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Weekly Issue: As Global Economy Slows, Investors Switch into Fear Mode

Weekly Issue: As Global Economy Slows, Investors Switch into Fear Mode


Key points inside this issue

  • The global economy continued to slow in August
  • Uncertainty has investors in Extreme Fear mode
  • Trade remains the focus of the stock market
  • Boosting our Disney (DIS) price target following D23’s Disney+ focus
  • Items to watch this week


The stock market has been a more volatile than usual over the last few weeks as investors:

  • Contend with the latest global economic data
  • Eye the yield curve
  • Question what the Fed will do next
  • Brace for the next round of trade talks

As if that wasn’t enough, we’ve also witnessed mixed June quarter retail earnings, which are now getting factored into second half of 2019 earnings-per-share expectations for the S&P 500. At the same time, the velocity of corporate buybacks has slowed, Washington is scrutinizing tech companies, and consumer confidence is waning. 

All in all, these issues weighing on investors minds have led to swings in the market based on the most recent headlines, and that can make for a challenging time in the market and for investors.


The global economy continued to slow in August

Last Thursday morning, we received the first meaningful piece of August economic data in the form of the IHS Markit Flash PMI data for the month, and in aggregate, it confirms the global economic slowdown. To date, the U.S. has been the best house on the slowing economic block, but Thursday’s data, which showed the domestic manufacturing sector contracting for the first time in a decade means the trade war and uncertain environment are weighing on the economy. 

During periods of uncertainty, whether we’re talking about companies or people, the natural instinct is to pull back, wait and assess the situation. For both people and companies, dialing back spending is an arguable course of action when faced with uncertainty, but from an economic perspective that translates into a headwind for growth. We’re seeing that headwind in the day’s Flash PMI data.

Aside from the headline, U.S. Flash Manufacturing PMI hit 49.9, marking a 119-month low; the index’s new orders component put in its weakest reading since 2009. Per the report, “Survey respondents often cited subdued corporate spending in response to softer business conditions and concerns about the global economic outlook.” 

But as we saw with the July Retail Sales report, consumers continue to spend, despite rising debt levels and banks are starting to report a pick-up in delinquency rates. The question that is coming to the forefront of investor minds is whether consumers will be able to spend and keep the economy chugging along during the all- important holiday shopping season that will soon be upon us? Given the continued increase in consumer debt levels and news that Citibank (C), JPMorgan Chase (JPM), Bank of America (BAC) and other banks are reporting rising credit card delinquency rates we could be starting to see the consumer spending breaking point. 

Looking at the August Flash PMI data for the eurozone, the slowdown continued as well, but the report also registered a “sizeable drop in confidence regarding the 12-month outlook” with sentiment down to its lowest level since May 2013. Digging into that report we find new order growth in Germany, the largest economy in the eurozone, falling to its weakest levels since early 2013. The August data for the region confirms current forecasts the region is likely to hit just 0.1%-0.2% Gross Domestic Product in the current quarter. Another round of weak data, and odds are we’ll soon see recession fears rising ahead of the European Central Banks upcoming mid-September monetary policy meeting.


Uncertainty has investors in Extreme Fear mode

If we were to step back and look at the data, what we are seeing is data that points to a continued slowdown with some bright spots. Granted those bright spots are also somewhat mixed and there are reasons to be concerned over the sustainability of those bright spots. Is it any wonder then that the CNN Money Fear & Greed Index has been firmly in “Extreme Fear” for the last week? In a word, no.

During periods of Extreme Fear, the jittery market is bound to overreact. Add in the fact that we are in one of the seasonally slowest times of the year for trading volumes means market reactions will be even more extreme one way or another. The danger for investors is to get caught up in the turbulence, and it can be rather easy to do, especially if one is looking to pile onto a money-making trade, be it a long or short one. This makes headline-grabbing, bold assertions increasingly digestible, like the one from hedge fund hired-gun Harry Markopolos on General Electric (GE) or rumor–mongering like the recent one that drove the recent pop in shares of Tesla Motors (TSLA).

Rumors and assertions are tricky things, and while some may turn out to be true, others may only have a whisper of truth, if any at all. In the case of Markopolos, he’s working with an unnamed hedge fund partner, and while it would be wrong to cast wide dispersion on the industry, the reality is it is hurting. In 2018, eVestment hedge fund performance data showed the overall hedge fund industry returned negative 5.08%. While the industry is in positive territory on a year-to-date basis this year, it still meaningfully lags the major market indexes.

The bottom line is that in a market environment that is teaming with uncertainty on several sides, it is even more important that investors continue to focus on the data rather than be led astray by rumors and conjecture. Whether it is digging into a company’s financial filings; cross referencing conference call transcripts across a company’s competitors, customers and suppliers; or wading deep into the economic data, now more than ever it is important to do the homework rather than simply piling onto an idea that could simply be one person talking his or her trade book.  In our case, we’ll continue to assess and revisit the tailwinds that powers each of our investing themes each week through Thematic Signals and our Thematic Reading as well as our Thematic Signals podcast. 

Along the way, we may find something that helps put some of those potentially over-the- top assertions into perspective. One such example is found in the work by Bronte Capital that took Markopolos’ assertion that GE’s industrial margins near 15% are “too good to be true” to task by comparing them with similar margins at Honeywell (HON), Emerson Electric (EMR) and others. Once again, digging into the data adds that layer of context and perspective that is both helpful and insightful to investors.

In my experience, making a trade without doing the homework first and getting conviction on the thesis rarely yields the hopium expected. If the homework checks out, it offers confidence and conviction in the position. Periodically checking the data to determine if that thesis remains on track can either keep one’s conviction running high or alert to a potential issue. Not doing the homework leaves one vulnerable to a change they might not even known was coming.


Trade remains the focus on the stock market

As we approached the end of last week, the stock market was poised to move higher week over week, but as we saw it finished up on a very different note given all of Friday’s news. That news spanned from China threatening countermeasures on tariffs set to be instilled on Sept. 1, to the Fed being ready to extend the current recovery even though it remains upbeat about the domestic economy, to President Trump “ordering” U.S. companies to look for “alternative to China” and then raising tariffs on China after the market close. 

There was little question, we were once again seeing U.S.-China trade tensions escalate, raising questions as to what it could mean for the next round of trade talks. In other words, as we headed into one of the last summer weekends, U.S.-China trade uncertainty continued. While the market absorbed China’s escalation and Fed Chair Powell’s “at the ready when needed” comment, it was Trump’s latest trade salvo that reversed the market’s direction for the week leading all the major stock indices to finish down for the week. Trump said he would raise existing duties on $250 billion in Chinese products to 30% from 25% on October 1 and increase the 10% tariff on another $300 billion of Chinese goods set to take effect on September 1 to 15%.

The trade drama at the G-7 meeting continued over the weekend, and it appeared the market was going to start this week off with more than a whimper given that last night US stock market futures were down more than 1%. However, like any good drama that has a number of twists, this morning President Trump shared that China wants to make a trade deal, which served to walk back last week’s jump in trade tensions. 

My stance on the trade war has been a combination of hope, patience and details. Hope for a trade deal, patience realizing it would take time to come together and that the details of any trade agreement matter. Despite the purported trade related developments today, my stance remains unchanged. 


Boosting our Disney price target following D23’s Disney+ focus

While many were watching the political and trade events unfold at the G-7 meeting over the weekend, there was another gathering of note – D23 2019 at which Walt Disney (DIS) shared quite a bit about its upcoming Disney+ service that is set to launch on November 12. As I’ve said before, that service not only grows Disney’s exposure to our Digital Lifestyle investing theme, it’s also going to change how Wall Street values both DIS shares as well as those for Netflix (NFLX). 

On its own Disney+ will cost users $6.99 a month, or $69.99 for a full year, but together with ESPN+ and ad-supported Hulu the bundle will run customers $12.99 per month, which is on par with the standard plan offered by Netflix that allows for two screens to be watching at the same time. The starter price for Disney+ allows for up to support for four simultaneous streams with 4K included. That’s quite a difference, and one that runs the risk of eating into Netflix’s business, particularly at the margin as Middle-class Squeeze consumers tally up how much they are spending on all of their streaming video and music as well as other subscription services

During D23 Disney showcased a plethora of Disney+ exclusive content ranging from its Star Wars to Marvel universes. On the Marvel front, Disney+ will include seven live action programs that are expected to tie into the active Marvel Cinematic Universe (MCU) that span existing characters and introduce new ones as well. While some may be missing the original Marvel streaming content that was found on Netflix, the upcoming Marvel content on Disney+ will continue the interlocking nature of the box office films that culminated in this summer’s blockbuster Avengers: Endgame. 

The original programming will be dribbled out over the coming quarters, but at launch Disney+ is expected to contain approximately 7,000 episodes of television series and 400 to 500 movies. According to Disney CEO Bob Iger, almost every single movie in the Disney catalog will eventually be available on the service. That is expected to pale in comparison to the sheer volume of content found on Netflix, which according to Ampere Analysis will be roughly eight times bigger than Disney+’s launch lineup. That may help explain the initial price point for Disney+ but what the service has going for it is it will be the only place one can find some of the biggest franchises in entertainment. That’s very much a page out of the Disney park playbook, and the odds are certainly high that Disney will leverage the content found on Disney+ across its merchandising and park businesses. It was also revealed that Disney and Target (TGT) will partner to open Disney shops inside Target locations, which should only add to the Disney merchandizing business. 

The looming question is to what degree will Disney+ attract subscribers? A far better sense will be had once the service goes live, but that hasn’t stopped Wall Street for putting forth expectations. Wedbush expects Disney to add between 10 million and 15 million subscribers to its service each year until they reach around 45 million. For context, that compares to roughly 60 million Netflix US subscribers and other firms are calling for a faster sign-up rate at Disney+ given the combination of cost and content. 

  • With details surrounding Disney+ becoming clearer, we are boosting our price target on Walt Disney (DIS) shares to $150 from $125. As subscriber data for Disney+ is shared, we’ll continue to refine our price target. 


What to watch this week

On the corporate earnings front this week, the parade of retail earnings will continue with J.Jill (JILL), Chico’s FAS (CHS), Tiffany & Co. (TIF), Best Buy (BBY), Ulta Beauty (ULTA), and Dollar Tree (DLTR) on tap to report, among others. In each of those reports, I’ll be looking for signals relating to our Living the Life, Digital Lifestyle, Aging of the Population, and Middle-class Squeeze investing themes. 

Beyond that cohort, we also have Sanderson Farms (SAFM) reporting and it will be interesting to see what it says about the growing prevalence of meat alternatives that are part of our Cleaner Living investing theme. . Yesterday, Cleaner Living Index company Beyond Meat (BYND) announced it will start testing plant-based fried chicken with YUM Brand’s (YUM) KFC in Atlanta beginning today, August 27. In keeping with that theme, we’ll be comparing and contrasting results at Campbell Soup (CPG) and Hain Celestial (HAIN) given the shifting preference among consumers for healthier foods and snacks. 

Also this week, specialty contractor and one-time Digital Infrastructure Thematic Leader Dycom Industries (DY) will issue its quarterly results and guidance, both of which should offer a view on 5G network buildout for its key customers that include AT&T (T) and Verizon (VZ). Given that Nokia (NOK) shares on the Select List, this will be a report worth digging into.   

While the number of economic data release last week were relatively light, they did pack quite a punch and that continued today with the July Durable Orders Report. While its headline figure showed a better than expected increase, excluding transportation, aircraft and defense to focus on core capital goods the data revealed a 0.4% increase in July, which followed the 0.9% increase in June. Sucking some of the air out of that improvement, core capital goods shipments in July dropped 0.7%, which will weigh on September quarter GDP forecasts. Over the coming days, we’ll get several other pieces of economic July data including trade inventories and Personal Income & Spending reports. 

Coming off a better-than-expected July Retail Sales report, we expect investors will be closely watching the July Personal Income & Spending report to gauge the degree to which consumers can be counted on to power the economy in the second half of the year. In addition to the usual monthly economic data, this week will also bring us the second GDP estimate for the June quarter. As focused as some might be on that revision, we here at Tematica far more focused on what the continued slowdown in the current quarter means for the market and investors. 

Doubling Down on Digital Infrastructure Thematic Leader

Doubling Down on Digital Infrastructure Thematic Leader

Key point inside this issue

  • We are doubling down on Dycom (DY) shares on the Thematic Leader board and adjusting our price target to $80 from $100, which still offers significant upside from our new cost basis as the 5G and gigabit fiber buildout continues over the coming quarters.

We are coming at you earlier than usual this week in part to share my thoughts on all of the economic data we received late last week.

 

Last week’s data confirms the US economy is slowing

With two-thirds of the current quarter behind now in the books, the continued move higher in the markets has all the major indices up double-digits year to date, ranging from around 11.5-12.0%% for the Dow Jones Industrial Average and the S&P 500 to nearly 18% for the small-cap heavy Russell 2000. In recent weeks we have discussed my growing concerns that the market’s melt-up hinges primarily on U.S.-China trade deal prospects as earnings expectations for this year have been moving lower, dividend cuts have been growing and the global economy continues to slow. The U.S. continues to look like the best economic house on the block even though it, too, is slowing.

On Friday, a round of IHS Markit February PMI reports showed that three of the four global economic horsemen — Japan, China, and the eurozone — were in contraction territory for the month. New orders in Japan and China improved but fell in the eurozone, which likely means those economies will continue to slug it out in the near-term especially since export orders across all three regions fell month over month. December-quarter GDP was revealed to be 2.6% sequentially, which equates to a 3.1% improvement year over year but is down compared to the 3.5% GDP reading of the September quarter and 4.2% in the June one.  Slower growth to be sure, but still growing in the December quarter.

Before we break out the bubbly, though, the IHS Markit February U.S. Manufacturing PMI fell to its lowest reading in 18 months as rates of output and new order growth softened as did inflationary pressures. This data suggest the U.S. manufacturing sector is growing at its slowest rate in several quarters, as did the February ISM Manufacturing Index reading, which slipped month over month and missed expectations. Declines were seen almost across the board for that ISM index save for new export orders, which grew modestly month over month. The new order component of the February ISM Manufacturing Index dropped to 55.5 from 58.2 in January, but candidly this line item has been all over the place the last few months. The January figure rebounded nicely from 51.3 in December, which was down sharply from 61.8 in November. This zig-zag pattern likely reflects growing uncertainty in the manufacturing economy given the pace of the global economy and uncertainty on the trade front. Generally speaking though, falling orders translate into a slower production and this means carefully watching both the ISM and IHS Markit data over the coming months.

In sum, the manufacturing economy across the four key economies continued to slow in February. On a wider, more global scale, J.P. Morgan’s Global Manufacturing PMI fell to 50.6 in February, its lowest level since June 2016. Per J.P. Morgan’s findings, “the rate of expansion in new orders stayed close to the stagnation mark,” which suggests we are not likely to see a pronounced rebound in the near-term. We see this as allowing the Fed to keep its dovish view, and as we discuss below odds are it will be joined by the European Central Bank this week.

Other data out Friday included the December readings for Personal Income & Spending and the January take on Personal Income. The key takeaway was personal income fell for the first time in more than three years during January, easily coming in below the gains expected by economists. Those pieces of data not only help explain the recent December Retail Sales miss but alongside reports of consumer credit card debt topping $1 trillion and record delinquencies for auto and student loans, point to more tepid consumer spending ahead. As I’ve shared before, that is a headwind for the overall US economy but also a tailwind for those companies, like Middle-class Squeeze Thematic Leader Costco Wholesale (COST), that help consumers stretch the disposable income they do have.

We have talked quite a bit in recent Tematica Investing issues about revisions to S&P 500 2019 EPS estimates, which at last count stood at +4.7% year over year, down significantly from over +11% at the start of the December quarter. Given the rash of reports last week – more than 750 in total –  we will likely see that expected rate of growth tweaked a bit lower.

Putting it all together, we have a slowing U.S. and global economy, EPS cuts that are making the stock market incrementally more expensive as it has moved higher in recent weeks, and a growing number of dividend cuts. Clearly, the stock market has been melting up over the last several weeks on increasing hopes over a favorable trade deal with China, but last week we saw President Trump abruptly end the summit with North Korea’s Kim Jong Un with no joint agreement after Kim insisted all U.S. sanctions be lifted on his country. This action spooked the market, leading some to revisit the potential for a favorable trade deal between the U.S. and China.

Measuring the success of any trade agreement will hinge on the details. Should it fail to live up to expectations, which is a distinct possibility, we could very well see a “buy the rumor, sell the news” situation arise in the stock market. As I watch for these developments to unfold, given the mismatch in the stock market between earnings and dividends vs. the market’s move thus far in 2019 I will also be watching insider selling in general but also for those companies on the Thematic Leader Board as well as the Tematica Select List. While insiders can be sellers for a variety of reasons, should we see a pronounced and somewhat across the board pick up in such activity, it could be another warning sign.

 

What to Watch This Week

This week we will see a noticeable drop in the velocity of earnings reports, but we will still get a number of data points that investors and economists will use to triangulate the speed of the current quarter’s GDP relative to the 2.6% print for the December quarter. The consensus GDP forecast for the current quarter is for a slower economy at +2.0%, but we have started to see some economists trim their forecasts as more economic data rolls in. Because that data has fallen shy of expectations, it has led the Citibank Economic Surprise Index (CESI) to once again move into negative territory and the Atlanta Fed’s GDPNow current quarter forecast now sat at 0.3% as of Friday.

On the economic docket this week, we have December Construction Spending, ISM’s February Non-Manufacturing Index reading, the latest consumer credit figures and the February reports on job creation and unemployment from ADP (ADP) and the Bureau of Labor Statistics. With Home Depot (HD) reporting relatively mild December weather, any pronounced shortfall in December Construction Spending will likely serve to confirm the economy is on a slowing vector. Much like we did above with ISM’s February Manufacturing Index we’ll be looking into the Non-Manufacturing data to determine demand and inflation dynamics as well as the tone of the services economy.

On the jobs front, while we will be watching the numbers created, including any aberration owing to the recent federal government shutdown, it will be the wage and hours worked data that we’ll be focusing on. Wage data will show signs of any inflationary pressures, while hours worked will indicate how much labor slack there is in the economy. The consumer is in a tighter spot financially speaking, which was reflected in recent retail sales and personal spending data. Recognizing the role consumer spending plays in the overall speed of the U.S. economy, we will be scrutinizing the upcoming consumer credit data rather closely.

In addition to the hard data, we’ll also get the Fed’s latest Beige Book, which should provide a feel for how the regional economies are faring thus far in 2019. Speaking of central bankers, next Wednesday will bring the results of the next European Central Bank meeting. Given the data depicted in the February IHS Markit reports we discussed above, the probability is high the ECB will join the Fed in a more dovish tone.

While the velocity of earnings reports does indeed drop dramatically next week, there will still be several reports worth digging into, including Ross Stores (ROST), Kohl’s (KSS), Target (TGT), BJ’s Wholesale (BJ), and Middle-class Squeeze Thematic Leader Costco Wholesale (COST) will also issue their latest quarterly results. Those reports combined with the ones this week, including solid results from TJX Companies (TJX) last week should offer a more complete look at consumer spending, and where that spending is occurring. Given the discussion several paragraphs above, TJX’s results last week, and the monthly sales reports from Costco, odds are quite good that Costco should serve up yet another report showcasing consumer wallet share gains.

Outside of apparel and home, reports from United Natural Foods (UNFI) and National Beverage (FIZZ) should corroborate the accelerating shift toward food and beverages that are part of our Cleaner Living investing theme. In that vein, I’ll be intrigued to see what Tematica Select List resident International Flavors & Fragrances (IFF) has to say about the demand for its line of organic and natural solutions.

The same can be said with Kroger (KR) as well as its efforts to fend off Thematic King Amazon (AMZN) and Walmart (WMT). Tucked inside of Kroger’s comments, we will be curious to see what the company says about digital grocery shopping and delivery. On Kroger’s last earnings conference call, Chairman and CEO Rodney McMullen shared the following, “We are aggressively investing to build digital platforms because they give our customers the ability to have anything, anytime, anywhere from Kroger, and because they’re a catalyst to grow our business and improve margins in the future.” Now to see what progress has been achieved over the last 90 or so days and what Kroger has to say about the late-Friday report that Amazon will launch its own chain of supermarkets.

 

Tematica Investing

As you can see in the chart above, for the most part, our Thematic Leaders have been delivering solid performance. Shares of Costco Wholesale (COST) and Nokia (NOK) are notable laggards, but with Costco’s earnings report later this week which will also include its February same-store sales, I see the company’s business and the shares once again coming back into investor favor as it continues to win consumer wallet share. That was clearly evident in its December and January same-store sales reports. With Nokia, coming out of Mobile World Congress 2019 last week, we have confirmation that 5G is progressing, with more network launches coming and more devices coming as well in the coming quarters. We’ll continue to be patient with NOK shares.

 

Adding significantly to our position in Thematic Leader Dycom Industries

There are two positions on the leader board – Aging of the Population AMN Healthcare (AMN) and Digital Infrastructure Dycom Industries (DY) – that are in the red. The recent and sharp drop in Dycom shares follows the company’s disappointing quarterly report in which costs grew faster than 14.3% year over year increase in revenue, pressuring margins and the company’s bottom line. As we’ve come to expect this alongside the near-term continuation of those margin pressures, as you can see below, simply whacked DY shares last week, dropping them into oversold territory.

 

When we first discussed Dycom’s business, I pointed out the seasonal tendencies of its business, and that likely means some of the February winter weather brought some added disruptions as will the winter weather that is hitting parts of the country as you read this. Yet, we know that Dycom’s top customers – AT&T (T), Verizon (VZ), Comcast (CMCSA) and CenturyLink (CTL) are busy expanding the footprint of their connective networks. That’s especially true with the 5G buildout efforts at AT&T and Verizon, which on a combined basis accounted for 42% of Dycom’s January quarter revenue.

Above I shared that coming out of Mobile World Congress 2019, commercial 5G deployments are likely to be a 2020 event but as we know the networks, base stations, and backhaul capabilities will need to be installed ahead of those launches. To me, this strongly suggests that Dycom’s business will improve in the coming quarters, and as that happens, it’s bound to move down the cost curve as efficiencies and other aspects of higher utilization are had. For that reason, we are using last week’s 26% drop in DY shares to double our position size in DY shares on the Thematic Leader board. This will reduce our blended cost basis to roughly $64 from the prior $82. As we buy up the shares, I’m also resetting our price target on DY shares to $80, down from the prior $100, which offers significant upside from the current share price and our blended cost basis.

If you’re having second thoughts on this decision, think of it this way – doesn’t it seem rather strange that DY shares would fall by such a degree given the coming buildout that we know is going to occur over the coming quarters? If Dycom’s customers were some small, regional operators I would have some concerns, but that isn’t the case. These customers will build out those networks, and it means Dycom will be put to work in the coming quarters, generating revenue, profits, and cash flow along the way.

In last week’s Tematica Investing I dished on Warren Buffett’s latest letter to Berkshire Hathaway (BRK.A) shareholders. In thinking about Dycom, another Buffett-ism comes to mind – “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” Since this is a multi-quarter buildout for Dycom, we will need to be patient, but as we know for the famous encounter between the tortoise and the hare, slow and steady wins the race.

  • We are doubling down on Dycom (DY) shares on the Thematic Leader board and adjusting our price target to $80 from $100, which still offers significant upside from our new cost basis as the 5G and gigabit fiber buildout continues over the coming quarters.

 

As the pace of earnings slows, over the next few weeks I’ll not only be revisiting the recent 25% drop in Aging of the Population Thematic Leader AMN Healthcare to determine if we should make a similar move like the one we are doing with Dycom, but I’ll also be taking closer looks at wireless charging company Energous Corp. (WATT) and The Alkaline Water Company (WTER). Those two respectively fall under our Disruptive Innovators and Cleaner Living investing themes. Are they worthy of making it onto the Select List or bumping one of our Thematic Leaders? We’ll see…. And as I examine these two, I’m also pouring over some candidates to fill the Guilty Pleasure vacancy on the leader board.

 

 

Weekly Issue: A Number of Our Thematic Leaders Well Positioned for the Holidays

Weekly Issue: A Number of Our Thematic Leaders Well Positioned for the Holidays

 

Normally we here at Tematica tend to shut down during the short week that contains Thanksgiving, but given all that is going on in the stock market of late, we thought it prudent to share some thoughts as well as what to watch both this week and next. From all of us here at Tematica, we wish you, your family, friends and love a very happy Thanksgiving!

Now let’s get started…

Key points in this issue

  • Despite the recent market pain, I continue to see a number of holdings being extremely well positioned for the holiday season including Amazon, Costco Wholesale (COST), United Parcel Service (UPS), McCormick & Co. (MKC) and both businesses at International Flavors & Fragrances (IFF).
  • I’ll continue to heed our Thematic Signals and look for opportunities for when the stock market lands on solid footing.
  • Later this week, Disney’s (DIS) latest family-friendly move, Ralph Breaks the Internet, hits theaters and we’ll be checking the box office tallies come Monday.
  •  Taking a look at shares of Energous Corp. (WATT), a Disruptive Innovator contender

 

The stock market so far this week…

There is no way to sugar coat or tap dance around it – this week has been a difficult slug ahead of the Thanksgiving holiday as the pressures we’ve talked about over the last two months continue to plague the market as the impact has widened out. Oil prices have continued to plummet, pressuring energy stocks; housing data continues to disappoint, hitting homebuilding stocks; and we’ve received more new of iPhone production cuts as well as potential privacy regulation that has rippled through much of the tech sector. Retail woes were added to the pile following disappointing results from Target (TGT) and L Brands (LB) that pressured those shares and sent ripples across other retail shares.

The net effect of the last few weeks has wiped out the stock market’s 2018 gains with both the Dow Jones Industrial Average and the S&P 500 down roughly 1.0% as of last night’s market close. While the Nasdaq Composite Index is now flat for the year, the small-cap heavy Russell 2000 is firmly in the red, down 4.3% for all of 2018 as of last night.

The overall market moves in recent days have weighed on several constituents of the Thematic Leaders and the Select List, most notably Apple (AAPL), Amazon and Alphabet/Google (GOOGL). Despite that erasure, we are still nicely profitable those positions as well as AMN Healthcare (AMN), Costco Wholesale (COST), Disney (DIS), Alphabet (GOOGL), ETFMG Prime Cyber Security ETF (HACK), and several others. More defensive names, such as McCormick & Co. (MKC), and International Flavors & Fragrances (IFF) have outperformed on a relative basis of late, which we attribute to their respective business models and thematic tailwinds.

As I describe below, the coming days are filled with events that could continue the pain or lead to a reprieve. As that outcome becomes more clear, we’ll either stay on the sidelines collecting thematic signals for our existing positions or take advantage of the recent market pain to scoop up shares in thematically well-positioned companies at prices we haven’t seen in months.

 

What to watch the rest of this week

As we get ready for the Thanksgiving holiday, we know before too long the official kick-off to the holiday shopping race will being. Some retailers will be open late Thursday, while others will open their doors early Black Friday morning and keep them open all weekend long. As we get the tallies for the shopping weekend, the fun culminates with Cyber Monday, a day that is near and dear to our hearts given our Digital Lifestyle investing theme.

Given the market mood of late, as well as the disappointing results from Target and L Brands earlier this week, we can count on Wall Street picking through the shopping weekends results to determine how realistic recently issued holiday shopping forecasts. The National Retail Federation’s consumer survey is calling for a 4.1% increase year over year this holiday season, which they define as November and December. The NRF’s own forecast is looking for a more upbeat 4.3%-4.8% increase vs. 2017.

Consulting firm PwC has a more aggressive view — based on its own survey, consumers expect to spend $1,250 this holiday season on gifts, travel and entertainment, a 5% increase year over year. One of the differences in the wider array of what’s included in the survey versus the NRF. In that vein, Deloitte’s inclusion of January in its findings explains why its 2018 holiday shopping forecast tops out among the highest at a 5.0%-5.6% improvement year over year. That Deloitte forecast includes a 17%-22% increase in digital commerce this holiday shopping season compared to 2017, reaching $128-$134 billion in the process. That’s a sharp increase but some estimates call for Amazon (AMZN) to increase its sales during the period by at least 27%.

I continue to see a number of holdings being extremely well positioned for the holiday season including Amazon, Costco Wholesale (COST), United Parcel Service (UPS), McCormick & Co. (MKC) and both businesses at International Flavors & Fragrances (IFF).

Also this week, Disney’s (DIS) latest family-friendly move, Ralph Breaks the Internet, hits theaters and we’ll be checking the box office tallies come Monday.

 

What to watch next week

As mentioned above, next week will bring us the full tally of holiday shopping results and begin with Cyber Monday, which means more holiday shopping data will be had on Tuesday. As we march toward the end of November, we’ll have several of the usual end of the month pieces of economic data, including Personal Income & Spending as well as New Home Sales and Pending Home Sales for October. We’ll also get the second print for the September quarter GDP, and many will be looking to measure the degree of revision relative to the initial 3.5% print.

As they do that, they will likely be taking note of the forward vector for GDP expectations, which per The Wall Street Journal’s Economic Forecast Survey sees current quarter GDP at 2.6% with 2.5% in the first half of 2019 and 2.15% for the back half of 2019. Taking a somewhat longer view, that means the economy peaked in the June quarter with GDP at 4.2%, due in part to the lag effect associated with the 2018 tax reform, and has slowed since due to the slowing global economy, trade war,  strong dollar, and higher interest rates compared to several quarters ago. As tax reform anniversaries, that added boost to the corporate bottom lines will disappear and in the coming weeks, we expect investors will be asking more questions about the likelihood of the S&P 500 delivering 10% EPS growth in 2018 vs. 2017.

With that in mind, perhaps the two most critical things for investors next week will be the minutes to the Fed’s November meeting and the G20 Summit that will be held Nov. 30-Dec. 1. Inside the Fed minutes, we and other investors will be looking for comments on inflation and the speed of rate future rate hikes, which the market currently expects to be four in 2019. And yes, the December Fed policy meeting continues to look like a shoe-in for a rate hike. Per White House economic adviser Larry Kudlow, US-China trade is likely to come to a head at the summit. If the speech given by Vice President Pence at the Asia-Pacific Economic Cooperation summit – the United States “will not change course until China changes its ways” – we could see the current trade war continue. We’ll continue to expect the worst, and hope for the best on this front.

On the earnings front next week, there will be a number of reports worth noting including those from GameStop (GME), Salesforce (CRM), JM Smucker (SJM) and a number of retailers ranging from Dick’s Sporting Goods (DKS) and Tiffany & Co. (TIF) to PVH (PVH) and Abercrombie & Fitch (ANF). Those retailer results will likely include some comments on the holiday shopping weekend, and we can expect investors to match up comparables and forecasts to determine who will be wallet share winners this holiday season. Toward the end of next week, we’ll also hear from Palo Alto Networks (PAWN) and Splunk (SPLK), which should offer a solid update on the pace of cybersecurity spending.

 

Taking a look at shares of Energous Corp. (WATT)

In our increasingly connected society, two of the big annoyances we must deal with are keeping our devices charged and all the cords we need to charge them. When I upgraded my iPhone to one of the newer models, I was pleasantly surprised by the ease of charging it wirelessly by laying it on a charging disc. Pretty easy.

I’m hardly alone in appreciating this convenience, and we’ve heard that companies ranging from Tesla Inc. (TSLA) to Apple Inc. (AAPL) are looking to bring charging pads to market. That means a potential sea change in how we charge our devices is in the offing, which means a potential growth market for a company that has the necessary chipsets to power one or more of those pads. In other words, if there were no such chipsets, we would not be able to charge wirelessly. This coming change fits very well inside our Disruptive Innovators investing theme.

Off to digging I went and turned up Energous Corp. (WATT) and its WattUp solution, which consists of proprietary semiconductor chipsets, software and antennas that enable radio frequency (RF)-based, wire-free charging of electronic devices. Like the charging disc I have and the ones depicted by Apple, WattUp is both a contact-based charging and at-a-distance charging solution, which means all we need do is lay our wireless devices down be it on a disc, pad or other contraption to charge them. In November 2016, Energous entered into a Strategic Alliance Agreement with Dialog Semiconductor (DLGNF), under which Dialog manufactures and distributes IC products incorporating its wire-free charging technology.

Dialog happens to be the exclusive supplier of these Energous products for the general market and Dialog is also a well-known power management supplier to Apple across several products, including the iPhone. Indeed, last week Dialog bucked the headline trend of late and shared that it isn’t seeing a demand hit from Apple after fellow suppliers Lumentum Holdings Inc. (LITE) and Qorvo Inc. (QRCO) cut guidance earlier this week.

On its September quarter earnings call, Dialog shared it was awarded a broad range of new contracts, including charging across multiple next-generation products assets, with revenue expected to be realized starting in 2019 and accelerating into 2020. I already can feel several mental carts getting ahead of the horse as some think, “Ah, Energous might be the technology that will power Apple’s wireless charging solution!”

Adding fuel to that fire, on its September quarter earnings conference call Energous shared that “given the most recent advances in our core technology” its relationship with its key strategic partner – Dialog – “has now progressed beyond development, exploration and testing to actual product engineering.”

If we connect the dots, it would seem that Energous very well could be that critical supplier that enables Apple’s wireless charging pads. Here’s the thing: We have yet to hear when Apple will begin shipping those devices, which also means we have no idea when a teardown of one will reveal Dialog-Energous solutions inside. Given that there was no mention of Apple’s wireless charging efforts at either its 2018 iPhone or iPad events, odds are this product has slipped into 2019. That would jibe with the timing laid out by Energous.

Based on three Wall Street analysts covering WATT shares, steep losses are expected to continue into 2019, which in my view suggests a ramp with any meaningful volume in the second half of the year. That’s a long way to go, and given the pounding taken by the Nasdaq of late, we’ll put WATT shares onto the Contender’s so we can keep them in our sights for several months from now.

 

 

WEEKLY ISSUE: Examining an Aging of the Population Contender as we wait for the Fed

WEEKLY ISSUE: Examining an Aging of the Population Contender as we wait for the Fed

 

Key Points from this Issue:

  • We’ll continue to stick with Facebook shares, and our long-term price target remains $225.
  • We continue to have a Buy rating and $1,300 price target on Alphabet (GOOGL) shares.
  • Our price target on Amazon (AMZN) shares remains $1,750.
  • We are adding shares of Aging of the Population company Brookdale Senior Living (BKD) to the Tematica Investing Contender List

 

The action has certainly heated up this week, with more talk of trade restraints with China, two more bombings in Austin, Texas and renewed personal data and privacy concerns thanks to Facebook. And that’s all before the Fed’s monetary policy concludes later today when we see how new Fed Chair Jerome Powell not only handles himself but answers questions pertaining to the Fed’s updated forecast and prospects for further monetary policy tightening. Amid this backdrop, we’ve seen the major US stock market indices trade off over the last week, but as I shared in this week’s Monday Morning Kickoff, what Powell says and how the market reacts will determine the next move in the market.

I continue to expect a 25bps interest rate hike with Powell offering a dovish viewpoint given the uncertainty emanating from Washington, the lack of inflation in the economy and the preponderance of weaker than expected data that has led to more GDP cuts for the current quarter than upward revisions. As of March 16, the Atlanta Fed’s GDP Now reading stood at 1.8% for 1Q 2017 vs. 5.4% on Feb. 1 – one would think Powell and the rest of the Fed heads are well aware of this.

We touched on these renewed personal data and privacy concerns earlier in the week, and the move lower in Facebook (FB) shares in response is far from surprising. As I wrote, however, I do expect Facebook to instill new safeguards and make other moves in a bid to restore user trust. At the heart of the matter, Facebook’s revenue model is reliant on advertising, which means being able to attract users and drive usage in order to serve up ads. As it is Facebook is wading into original content with its Watch tab and moves to add sporting events and news clearly signal there is more to come. I see it as part of a strategy to renews Facebook’s position as a sticky service with consumers and one that advertisers will turn to in order to reach consumers as Facebook focuses on “quality user engagement.”

The ripple effects of these renewed privacy concerns weighed on our Alphabet/Google (GOOGL) shares, which traded off some 4% over the last week, as well as other social media companies like Twitter (TWTR) and Snap (SNAP). The silver lining to all of this is these companies are likely to address these concerns, maturing in the process.

Not a bad thing in my opinion and this keeps Alphabet/Google shares on the Tematica Investing Select List, while the company’s prospect to monetize YouTube, mobile search, Google Express (shopping) and Google Assistant keep my $1,300 price target intact. Per a new report from Reuters, Google is working with large retailers such as Target Corp (TGT), Walmart (WMT), Home Depot (HD), Costco Wholesale (COST and Ulta Beauty (ULTA) to list their products directly on Google Search, Google Express, and Assistant. I see this as Alphabet getting serious with regard to Amazon (AMZN) as Amazon looks to grow its advertising revenue stream.

  • We’ll continue to stick with Facebook shares, and our long-term price target remains $225.
  • We continue to have a Buy rating and $1,300 price target on Alphabet (GOOGL) shares.
  • Our price target on Amazon (AMZN) shares remains $1,750.

 

On the housekeeping front, earlier in the week, we shed Universal Display (OLED) shares, bringing a close to one of the more profitable recommendations we’ve had over the last year here at Tematica Investing. Now let’s take a look at a Brookdale Senior Living and our Aging of the Population investing theme.

 

Brookdale Senior Living – A well-positioned company, but is it enough?

One of the great things about thematic investing is there is no shortage of confirming data points to be had in and our daily lives. For example, with our Connected Society investing theme, we see more people getting more boxes delivered by United Parcel Service (UPS) from Amazon (AMZN) and a several trips to the mall, should you be so inclined, will reveal which retailers are struggling and which are thriving. If you do that you’re also likely to see more people eating at the mall than actually shopping; perhaps a good number of them are simply show rooming in advance of buying from Amazon or a branded apparel company like Nike (NKE) or another that is actively embracing the direct to consumer (D2C) business model.

While it may not be polite to say, the reality is if you look around you will notice the domestic population is greying More specifically, we as a people are living longer lives, which has a number of implications and ramifications that are a part of our Aging of the Population investing theme. There are certainly issues of having enough saved and invested to support us through our increasingly longer life spans, as well as the right healthcare to deal with any and all issues that one might face.

According to data published by the OECD in 2013, the U.S. expectancy was 78.7 years old with women living longer than men (81 years vs. 76 years). Cross-checking that with data from the Census Bureau that says the number of Americans ages 65 and older is projected to more than double from 46 million today to 75.5 million by 2030, according to the U.S. Census Bureau. Other data reveals the number of older American afflicted with and the 65-and-older age group’s share of the total population will rise to nearly 25% from 15%. According to United States Census data, individuals age 75 and older is projected to be the fastest growing age cohort over the next twenty years.

As people age, especially past the age of 75, it becomes challenging for individuals to care for themselves, and this is something I am encountering with my dad who turns 86 on Friday. Now let’s consider that roughly 6 million Americans will have Alzheimer’s by 2020, up from 4.7 million in 2010, and heading to 8.4 million by 2030 according to the National Institute of Health. Not an easy subject, but as investors, we are to remain somewhat cold-blooded if we are going to sniff out opportunities.

What all of this means is we are likely to see a groundswell in demand over the coming years for assisted living facilities to house and care for the aging domestic population.

One company that is positioned to benefit from this tailwind is Brookdale Senior Living (BKD), which is one of the largest players in the “Independent Living, Assisted Living and Memory Care” market with over 1,000 communities in 46 states. The company’s revenue stream is broken down into fives segments:

  • Retirement Centers (14% of 2017 revenue; 22% of 2017 operating profit) – are primarily designed for middle to upper income seniors generally age 75 and older who desire an upscale residential environment providing the highest quality of service.
  • Assisted Living (47%; 60%) – offer housing and 24-hour assistance with activities of daily living to mid-acuity frail and elderly residents.
  • Continuing care retirement centers (10%; 8%) – are large communities that offer a variety of living arrangements and services to accommodate all levels of physical ability and health.
  • Brookdale Ancillary Services (9%; 4%) – provides home health, hospice and outpatient therapy services, as well as education and wellness programs
  • Management Services (20%; 6%) – various communities that are either owned by third parties.

 

In looking at the above breakdown, we see the core business to focus on is Assisted Living as it generated the bulk of the company’s operating profit stream. This, of course, cements the company’s position in Tematica’s Aging of the Population theme, but is it a Contender or one for the Tematica Investing Select List?

 

Changes afoot at Brookdale

During 2016 and 2017, both revenue and operating profit at Brookdale came under pressure given a variety of factors that included a more competitive industry landscape during which time Brookdale had an elevated number of new facility openings, which is expected to weigh on the company’s results throughout 2018. Also impacting profitability has been the growing number of state and local regulations for the assisted living sector as well as increasing employment costs.

With those stones on its back, throughout 2017, Brookdale surprised to the downside when reporting quarterly results, which led it to report an annual EPS loss of $3.41 per share for the year. As one might imagine this weighed heavily on the share price, which fell to a low near $6.85 in late February from a high near $19.50 roughly 23 months ago.

During this move lower in the share price, Brookdale the company was evaluating its strategic alternatives, which we all know means it was putting itself up on the block to be sold. On Feb. 22 of this year, the company rejected an all-cash $9 offer as the Board believed there was a greater value to be had for shareholders by running the company. Alongside that decision, there was a clearing of the management deck with the existing President & CEO as well as EVP and Chief Administrative Officer leaving, and CFO Cindy Baier being elevated to President and CEO from the CFO slot.

Usually, when we see a changing of the deck chairs like this it likely means there will be more pain ahead before the underlying ship begins to change directions. To some extent, this is already reflected in 2018 expectations calling for falling revenue and continued bottomline losses. Here’s the thing – those expectations were last updated about a month ago, which means the new management team hasn’t offered its own updated outlook. If the changing of the deck history holds, it likely means offering a guidance reset that includes just about everything short of the kitchen sink.

On top of it all, Brookdale has roughly $1.1 billion in long-term debt, capital and leasing obligations coming due this year. At the end of 2017, the company had no borrowings outstanding on its $400 million credit facility and $514 million in cash on its balance sheet. It would be shocking for the company to address its debt and lease obligations by wiping out its cash, which probably means the company will have to either refinance its debt, raise equity to repay the debt or a combination of the two. This could prove to be one of those overhangs that keeps a company’s shares under pressure until addressed. I’d point out that usually, transaction terms in situations like this are less than friendly.

While I like the drivers of the underlying business, my recommendation is we sit on the sidelines with Brookdale until it addresses this balance sheet concern and begins to emerge from its new facility opening drag and digestion. Odds are we’ll be able to pick the shares up at lower levels. This has me putting BKD shares on the Tematica Investing Contender List and we’ll revisit them in the coming months.

 

 

Weekly Issue: Looking for Trump-Proof Companies

Weekly Issue: Looking for Trump-Proof Companies

We exited last week with the market realizing there was more bark than bite associated with President Trump’s steel and aluminum tariffs. That period of relative calm, however, was short-lived as the uncertainty resumed in Washington yesterday in the form of changeups in the administration with Trump letting go Secretary of State Rex Tillerson just after agreeing to talks with North Korea, and more saber rattling with trade actions against China for technology, apparel, and other imports. This also follows Trump’s intervention in the proposed takeover of Qualcomm (QCOM) by competitor Broadcom (BRCM).

While many an investor will focus on the “new” volatility in the market, I’ll continue to use our thematic lens to look for companies that are “Trump-Proof” in the short-term. That’s not a political statement, but rather a reflection of the reality that the modus operandi of President Trump and his Twitter habit often cause significant swings in the market as the media attempts to digest and interpret his comments.

How will we find these so-called Trump-proof companies? By continuing to use our thematic lens to uncover well-positioned companies that are benefitting from thematic tailwinds that alter the existing playing field, regardless of the latest noise from Washington politicians.

At least for now, volatility is back in vogue and that is bound to drive headlines and other noise. I’ll continue to focus on the data, and if you read this week’s Monday Morning Kickoff you know we are in the midst of a whopper of a data week. While the Consumer Price Index (CPI) for February was in line with expectations, and on a year over year basis core rose 1.8% — the same as in January — which should take some wind out of the inflation mongers. This morning we have the February Retail Sales report, which in my view should once again serve up confirming data for our positions in Amazon (AMZN) and Costco Wholesale (COST), which continue to benefit from our Connected Society and Cash-strapped Consumer investing themes.  Later in the week, the February reading on Industrial Production should confirm the demands that are exacerbating the current heavy truck shortage here in the U.S. – good news for the Paccar (PCAR)shares on the Tematica Investing Select List.

 

 

An Update on Our Once Star Performer, Universal Display (OLED)

A few weeks ago, I shared an update on Universal Display (OLED) shares, which have been essentially treading water following the company’s December quarter results. Later today, the management team will be presenting at the Susquehanna’s Seventh Annual Semi, Storage & Tech Conference. Odds are the management team will reiterate its view on market digesting the organic light emitting diode capacity additions made over the last several quarters, but I expect they will also describe the growing number of applications that will come on stream in the next 3-6 quarters.  As of late February, Susquehanna had a positive rating on OLED shares with a price target of $200 and I suspect they will have some bullish comments following today’s presentation.

 

Considering the ripples to be had with the latest Connected Society victim, Toys R Us

Over the weekend we were reminded of the situation facing many brick & mortar retailers that are failing to adapt their business to ride our Connected Society investing theme. I’m referring to toy and game retailer Toys R Us, the one-time Dick’s Sporting Goods (DKS) or Home Depot (HD) of its industry. Like several sporting goods retailers and electronic & appliance retailers such as Sports Authority, Sports Chalet, and HH Gregg that have gone belly up, if Toys R Us doesn’t get a last-minute lifeline or find a buyer it will likely file Chapter 7.

It’s been a rocky road for the one-time toy supermarket company as it entered bankruptcy in September, aiming to emerge with a leaner business model and more manageable debt. The company obtained a new $3.1 billion loan to keep the stores open during the turnaround effort, but results worsened more than expected during the holidays, casting doubt on the chain’s viability. The company entered this year with more than 800 stores in the U.S. — under both the Toys “R” Us and Babies “R” Us brands, but by January, it announced the shuttering of 180 locations.

The pending bankruptcy to be had at Toys R Us is but the latest in the retail industry, but it’s not likely to be the last. Claire’s Stores Inc., the fashion accessories chain with a debt load of $2 billion, is also preparing to file for bankruptcy in the coming weeks as is Walking Co. Holdings Inc.

What these all have in common is the increasing shift by consumers to digital commerce and the growing reliance on retailers for what is termed the direct to consumer (D2C) business model. Certain branded apparel, footwear, and other consumer product companies, like Nike (NKE) have embraced Amazon’s formidable logistics capabilities and this has benefitted our United Parcel Service (UPS) shares. As we have said before, and we recognize it sounds rather simplistic, when you order products online they have to get to where they are being sent. Hello UPS!

Now let’s consider the ripple effect of the pending Toys R Us bankruptcy.

When events such as this occur, there is a liquidation effect and a subsequent void. As we saw when Sports Authority went bankrupt, the businesses at Nike and Under Armour (UAA) were impacted by liquidation sales in the short term. At the same time, both lost the recurring sales associated with Sports Authority. Odds are we will see the same happen with Toys R Us with companies like Mattel (MAT) and Hasbro (HAS) taking it on the chin. In my view these companies are already struggling as teens, tweens and kids of all ages shift to digital games, apps and e-gaming, which are aspects of our Connected Society and Content

In my view these companies are already struggling as teens, tweens and kids of all ages shift to digital games, apps and e-gaming, which are aspects of our Connected Society and Content is King themes. When was the last time you saw an elementary schooler play with Ken or Barbie? More likely they are on an iPad or Microsoft (MSFT) Xbox while their older siblings are playing the new craze sweeping the nation – Fortnite. And yes, that it appears the rumors are true and Fornite will soon be available across Apple’s iDevices.

Looking at the financial performance of Mattel, not even the all mighty Star Wars franchise could save them from delivering declining revenue and earnings this past holiday shopping season. On the liquidation front, we are likely to see the toys businesses at Target (TGT) as well as Walmart (WMT) take the brunt of the blow. But here too this is likely just another hit as these two retailers have already been dealing with falling revenue at Mattel and Hasbro. Walmart is the largest customer for Mattel and Hasbro, accounting for about 20% of total sales for each toy maker. Both toy companies get nearly 10% of their revenue from Target too.

One of the investing strategies that I employ with the Select List is “buy the bullets, not the guns” which refers to buying well-positioned suppliers that serve a variety of customers. In situations like what we are seeing in the brick & mortar retail sector, we can turn that strategy upside down and uncover those companies, like Mattel and Hasbro, that we as investors should avoid given the multiple direct and indirect headwinds they are currently facing or about to.

 

Our Costco thesis remains intact

Our Costco thesis remains intact

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

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

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

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

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

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

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

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

Understanding these two perspectives keeps us bullish on COST shares.

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

 

 

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

Woeful Earnings from Kroger Has Us Tightening Position in UNFI

Woeful Earnings from Kroger Has Us Tightening Position in UNFI

While many have been focused on the retail environment —and we count ourselves among them here at Tematica — we’ve also been watching the painful restaurant environment over the past few months. It’s been one characterized by falling same-store-sales and declining traffic – not a harbinger of good things when paired with rising minimum wages.

For those that are data nut jobs like we are, per TDn2K, same-store sales for restaurants fell 1.1 percent in May, a decline of 0.1 percentage points from April. In May, same-store traffic growth was -3.0 percent. Now for the perspective, the industry has not reported a month of positive sales since February 2016 – that’s 15 months! One month shy of the bad streak the May Retail Sales Report has been on. Clearly not a good operating environment, nor one that is bound to be friendly when it comes to growing revenue and earnings.

Reading those tea leaves, we’ve avoided that the restaurant aspect of our Fattening of the Population investing theme, and with Ignite Restaurant Group filing bankruptcy, Cheesecake Factory (CAKE) warning about its current quarter outlook we confident we’ve made the right decision.

But people still need to eat, and we’ve seen consumers increasingly flock back to grocery stores in 2017. Year to date, grocery retail sales are up 1.7 percent through May. Breaking down the data, we find that in recent months those sales have accelerated, with March to May 2017 grocery sales up 2.8 percent year over year and standalone May grocery store sales up 2.2 percent year over year.

Yet, when grocery company Kroger (KR) reported in-line earnings for its latest quarter, it lowered its 2017 EPS outlook, cutting in the process to $2.00-$2.05 from the prior $2.21-$2.25, with the current quarter to be down year over year. Aside from price deflation in the protein complex and fresh foods, the company cited its results continue to be pressured by rising health care and pension costs for employees, as well as the need to defend market share amid “upheaval” in the food retailing industry. We see that as company-speak for Kroger and its grocery store competitors having to contend with our

We see that as company-speak for Kroger and its grocery store competitors having to contend with our Connected Society investment theme that is bringing in not only Amazon (AMZN), MyFresh, and FreshDirect into the fray, but also leading Wal-Mart (WMT), Target (TGT), and Safeway among others to expand their online shopping capabilities, which in some cases includes delivery. Another reason not to get off the couch when shopping.

Candidly, we’re bigger fans of companies that focus on profits over market share given that short-term market share led strategies, often times with aggressive pricing, tend to sacrifice margins, but focusing on profits tends to lead to better market-share over the long-term. We’ve seen the “strategy” that Kroger is adopting many times in the past and while it may have short-term benefits, increasing prices later on, runs the risk of alienating customers.

Getting back to Kroger’s guidance cut, that news sent Kroger’s shares down almost 20 percent on Thursday and led to United Natural Foods (UNFI) shares to fall more than 3.5 percent, while Amplify Snacks (BETR) slumped by 2 percent. In our view, most of Kroger’s bad news was likely priced into UNFI’s mixed guidance last week when it reported its own quarterly earnings. Without question, 2017 has been a rough ride for UNIF shares despite the Food with Integrity tailwind, but despite Kroger’s guidance cut, management shared on the company earnings call that it continues “to focus on the areas of highest growth like natural and organic products.” Even Costco Wholesale (COST) recently shared it has room to grow in packaged organic food items, excluding fresh), which plays to the strengths at both United Natural Foods and Amplify Snacks.

 

Tightening Our Position in UNFI, But Staying the Course with BETR

With our Food with Integrity thematic tailwind still blowing and UNFI shares down just 7.5 percent relative to our blended cost basis on the Tematica Select List, we’ll remain patient with the position. That said, from a technical perspective the shares are near support levels and if they break through $38.50 the next likely stop is between $33 and $34. Therefore, to manage potential downside risk, we’re instilling a stop loss on UNFI shares at $38.50. As we do this, we’ll acknowledge the tougher operating environment and reduce our UNFI price target to $50 from $65, which still offers upside of just over 25 percent from current levels.

  • We are keeping our Buy rating on United Natural Foods, but trimming our price target back to $50 from $65.
  • We are instilling a stop loss at $38.50 to manage additional downside risk near-term.

With regard to Amplify Snacks, with today’s close the shares are down just 6 percent from our late April Buy recommendation. Generally speaking, these single digit stocks tend to be volatile and require some extra patience, and that’s the tact will take with BETR shares. Our price target remains $11.

  • We continue to have a Buy on Amplify Snacks (BETR) shares and our price target remains $11.

 

 

 

Consumers Spend More in December, But Ouch Those Revolving Debt Levels Sure Could Hurt

Consumers Spend More in December, But Ouch Those Revolving Debt Levels Sure Could Hurt

This morning the US Bureau of Economic Analysis published its take on Personal Income & Spending for December. We’re rather fond of this monthly report given the data contained within and the implications for several of our investment themes, including Cash-strapped Consumers as well as Affordable Luxury and the Rise & Fall of the Middle Class. 

So what did the December report show?

Personal Income rose 0.3 percent, far faster than in November, but still below the 0.4-0.5 percentage gains registered in September and October. We saw the same pattern with Disposable Income (which is a better barometer for discretionary spending), as one would expect to see during the holiday shopping laden month of December.

That’s as good a segue as any to remind our readers that holiday shopping during November and December came in stronger than the National Retail Federation had forecasted. The final tally was a year over year increase of 4.0 percent compared to the NRF’s 3.6 percent forecast.

Now you’re probably saying to yourself, “How can that be given all the bad news that we’ve been hearing from Macy’s (M), Target  (TGT), Kohl’s (KSS), Sears (SHLD) and other brick and mortar retailers?”

To be honest, we doubt the average person would have thrown in the “other brick and mortar retailers” part, but we know our readers are smarter than the average bear.

The answer to that question is that non-store sales, Commerce Department verbiage for e-tailers like Amazon (AMNZ), eBay (EBAY) and digital Direct to Consumer business like those found at Macy’s, Under Armour (UAA), Nike (NKE) and other retailers, rose 12.6 percent year over year to $122.9 billion. We certainly like those stats as they confirm several aspects of our Connected Society investing theme, but we would argue a more telling take on the data is that non-store sales accounted for 19 percent of holiday shopping in 2016, up from 17 percent the year before. Nearly one-in-five shopping dollars was spent through online or mobile shopping.

We’ll get a better sense of this shift, which we only see as accelerating, later this week when both United Parcel Service (UPS) and Amazon report their quarterly results for the December quarter. Team Tematica will also be listening to Direct to Consumer comments from Under Armour and other apparel and footwear companies as they too report quarterly results over the next few weeks.

Now let’s take a look at December Personal Spending – it rose 0.5 percent, a tick higher than was expected. Given the NRF data above, it was rather likely we were going to get a better print vs. expectations.

In combining both the income and spending data for the month, we get the savings rate, which fell to 5.4 percent, a five-month low. Compared to a few years ago, that savings level looks rather solid even though it’s well below the longer-term trend line. What we do find somewhat disconcerting, given the prospects for the Fed to boost interest rates up to three times this year after only doing so just two times in the last two years, is the amount of revolving consumer debt outstanding. As evidenced in the graph below, those levels have continued to climb steadily higher during 2015 and 2016.

Should interest rates move higher in 2017, the incremental interest expense could crimp consumer wallets, reducing their disposable income in the process. To us, that could mean less Affordable Luxury or even Guilty Pleasure spending as more become Cash-strapped Consumers.

World Trade Center Teams With Tribeca Enterprises For Virtual Reality Arcade 

World Trade Center Teams With Tribeca Enterprises For Virtual Reality Arcade 

November will showcase virtual reality technology, the next potentially disruptive technology to how people consume content. With VR headsets available from Google, Facebook, Samsung and HTC among others at a growing number of retail locations ranging from Target to Macy’s and Amazon, the showcase is likely to stoke interest this holiday shopping season. The secret sauce for more widespread adoption will be more VR content and headsets at more affordable prices. We expect that to happen over the coming quarters.

“Blurring the boundaries between reality, fantasy, and the future of cinema, Westfield’s new landmark destination in Lower Manhattan to give visitors the opportunity to watch — at no charge — mind-blowing VR programming created by directors of Antz and Madagascar, The Bourne Identity, and from Cirque du Soleil”

In partnership with the premier curators of VR, Tribeca Enterprises, the Tribeca Virtual Reality Arcade at Westfield World Trade Center will, over three weekends in November, present four VR selections that represent the very best of cutting-edge narrative storytelling from the medium’s most innovative content creators.  The experiences will be screened on viewing devices that allow visitors to experience film as a 360° total immersive experience instead of on the traditional two-dimensional movie screen.

Source: Westfield World Trade Center Teams With Tribeca Enterprises To Host Tribeca Virtual Reality Arcade | Virtual Reality & Augmented Reality Trend News & Reviews – Virtual Reality Reporter