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Weekly Issue: Insights on Apple, Cutting Trade Desk and a look at eGaming and Body Cameras

Weekly Issue: Insights on Apple, Cutting Trade Desk and a look at eGaming and Body Cameras

 

KEY POINTS FROM THIS WEEK’S ISSUE:

  • Raging fires in So-Cal has us cutting Trade Desk shares loose
  • Here’s why we’re avoiding body camera stocks
  • Speaking of Apple…
  • Some mobile gaming stocks go under the microscope

 

It’s been a wild ride in the market this past week, as investors shift their view from “will tax reform pass” to “with tax reform likely, which sectors will benefit?” Candidly we find this to be the wrong question to ask, not just because we believe sector investing is dead (it is!) but because we see a better question being which thematically well-positioned companies are poised to benefit from lower tax rates in 2018?

We’re rolling up our sleeves, proceeding with that analysis and we’ll have some answers in the coming days. In the meantime, we’ve got another full weekly issue of Tematica Investing to share with you. Here goes…

 

Raging fires in So-Cal has us cutting Trade Desk shares loose

Shares of digital advertising platform company Trade Desk have been under renewed pressure this week, in part due to weakness in the Nasdaq Composite Index, but also to the fires raging in southern California. As a reminder, Trade Desk is headquartered in Ventura, California and despite the prospects for half of all global advertising to be spent online by 2020, odds are Trade Desk will experience either some disruption or distraction in the current quarter that could lead to the company missing quarterly expectations. We’ve seen how share prices react to such misses, and we’d rather get out ahead of any potenital miss to expectations and minimize the impact to Select List.

As such, we are cutting Trade Desk shares loose at market today, which will generate a blended loss of more than 17% across the two tranches on the Tematica Investing Select List. We’ll look to revisit the shares once the full extent of the damage has been priced into the shares.

  • We are issuing a Sell on Trade Desk (TTD) shares.

 

 

Here’s why we’re avoiding body camera stocks

One of the key investment themes that we talk quite a bit about here at Tematica is the Connected Society investment theme and the impact it is having on industries and companies. It’s not to take anything away from our other themes, it’s just the Connected Society has been a disruptive force across a growing number of industries. We’re seeing its impact stretch across how we shop, bank, communicate and consume content ranging from video and audio to news and even stock information.

We’re also seeing the impact outside of consumer-facing opportunities in part with the Internet of Things, but also with our Safety & Security investing theme. As a quick reminder, this theme spans defense, homeland security, personal security, and cybersecurity, but also law enforcement. When it comes to law enforcement we have seen a number of new items ranging from rubber bullets to bean bag guns come to market, but with the Connected Society, we are seeing a shift from reactive to proactive monitoring via body cameras. It’s a razor to razor blade business model, with the body cameras serving as the razor and the data management the ongoing spend, a model that is similar to buying new blades every month.

Interestingly enough, I received a subscriber email that was asking about a company that falls into this category – Digital Ally (DGLY). Trading at just under $3 per share the past month, DGLY shares are well off their 52-week high of $6 per share, and yet have a consensus price target of $5. That along with the underlying fundamentals of the body camera market were more than enough to get me to look at the shares.

Not to be all Debbie Downer, but in reviewing the company’s financials, I have a few cautionairy observations to share:

  • The company’s business model has been and looks to be currently upside down. In that I mean it’s operating expenses vastly outweigh its revenue stream. Over the last 12 months, Digital Ally’s revenues totaled a whopping $15.2 million, while its operating expenses over the same period hit $26.6 million
  • It should come as little surprise the company is bleeding on its bottom line and hemorrhaging cash, which it doesn’t have much of. Exiting the September quarter Digital Ally had $0.3 million in cash and short-term equivalents. In the same quarter, its net loss was $3.5 million.

 

As the saying goes, the numbers don’t lie and simply put, DGLY shares are not a pretty picture. This lack of balance sheet strength in the face of ongoing losses was one of the flag’s I identified with Blue Apron (APRN) shares and I see it here with Digital Ally as well. And for those keeping score, Blue Apron shares are down 27% since my initial bearish comments on October 24th.

Aside from the financial statements, there are other concerns that also have me steering away from DGLY shares — namely back and forth patent infringement cases with competitors WatchGuard and Axon Enterprise (AXON), the company formerly known as Taser. These cases are always messy, with companies throwing resources at legal fees and that’s going to hurt a company with Digital Ally’s balance sheet. Based on what is seen here, it’s quite possible that Digital Ally could be one of those companies that vanishes unless it were to undergo what would likely be a painful and dilutive secondary offering that injects capital onto the balance sheet.

Is it possible that Digital Ally could be a takeout candidate? Perhaps, but as one Chief Financial Officer once shared with me when I asked him why not buy out a struggling company to improve his company’s competitive position – “why buy it now when in a few months I can probably buy it for cents on the dollar?” It was a great point, and besides what acquirer would want to step into the current lawsuit mess?

Better to move along and examine other potential candidates than take a flyer on a stock that is cheap for a reason. And for those wondering, that same set of lawsuits, as well as another factor, has me on the sidelines with Axon Enterprise shares as well. That other factor I mentioned is the current pilot program being run by the Jersey City Police Department that is testing a new smartphone app called CopCast that would allow police officers to turn an everyday smartphone into a body camera. While this is the first test in country, the JCPD has already expanded its pilot program to 250 officers from an initial ten. We’ll continue to monitor both this program, as well as those body camera company lawsuits. On the one hand, the outcome of that monitoring program could be a positive for the Apple (AAPL) shares on the Tematica Investing Select List, on the other it could mean revising DGLY and AXON shares. Time will tell.

 

 

Speaking of Apple…

Over the last week as part of the move lower in the Nasdaq, shares of smartphone company Apple (AAPL) moved lower by 2% — a hair better than the 2.2% decline in the Nasdaq. We here at Tematica remain upbeat on this recent addition to the Tematica Investing Select List with our confidence in Apple buoyed by two recent findings. First, a new report from Barclays’ surveyed 1,000 people and found that 62% will upgrade their smartphone in the next year, while 72% plan on doing so in the next 18 months. Of those upgrading, 54% are planning on choosing an iPhone with 35% choosing the iPhone X. It’s worth noting this iPhone X percentage is significantly higher than the August Barclays’ survey that found just 18% of would be Apple buyers would be willing to spend $1,000+ on the iPhone X.

The second report comes from IHS Markit, which forecasts that Apple will sell 88.8 million iPhones in the current quarter – its biggest quarter ever. As robust as that might be, the item that caught our analytical eye was the notion that Apple needs to ship just 31 million iPhone X units for its overall iPhone average selling price to crack $700 – another new record for the company. IHS’s forecast hinges on the collapsed shipping times for the iPhone X, which have fallen from 5-6 week initially, to roughly one week as Apple ramped production.

We expect additional forecasts to follow, but with the iPhone X making a number of “best of” lists, it appears this latest iPhone could once again be the holiday gift to get.

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

 

 

Some mobile gaming stocks go under the microscope

One of the key themes that caught investor attention over the last few quarters is the accelerating shift to digital consumption, especially mobile consumption that is part of our Connected Society investing theme. We saw this over the recent Thanksgiving-to-Cyber-Monday holiday shopping period, as digital sales over the five-day period hit a new record of $19.6 billion. Based on reports from Adobe (ADBE), Shopify (SHOP) and others, it appears that mobile sales rose to equal 40%-45% of all digital shopping sales this year.

We would also point out this shift to digital shopping is not occurring just inside the U.S. This year, Alibaba’s Singles Day hit $25.3 billion in sales, with over 90% of Alibaba’s sales made on mobile devices compared to 82% in 2016 and 69% in 2015.

I believe we can all agree that there is a pronounced shift underway favoring mobile consumption.

A few weeks’ back, we shared some thoughts on e-sports, which tie into how gaming is becoming a new kind of content that people consume not only by themselves or in small groups, but also in communal experiences. And in size… such size that corporate advertisers are sitting up and taking notice when such events are selling out Madison Square Garden for instance. It’s safe to say that eSports and video games fall well within the scope of our Content is King investing theme, on top of the Connected Society theme given the demands the games place on connectivity over the internet as well as viewing and playing over mobile devices.

Put these two tailwinds together, and it means looking at mobile gaming, and as luck would have it another subscriber asked about shares of Glu Mobile (GLUU) and Zynga (ZNGA). In the case of Glu — aside from the fact that they count companies like Activision and Hasbro (HAS) as strategic partners, and which game titles they have (if the dog doesn’t like the dog food, what’s the point in owning the company) — the key investor concern entails wrapping our head around 2018 expectations compared to 2017. We are essentially at that time of year when we make the transition to relying more on 2018 metrics and valuations, and it makes sense as we are inclined to own new positions into at least the first half of 2018.

In the case of Glu, the answer to the question set we’ll be asking is how does the company intend to meet (or beat) consensus expectations that have it delivering EPS of $0.09 in 2018, up from a -$0.08 loss this year? It’s a hefty swing, especially when 2018 revenue is expected to grow a tad more than 5% year over year.

The question for Zynga (ZNGA) is a bit different. It is expected to deliver EPS of $0.13 next year, up from $0.10 this year, which is 30% EPS growth, but why the sharp drop compared to year over year EPS growth this year, especially when 2018 revenue is slated to rise by more than 9%?

If you ask a carpenter how they look to minimize mistakes, the answer you usually get is “measure twice and cut once.” Essentially, that’s what we’ll be doing as we get to the bottom of those questions as well as others over the coming days.

As we do that, I’m going to offer a disclaimer of sorts. While we’ve smartly added companies like USA Technologies (USAT) and AXT Inc. (AXTI) to the Tematica Choice List, we generally stick with larger capitalization stocks, which tend to be more liquid and have better established business models, a track record of earnings and cash flow, better capitalized balance sheets and in some cases dividends.

All things being equal, those kinds of companies are less risky and less volatile than micro-cap stocks like Digital Ally or small-cap ones such as Glu Mobile, which often lack institutional investors and whose shareholders tend to be littered with speculators, not investors. In some cases, those stocks are nothing but glorified option plays, and we leave that kind of trading to our Tematica Options+ service, which focuses on trading options and other aggressive trading tactics, while here at Tematica Investing we are long-term and patient investors.

That’s not to say we won’t take advantage of a mismatch between a company’s stock price and the opportunity to be had, rather we’re going to examine each thematic contender on its own individual merits from a thematic and financial perspective. That being said, as we examine GLUU and ZNGA shares, I’ll be doing the same with Activision Blizzard (ATVI), Electronic Arts (EA) and Take-Two Interactive (TTWO) as well.

Before we close out this week’s issue, I’d like to hammer home that the answers to the questions we asked above and ones like them are what we consider to be the basic building block of analyzing and understanding a company and now its business is performing. For those subscribers that are looking for a more detailed set of primer questions, we – that’s Tematica Chief Macro Strategist Lenore Hawkins and myself – included them in Chapter 10 of our book, Cocktail Investing – Distilling Everyday Noise into Clear Investing Signals. And yes, that book inspired our weekly podcast and it would make a great holiday present to a burgeoning investor.

 

 

 

SPECIAL ALERT: Some House Cleaning of the Tematica Select List

SPECIAL ALERT: Some House Cleaning of the Tematica Select List

 

KEY POINTS FROM THIS POST:

  • Adding to the Trade Desk (TTD) position and improving the cost basis along the way
  • Funding the TTD move by exiting Teucrium Corn Fund (CORN) shares
  • Boosting our International Flavors & Fragrances (IFF) price target
  • Upping our USA Technologies price (USAT) target as well
  • MGM Resorts (MGM) enters a seasonally slow period
  • What’s expected from Applied Materials (AMAT) on Thursday?

 

As we shared in today’s Monday Morning Kickoff, this week will see a downtick in the pace of corporate earnings. There are, however, still companies worth listening to beyond Applied Materials (AMAT) — the only Tematica Investing Select List company reporting this week. In addition to sharing what’s expected from Applied later this week, today we’re boosting our price targets on International Flavors & Fragrances (IFF) and USA Technologies (USAT) as well as scaling into recently added Trade Desk (TTD) shares, using the proceeds from closing out the position in Teucrium Corn Fund (CORN) shares. We’ve also got an update of MGM Resorts (MGM) following its quarterly earnings report last week.

 

Adding to the Trade Desk position and improving the cost basis along the way

As we shared on Friday, we are using the sharp pullback in Trade Desk (TTD) shares to add to our position on the Tematica Investing Select List, while improving our cost basis from just under $65. Our view is the 21% move lower in TTD shares last week was an extreme overreaction given the company’s current quarter guidance was less than 1% below consensus expectations. At the same time, we only see the shift to digital advertising accelerating as consumers flock to digital platforms from podcasts, like our own Cocktail Investing podcast to various social media and streaming platforms.

  • Adding to the Trade Desk (TTD) position
  • Our price target on Trade Desk (TTD) shares remains $80

 

Funding the TTD move by exiting Teucrium Corn Fund (CORN) shares

To help fund this doubling down in Trade Desk shares — and continuing the process of house cleaning as we prepare to exit 2017 — we are issuing a Sell on Scarce Resource play Teucrium Corn Fund (CORN) shares. Here’s why: last week in its November Crop Production and Supply/Demand Report, the US Department of Agriculture (USDA) shared U.S. corn production reached “175.4 bushels per acre vs. the trade’s expectations of 172.4 bushels per acre and the USDA’s October estimate of 171.8.”

This means despite rising international demand for corn, the ending stocks are much greater than expected a month ago, let alone several months ago, and that has this consumable resource being far less scarce than expected when we added the CORN shares to the Select List. We’ll move the shares down to the Contender List, but it won’t be until the spring 2018 planting season that we look to revisit CORN shares and even then, it will depend on the geopolitical environment for agriculture exports and demand.

While never an enjoyable moment to close a position, we see this as the right move at the right time as the 13% loss endured will offset short-term taxable gains booked earlier in the year when we closed positions in PowerShares NASDAQ Internet Portfolio ETF (PNQI), Costco Wholesale (COST), and more recently CalAmp Corp. (CAMP).

  • We are issuing a Sell on Teucrium Corn Fund (CORN) shares and placing them on the Tematica Investing Contender List.

 

Boosting our International Flavors & Fragrances price target

In last Wednesday’s Weekly Tematica Investing issue, as part of our review of International Flavor & Fragrances (IFF) September quarter earnings that handily beat expectations, I shared that my $150 price target was under review. I can now share that my new price target on the shares is $160, which is in line with the shares average dividend yield of 1.7% over the 2005-2016 period when applied to the current $0.69 quarterly dividend. On a price to earnings basis, my new price target is a modest premium to the 10-year average, but we see as warranted given the rising demand for organic flavoring solutions as well as the shifting preference for non-sugar flavoring that is forcing beverage companies, like PepsiCo (PEP) and Coca-Cola (KO) to reformulate their beverages.

  • Our new price target on International Flavors & Fragrances (IFF) shares is $160, which keeps our Hold rating intact.

 

Upping our USA Technologies price target as well

Last week USA Technologies (USAT) reported mixed September-quarter results, with earnings per share that beat expectations while revenue fell modestly short of Wall Street consensus. Also last week, USA shared it would acquire Cantaloupe Systems, a provider of cloud and mobile solutions for vending and office coffee services. At the same time, the company boosted its 2018 outlook. Factoring in Cantaloupe, USA now sees its 2018 revenue falling in the range of $127 million to $142 million, compared to the pre-earnings consensus of $123.8 million.

Given the lift in revenue, as well as favorable margins associated with Cantaloupe, we’re boosting our price target to $8.00 from $6.50, which offers around 13% potential upside from current levels. This keeps our Hold rating on USAT shares intact.

Getting back to the USA’s results, revenue rose 19%, year to year, to $25.6 million, marking its 32nd consecutive quarter of year-over-year revenue growth. We’d note that even before including Cantaloupe in the outlook for the coming quarters, USA’s base 2018 guidance means the company would have had to grow its revenue another 21% even after we annualized September-quarter revenue.

So, what gives us the confidence the company can continue to deliver on those growth metrics with its core business? Let’s look at some operating metrics from the September quarter:

  • Net new connections rose 37%, year over year, to 26,000, bringing total connection count to 594,000, of which approximately 500,000, or 84%, are a near-field communication (NFC) enabled.
  • USA’s customer base rose by 550 new customers in the quarter and was the highest new customer count it has achieved in two years, bringing the total number of customers on the ePort Connect service to 13,250. While it may be simple or obvious, the more customers on ePort Connect, the more potential transactions there are in vending and unattended retail.

On the earnings call, USA management shared several new developments that bode very well for continued ePort Connect growth in the coming quarters:

  • As part of its partnership with Canteen, the largest automated merchandising company in the United States, offering vending, micro-market, office coffee and dining services to a large network of corporate-owned and franchise locations, two Canteen franchisees will transition their business to 100% connectivity for cashless payments.
  • Premier Food Service, a leading food service provider in Kansas, will upgrade more than 1,400 locations to USA’s ePort Connect service and over 300 kiosks to its consumer engagement and loyalty program.
  • Berkshire Foods, a leading vending and food service company in Connecticut and New York, is widening its footprint with the addition of 1,000 new ePort Interactive and ePort G10-S units to its existing network of approximately 1,500 locations that use USA’s services.

With regard to Cantaloupe, we like the acquisition as it builds on the company’s service offering as well as helps expand its footprint even further. Cantaloupe is headquartered in San Francisco and has approximately 300,000 machines on its service with more than 1,300 operator customers in the U.S., Canada, Australia and South America. The acquisition is expected to close in short order, and as such, we expect more associated synergies to come to light in the coming weeks and months.

  • We are boosting our price target on USA Technologies (USAT) shares to $8.00 from $6.50.

 

MGM Resorts (MGM) enters a seasonally slow period

Last Wednesday, MGM Resorts (MGM) reported its September quarter results, which beat on revenue but missed by $0.02 per share on EPS. Despite that mixed result, due in part to the August typhoon in Macau, the management team echoed comments from Las Vegas Sands (LVS) that it is seeing Las Vegas return to normalized activity levels as the impact of the Oct. 1 shooting fades.

This prompted MGM to issue current quarter guidance for its Las Vegas business that is down low to mid-single digits, far better than many had feared, given the events early in the quarter and led our shares to climb more than 5% on Wednesday. With regard to Macau, activity in Asia’s tourist and leisure capital has also bounced back and MGM confirmed its second property in the region will open late this coming January.

Stepping back, the company shared more on how it responded to the October shooting explaining that, along with other casino operators, it shut down all marketing channels, bringing them back online on Oct. 10. Since then, the company has seen the historical patterns of October — typically the strongest month in the quarter and one of the stronger ones during the year — take hold.

As we move past this relief rally and digest the current guidance, the company’s prospects in the short term will be facing continued spending to revamp several of its properties, as well as open its next Macau property in January. This opening will keep the recent stream of new or updated properties flowing following the acquisition of the Borgata Hotel Casino and Spa in August 2016 and the MGM National Harbor opening in December 2016; we expect it to continue as MGM re-opens its Monte Carlo property as the Park MGM.

There will also be some impact of time shifts, with the Las Vegas convention season in the first quarter of 2018. The company has already booked 80% of its convention room nights for 2018, which is great given that roughly 60% of its business is corporate in nature. It has a robust entertainment calendar at all of its arenas (Mandalay Event Center, MGM Grand Garden or T-Mobile Park Theatre) that should bode well for its hotel, restaurant, and gaming operations.

What this means, at least over the next few months, is that we will have to be patient with MGM shares as spending is curtailed, allowing the company’s operating strategy to flow through to the bottom line. Helping soften the would-be blow, earlier this week the company’s board approved the next quarterly dividend of $0.11 per share that will be paid on Dec. 15. On the earnings call, management reiterated that they remain committed not only to the current dividend but to increase it over time.

Here’s what we’re going to do with MGM shares… Following last week’s 5% move higher in MGM shares, we have roughly 13% upside to our $37 price target, but as discussed above, we see some short-term headwinds that will likely keep the shares range bound. As we move into 2018, we’ll look to revisit our $37 price target provided the company’s investments in new and existing properties wanes, which should enhance the company’s earnings and cash generation.

  • Our price target on MGM Resorts (MGM) shares remains $37.

 

What’s expected from Applied Materials on Thursday?

On Thursday, after the market close, Applied Materials (AMAT) will be reporting its quarterly results. The results come on the heels comments made earlier in the current earnings season regarding growing chip demand due to the expanding roster of connected devices, artificial intelligence, gaming, data center expansion and China’s goal of building its own semiconductor capacity. We’ve also heard bullish display commentary from not only our own Universal Display (OLED), but also LG Display and Samsung as they increasingly focus on organic light-emitting diodes for smartphones, TVs and eventually other applications like automotive and general lighting.

Consensus expectations have Applied Materials achieving EPS of $0.91 on revenue of $3.94 billion for the quarter. We’ll also be reviewing the company’s backlog and book to bill metric for the quarter as we reassess our current $65 price target.

  • Heading into Applied Material’s (AMAT) earnings call on Thursday, our price target on the shares is $65.
  • Our price target on Universal Display (OLED) shares remains $200.

 

Special Alert: Tematica’s take on Trade Desk earnings

Special Alert: Tematica’s take on Trade Desk earnings

 

Last night recently added Connected Society / Content is King company Trade Desk (TTD) reported results that beat September quarter expectations. However, after several “beat and raise” quarters, TTD shares were trading off in the aftermarket last night and again in pre-market trading this morning due to “underwhelming” revenue guidance — guidance that was modestly short of consensus expectations. For the current quarter Trade Desk guided revenue to $101 million, while the consensus forecast was $101.6 million. For those doing the math, yes that’s a variance of less than 1% — a variance on guidance, not a variance of actual results, Still, TTD shares are down more than 11%.

What’s going on?

As we mentioned when we added Trade Desk shares earlier this week to the Tematica Investing Select List, the company has a reputation for “beating and raising”.  While it clearly beat September quarter expectations that were looking for EPS of $0.26 on revenue of $76.8 million last night with EPS of $0.35 on revenue of $79.4 million, the guidance, which is likely to prove to be conservative in our view is the issue. Plain and simple, Trade Desk management did not boost its outlook for the current quarter above the consensus view, and that is catching some investors off guard.

We’ve seen this before when a company that has a track record of raising expectations quarter after quarter, suddenly doesn’t follow the expected playbook. Some investors panic and sell thinking “things must be over” or “something is wrong.”

In our experience, more often than not, what we are seeing in Trade Desk — a company that is benefitting from the accelerating shift in advertising spend to digital platforms — is simply re-casting the expectations bar so it can continue to walk over it, beating expectations in the process. To use Wall Street lingo, we suspect Trade Desk is sandbagging the current quarter in order to keep its “under promise and over deliver” reputation intact. While it’s not fun in the short-term, such actions that drive a stock’s price lower offers us an opportunity to improve our cost basis at better prices as we scale into the position.

When we added the shares, we mentioned that there was the chance that Trade Desk could deliver a flub. We didn’t think it was likely, and the performance in the September quarter was robust — a quarter that showed 95% customer retention as well as solid growth across mobile, international and other advertising platforms including audio the underlying business. On the earnings conference call, Trade Desk shared it added “3 large global brands” during the quarter with spending in the test phase.

What this tells us is Trade Desk continues to gain advertising spend share as companies continue to look for ways to reach consumers in today’s increasingly connected and digital world. Considering how brand conscious companies are, and rightly so, we see it as a huge vote of confidence that Trade Desk continues to win and retain customers.

 

Here’s our strategy for TTD shares

Our strategy with Trade Desk shares will be to remain patient with our current shares and sit on the sidelines in the very short-term while sellers weigh down on the stock price. In relatively short order, we expect to be in a position to step in and add to our position at better prices given that we see no slowdown in the shift toward digital advertising.

If there was any doubt, all we need do is look at where people are spending their time — on connected devices. While there may be some bumps along the way, we see this creative destruction in how and where advertising spend occurs as 2.0 version of how the internet impacted newspaper advertising. There is no putting the genie back in the battle, especially as video consumption shifts from broadcast to streaming services, with more players ranging from Facebook (FB), Alphabet (GOOGL), Amazon (AMZN) and Apple (AAPL) getting involved. If anything, we see advertisers pivoting toward Trade Desk.