (PCAR) shares remains $85 and offers 25% upside from current levels.

 

 

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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