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Weekly Issue December 17 2018

Weekly Issue December 17 2018

Key points inside this issue:

  • The Duke University/CFO Global Business Outlook survey surprises the market
  • Costco stumbles, but it is far from down and out
  • Thematic confirmation had in the November Retail Sales Report
  • Digging into Friday’s other economic reports
  • What to watch this week
  • Holiday Housekeeping

The Duke University/CFO Global Business Outlook survey surprises the market

What looked to be shaping up as a positive week for the stock market turned on its head Friday following renewed concerns over the pace of the global economy. As we’ve talked about recently, the vector and velocity of the latest economic reports suggest a slowing economy and that is fueling questions over the top and bottom-line growth prospects for 2019.

Tossing some logs on the that fire late last week was the new survey findings from the Duke University/CFO Global Business Outlook survey that showed almost half (48.6%) of US chief financial officers believe the United States will be in recession by the end of next year while 82% of CFOs surveyed believe that a recession will begin by the end of 2020. That’s quite different than the Wall Street consensus, which per The Wall Street Journal’s Economic Forecasting Survey sees the speed of the economy slowing from 3.5% in the September 2018 quarter to 2.5% in the current one to 2.4% in the first half of 2019 followed by 2.2% in the back half of the year.

This revelation has added to the list of concerns that I’ve been discussing of late and adds to the growing worries over EPS growth prospects in 2019.

 

Costco stumbles, but it is far from out

Last Thursday night, Costco Wholesale (COST), our Middle-Class Squeeze Thematic Leader, reported an EPS beat by $0.05 per share for the quarter, but revenue came in a tad short at up 10.3% year over year, or $34.3 billion vs. the expected $34.66 billion. Same-store sales for the quarter rose 8.8% (+7.5% ex-gasoline and currency), which is well above anything we’ve seen for the September-November period per Friday’s November Retail Sales report save for digital shopping (Non-store retailers) and gas station sales – more on that shortly.

Despite the positive EPS, COST shares fell 8.6% on Friday.

The issue with Costco was the margin profile as reported operating income was essentially flat year over year. When combined with the top line increase vs. the year-ago quarter it means the company’s operating margin hit 2.7% vs. 3.0% in the year-ago quarter, and 3.2% this past August quarter. Part of the issue was the jump up in pre-opening expenses for new warehouse locations which rose by 6% quarter over quarter. The real culprit was the step up in merchandising costs, which climbed 10.8% year over year for the November quarter vs. 5.4% year over year in the September quarter. Clearly, Costco is seeing the impact of not only higher prices but also the impact of tariffs associated with the U.S.-China trade war.

Despite that, the core basics at the company – foot traffic, renewal rates, and membership growth – continue to fire on all cylinders. That to me makes Costco one of the best-positioned retailers, and the fact that its e-commerce business continues to blossom is positive as well. In all of 2019, Costco looks to open 20-23 net new warehouses, which equates to an increase of 2.5%-3.0% year over year. This will likely drive pre-opening expenses higher in the coming months, but given the favorable metrics associated with each new location over the medium to longer-term, we’ll take it, especially if the economy slows more than expected. Odds are that will drive more consumers to Costco than not.

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

 

Thematic confirmation in the November Retail Sales Report

Looking over Friday’s November Retail Sales Report, core Retail Sales rose 4.0% year over year with strong performance as expected for Non-store Retailers (+10.8% year over year), Gasoline Stations (+8.2%) and Food Service & Drinking Places (+5.6%). To me, those first and third categories ring positive for our Digital Lifestyle and Living the Life investing themes. That means I see those as positive signs for our thematic and holiday shopping positioned companies, which includes the aforementioned Costco, but also Amazon (AMZN), United Parcel Service (UPS), McCormick & Co. (MKC), International Flavors & Fragrances (IFF) and Del Frisco’s Restaurant Group (DFRG).

Back to the November Retail Sales report, while the sequential overall retail comparisons came in either as expected or slightly better depending on the forecast one is looking at, what’s likely to catch the market’s attention is the sequential drop in year over year retail sales growth that was had in November. Again, year over year November retail sales growth rose 4.0%, which was down compared to the October year over year increase of 4.5%.

Given the growing amount of data that points to a slowing domestic economy, one that is driven meaningfully by the consumer, odds are market watchers will not love what they saw in those year over year comparisons. Add to it that a recent Gallup poll found that Americans plan to spend less on holiday gifts today than they expected back in October and less than they expected to spend in 2017. The $91 decline in expected spending since October is “one of the steeper mid-season declines, exceeded only by a $185 drop that occurred in 2008, as the Wall Street financial crisis was unfolding, and a $102 drop in 2009 during the 2007-2009 recession.”

Clearly, those latest data points weighed on the overall stock market last week, but those weren’t the only ones.

 

Digging into Friday’s other economic reports

The November Retail Sales report wasn’t the only set of key data that weighed on the market last Friday. The November Industrial Production Report showed a flat manufacturing economy following the modest dip in October. On the December Flash PMI reports, the U.S. hit a 19-month low for the month with softer new order growth, while “Lower oil-related costs contributed to the slowest rate of input price inflation since the start of the year.” Turning to the eurozone, its Composite Output PMI hit 51.3, down from 52.7 in November, and reached a four-year low. The Flash Manufacturing PMI data for Japan was better, as it rose to 52.4 for December up from 52.2 in November, but that is hardly what we would call a robust figure given the expansion/contraction line at the 50.0 level. While new orders activity improved in Japan, new export orders fell, signaling a change of direction, which supports the notion of a slowing global economy.

This data along with the back and forth on U.S.-China trade, Brexit developments, Italy budget concerns, protests in France, and the potential government shutdown have all raised investor uncertainty levels. We see this in the current “Extreme Fear” (9) reading on the CNN Business Fear & Greed Index, which is little changed over the last few weeks. We’ve seen this play out in the stock market as the number of stocks hitting new highs pales in comparison to hitting 52-week lows. As one likely suspects, we saw this play out in small cap stocks, which per the Russell 2000 last week, were once again the hardest hit of the major stock categories. Quarter to date, small cap stocks are down just under 17% quarter to date.

We saw a number of these concerns brewing as we exited September and entered the September- quarter earnings season. We have been careful in making additions to the Select List given what I’ve viewed as an environment that has been more skewed to risk than reward. Odds are that will continue to be the case between now and the end of the year, which means we will continue to be overly selective when it comes to deploying capital. For that reason, last week we added the ProShares Short S&P 500 ETF (SH) shares to our holdings to add some downside protection.

 

What to Watch This Week

Following last week’s rash of economic data, don’t ask me how or why but the Atlanta Fed saw fit to boost its GDP Now forecast for the current quarter to 3.0% from 2.4% last week. As subscribers know, I prefer the far more solid track record at the NY Fed and its Nowcast report, which now calls for the current quarter to be +2.4%, down from +2.44% last week. That’s in line with The Wall Street Journal’s Economic Forecasting Survey, but again that Duke poll is likely to be in the forefront of investor minds this week as more data is had. This includes several pieces of housing data — the November Housing Starts & Building Permits as well as November Existing Home Sales and the October NAHB Housing Market Index — as well as the November Durable Orders Report and November Personal Income & Spending data.

As I mentioned above, the number of economic numbers suggesting the global economy continues to slow are growing, which likely gives the Fed far more room to issue dovish comments after next week’s all but done December rate hike. In recent weeks as the Fed has once again signaled it will more than likely remain data dependent in 2019, we’ve seen a change in the futures market, which is now pricing in less than 20 basis points of rate hikes next year versus over 55 basis points just a few months ago. But we have to consider the reason behind this slower pace of rate hikes, which is the suggestion by recent data that the economy is far from overheating, which also adds to the core question we suspect investors and the market are asking: how fast/strong will EPS growth be in 2019?

As we prepare for Fed Chair Powell’s remarks, it’s not lost on me that we could very well see a “buy the rumor, sell the news” event following the FOMC meeting next week.

Heading down the final stretch of 2018, I’ll be looking at well-positioned companies relative to our investment themes that have been hard hit by the quarter to date move in the market. As of Friday’s market close, the S&P 500 was down X% quarter to date, while the tech-heavy Nasdaq Composite Index and the small-cap heavy Russell 2000 were down 14% and nearly 17%, respectively, on that basis. One of the criteria that I’ll be focusing on as I weed through this growing list of contenders is favorable EPS growth year over year relative to the S&P 500. And, yes, when I say that I do mean to “real” EPS growth due to rising profit margins and expanding dollar profits instead of those lifted largely by buyback activities.

With that in mind, I’ll be paying close attention to a number of key earnings reports coming at us next week. These include Nike (NKE), Carmax (KMX), ConAgra (CAG), General Mills (GIS), Micron (MU), FedEx (FDX) and Darden Restaurants (DRI). Inside these reports and company commentaries, I’ll be looking for data points that to confirm our investment themes, the question of inflation vs. deflation and where it may be, and a last-minute update from FedEx on digital commerce for this holiday shopping season that we are all in the thick of. Also, among those reports is Del Frisco’s competitor – The Capital Grill, which is owned by Darden. I’ll be paying extra close attention to that report and what it means for our DFRG shares.

 

Holiday Housekeeping!

And that brings us to our Housekeeping note, which is this – given the way the Christmas and New Year’s holidays fall this year, barring any unforeseen issues that will require our attention and immediate action, we here at Tematica will be in “get ready for 2019” mode. That means we’ll be using the quiet holiday time to review the Thematic Leaders as well as positions on the Select List to ensure we are well prepared for the coming months ahead.

As such, we’re likely to be back the week of January 7th, although I can’t rule out the urge to share some thoughts with you sooner. For example, if the Fed says something that rolls the stock market’s eyes later this week, I’ll be sure to weigh in and share my thoughts. The same goes for the Darden earnings report I mentioned above and what it may mean for our DFRG shares.

We will have a new podcast episode or two before then, and we will be sharing a number of Thematic Signals over the coming weeks – if only those confirming signs for our investment themes would take a break. I’m only kidding, but of course, I love how recognizable and relatable the themes are in and around our daily lives.

To you and your loved ones, Merry Christmas, Happy Holidays, and Happy New Year! See you 2019!!

 

 

Weekly Issue: Investor anxiety continues

Weekly Issue: Investor anxiety continues

Key points inside this issue

  • As the investors grapple with anxiety over trade as well as the speed of economic and earnings growth, we’ll continue to hold ProShares Short S&P 500 (SH) shares.
  • Our price target on the shares of Guilty Pleasure Thematic Leader Del Frisco’s Restaurant Group (DFRG) remains $14.
  • Our price target on Middle-Class Squeeze Thematic Leader Costco Wholesale (COST) shares remains $250.
  • Our price target on Amazon (AMZN) shares remains $2,250

 

The stock market experienced another painful set of days in last week as it digested the latest set of economic data, and what it all means for the speed of the domestic and global economy. Investors also grappled with determining where the U.S. is with regard to the China trade war as well as the prospects for a deal by the end of March that would prevent the next round of tariffs on China from escalating.

There remain a number of unresolved issues between the U.S. and China, some of which have been long-standing in nature, which suggests a fix in the next 100+ days is somewhat questionable. This combination induced a fresh round of anxiety in the market, leading it to ultimately finish the week lower as the major indices sagged further quarter to date. In turn, that pushed all the major market indices into the red as of Friday’s close, most notably the small-cap heavy Russell 2000, which finished Friday down 5.7% year to date. For those keeping score, that equates to the Russell 2000 falling just under 15% quarter to date.

Last week we added downside protection to our holdings in the form of ProShares Short S&P 500 (SH) shares, and we’ll continue to hold them until signs of more stable footing for the overall market emerge. As we do this, I’ll continue to evaluate not only the thematic signals that are in and around us day-in, day-out, but also examine the potential opportunities on a risk to reward basis the market pain is creating.

 

Shares of Del Frisco’s get some activist attention

Late last week, our shares of Guilty Pleasure Thematic Leader Del Frisco’s Restaurant Group (DFRG) bucked the overall move lower in the domestic stock market following the revelation that activist hedge fund Engaged Capital has acquired a nearly 10% in the company with a plan to push the company to sell itself according to The Wall Street Journal. Given the sharp drop in DFRG shares thus far in 2018, down 52%, it’s not surprising to see this happen, and when we added the shares to our holdings, we shared the view that at some point it could be a takeout candidate as the restaurant industry continues to consolidate. In particular, Del Frisco’s presence in the higher end dining category and its efforts over the last few months to become a more focused company help explain the interest by Engaged.

In response, Del Frisco’s issued the following statement:

“Del Frisco’s is committed to maximizing long-term value for all shareholders. While we do not agree with certain characterizations of events or of our business and operations contained in the letter that we received from Engaged Capital, the Company values constructive input toward the goal of enhancing shareholder value. “

Compared to other Board responses this one is rather tame and suggests Del Frisco’s will indeed have a dialog with Engaged. Given the year to date performance in DFRG shares, odds are there are several on the Board that are frustrated either with the rate of change in the business or how that change is being viewed in the marketplace.

In terms of who might be interested in Del Frisco’s, we’ve seen a number of going private transactions in recent years led by private equity investors that re-tool a company’s strategy and execution or combine it with other entities. We’ve also seen several restaurant M&A transactions as well. Let’s remember too how on Del Frisco’s September quarter earnings conference call, the management team went out of its way to explain how the business performed during the last recession. That better than industry performance may add to the desirability of Del Frisco’s inside a platform, multi-branded restaurant company.

As much as we may agree with the logic behind Del Frisco’s being taken out, we’d remind subscribers that buying a company on takeout speculation can be dicey. In the case of Del Frisco’s, we continue to see a solid fundamental story. We are seeing deflation in food prices that bode well for Del Frisco’s margins and bottom line EPS. Over the last quarter we’ve seen prices in the protein complex – beef, pork, and chicken – move lower across the board. According to the United Nation’s Food and Agriculture Organisation’s (FAO) food price index, world food prices declined during the month of November to their lowest level in more than two years. We’re also seeing favorable restaurant spending per recent monthly Retail Sales reports, which should only improve amid year-end holiday dinners eaten by corporate diners and individuals.

We’ll continue to hold DFRG for the fundamentals, but we won’t fight any smart, strategic transaction that may emerge.

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

 

What to watch in the week ahead

As we move into the second week of the last month of the quarter, I’ll continue to examine the oncoming data to determine the vector and velocity of the domestic as well as global economy. Following Friday’s November Employment Report that saw weaker than expected job creation for the month, but year over year wage gains of 3.1% the Atlanta Fed continued to reduce its GDP forecast for the current quarter. That forecast now sits at 2.4%, down from 3.0% at the end of October.

With the sharp drove in oil prices has consumers feeling a little holiday cheer at the gas pump, odds are next week’s November inflation reports will be tame. The fact that world food prices per the Food and Agriculture Organization’s (FAO) food price index hit the lowest level since May 2016 also bodes well for a benign set of inflation data this week. Later in the week, we’ll get the November Retail Sales report, which should be very confirming for our holiday facing positions – Amazon (AMZN), United Parcel Service (UPS), McCormick & Co. (MKC) and Costco Wholesale (COST) – that given the kickoff of “seasons eatings” with Thanksgiving and the start of the holiday shopping season that clearly shifted to digital shopping.

That report will once again provide context for this shift as well as more than likely confirm yet again that Costco Wholesale (COST) continues to take consumer wallet share. Speaking of Costco, the company will report its quarterly results this  Thursday. Quarter to date, the company’s monthly same store sales reports are firm evidence it is winning consumer wallet share, and we expect it did so again in November, especially with its growing fresh foods business that keeps luring club members back. Aside from its top and bottom line results, I’ll be focused once again on its pace of new warehouse openings, a harbinger of the crucial membership fee income to be had in coming quarters.

  • Our price target on Middle-Class Squeeze Thematic Leader Costco Wholesale (COST) shares remains $250.

We’ll end the economic data stream this week with the November Industrial Production report. Given the sharp fall in heavy truck orders in November, I’ll be digging into this report with a particular eye for what it says about the domestic manufacturing economy.

As discussed above, this week Costco will report its results and joining it in that activity will be several other retailers such as Ascena Retail (ASNA), DWS (DWS), American Eagle (AEO) and Vera Bradley (VRA). Inside their comments and guidance, which will include the holiday shopping season, I’ll be assessing the degree to which they are embracing our Digital Lifestyle investing theme. We’ll also see Adobe Systems (ADBE) report its quarterly result and I’ll be digesting what it has to say about cloud adoption, pricing and prospects for 2019. As we know, that is a core driver of Amazon Web Services, one of the key profit and cash flow drivers at Amazon (AMZN).

  • Our price target on Amazon (AMZN) shares remains $2,250

 

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: The Changing Mood of the Market

Weekly Issue: The Changing Mood of the Market

Over the last several days, volatility in the stock market has been rampant with wide swings taking place. Part and parcel of this has been a mood change in the stock market as high-flying stocks, including a number of technology ones, have come under pressure as investors re-think their growth prospects. That continued yesterday as shares of iPhone maker Apple (AAPL) became the latest one to dip into bear market territory with last night’s close following renewed concerns over the company’s device shipments in the near-term. This, in turn, has led to a few downgrades by Wall Street analysts, that at least in my view, are being somewhat short-sighted as the company continues to morph its business into one that is more reliant on high margin services rather than just the iPhone.

The same can be said with Amazon (AMZN), which has seen its shares tumble despite there being no slowdown in the shift to digital commerce as evidenced by the October Retail Sales Report. That report showed Nonstore retail sales for the month climbing just shy of 3x as fast as overall retail sales year over year. That was certainly confirmed in the latest earnings reports this week from Macy’s (M) and Walmart (WMT).  All indications, as well as expectations, have this aspect of our Digital Lifestyle investing theme accelerating into the all-important holiday shopping season. And yes, this keeps me bullish on our shares of United Parcel Service (UPS)

Now here’s the tough part to swallow – while we and our thematic way of investing are likely to be right in the medium to long-term, the mood in the stock market tends to prevail in the short-term. And with several of the concerns I’ve talked about here as well as in Tematica Investing and on our podcast, Cocktail Investing, rearing their heads odds are the stock market will continue to be a volatile one in the very near-term. This will likely see the current expectation resetting continue, especially for the sector-based investor view of “technology” stocks. Talk about a multi-headed sector that is simply a mish-mash of things – I’ll stick to our thematic lens approach, thank you very much. That said, with “tech” being in the doghouse, I’m using the time to evaluate a number of companies for the currently open Disruptive Innovators slot in our Thematic Leaders. Some of the current contenders include cloud-focused companies Dropbox (DBX), Instructure (INST) and Okata (OKT) among others.

This week

What’s been driving the latest round of roller coaster like thrills in the stock market can be found in the intersection of the latest earnings reports, economic data, and political developments. From sector investing perspective, we continue to get mixed results as evidenced by this week’s earnings reports as JC Penney (JCP) lagged expectations while Walmart (WMT) and Macy’s (M) beat them. From a thematic one, however, we see the dichotomy in those results as strong confirmation in our Digital Lifestyle investing theme as both Macy’s and Walmart delivered strong digital shopping performance in those quarterly reports, while JC Penney continues to struggle with its brick & mortar business.

Our Living the Life investing theme was also the recipient of positive confirmation this week as high-end outerwear company Canada Goose (GOOS) simply smashed top and bottom line expectations. Similarly, profits at luxury car company Aston Martin (AML.L) soared as its sales volume doubled year over year in the September quarter.

 

Sticking with Del Frisco’s

And while the Living the Lifestyle Thematic Leader that is Del Frisco’s (DFRG) reported a sloppy quarter following the disposal of its Sullivan’s business, the company shared a vibrant outlook, including the plan to grow its revenue and EBITDA to at least $700 million and $100 million by, respectively, by 2020 from the September quarter run rates of $420 million and $74 million, respectively. The intent on average will be to roll out two to three Double Eagles, two to three Barcelona Wine Bars and six bartacos restaurants each year, which is a measured move over the coming years and one that could be scaled back quickly should the domestic economy begin to falter several quarters out.

Near-term, Del Frisco’s should benefit from a pick-up in activity quarter to date following the arrival in the third quarter of its new chief marketing officer. On the earnings conference call, management shared Double Eagle’s private dining is up almost 20% in the first few weeks of the quarter and bookings for the rest of the quarter are up more than 20% compared to last year at this time.

The company also confirmed one of the key aspects of our investment thesis, which centers on margin improvement due in part to beef deflation. As discussed on the earnings call, the company’s total cost of sales as a percentage of revenue for the quarter decreased by 60 basis points to 27.3% from 27.9% in the year-ago period due to margin improvements at Double Eagle, Barcelona, and bartaco. This improvement and the year-over-year jump in bookings certainly point to the expected holiday inflection point panning out, which is also the most seasonally profitable time of year for Double Eagle and Grille. Cost-reduction efforts put in place earlier this year at these two brands should lead to visible margin improvement versus year-ago levels as the holiday volumes take effect.

  • For now, we’ll keep our long-term price target of $14 for Del Frisco’s (DFRG) shares intact, revisiting as needed should the company’s rollouts begin to slip.

 

Several headwinds remain in place

Despite these positive signals and happenings, we have to remember there are several headwinds blowing on the overall stock market. These include Italy standing firm with its latest budget, which puts it at odds with the European Union; Brexit limping forward; inflationary readings in both the October Producer Price Index and Consumer Price Index that will more than likely keep the Fed’s rate hike path intact, a looming concern for consumer debt and high levels of corporate debt; and the pending trade talks between the US and China at a time when more data shows a cooling in the global economy.

On a positive note, the NFIB Small Business Index’s October reading continued the near-two year string of record highs with more small businesses than not citing a bullish attitude toward the economy and expanding their businesses. A note of caution here as most businesses tend to exude such sentiment at or near the economic peak – few see the looming the downside. The NFIB’s report once again called out the lack of skilled workers with 53% of those surveyed reporting few or no qualified applicants.

This signals potential wage pressures ahead, however, the sharp fall in oil prices, which follows the notion of the slowing global economy and rising inventory levels, is poised to give some relief to both businesses and consumers as we head into the holiday shopping season. Yes, average gas prices have fallen to $2.68 per gallon from $2.89 a month ago, but they are still up vs. $2.56 per gallon this time last year. When it comes to gas prices, most consumers think sequentially, which means they are recognizing the drop in recent weeks, which in their minds offers some relief.

Noticed, I said some relief – consumers still face high debt levels with larger servicing costs vs. the year-ago levels. And let’s be honest, a consumer with a 12-gallon gas tank in his or her car that fills up twice a week is saving all of $4.80 per week compared to this time last month. In today’s world, that’s about enough to buy one pizza with some toppings a month. In other words, it will take more pronounced declines in gas prices to make a meaningful difference for those investors that resonate with our Middle-Class Squeeze investing theme.

 

What to watch next week

In looking at the calendar for next week, we have the Thanksgiving holiday, which long-time subscribers know is one of my favorites. While the stock market is only closed for that holiday, we do have shortened trading hours next Friday – better known as Black Friday – and that will kick off the race for holiday shopping. That means we can expect the litany of headlines over initial holiday shopping sales over the post-holiday weekend as we ease into Cyber Monday. And yes, I will be paying close attention to those results given our positions in Amazon and UPS.

Before we get to share our thankfulness with family and friends, we will have a few economic reports to chew through including October Housing Starts, Durable Orders and Existing Home Sales. This week even Fed Chair Powell recognized the softening housing market as a headwind to the economy, and in my view that sets the stage for yet another lackluster housing report next week. Inside the Durable Orders report, we’ll be watching the all-important core capital goods line, a proxy for business investment. The stronger that number, the better the prospects for the current quarter, which tends to benefit from “use it or lose it” capital spending budgets.

On the earnings front next week, we will continue to hear from retailers, such as Best Buy (BBY), Kohl’s (KSS), Ross Stores (ROST) and TJX Companies (TJX). With regard to our own Costco Wholesale (COST) shares, we’ll be paying close attention to results from competitor BJ Wholesale (BJ). Outside of those retailers, I’ll be listening to what Nuance Communications (NUAN) has to say about the adoption of voice interfaces and digital assistants next week.

Looking past this week’s market relief rally

Looking past this week’s market relief rally

As expected, the last few days in the market have been a proverbial see-saw, which culminated in the sharp market rally following the mid-term elections. The outcome, which saw the Democrats gain ground in Washington, was largely expected. We’ll see in the coming weeks and months the degree of gridlock to be had in Washington and what it means for the economy, but we have to remember several other concerning items remain ahead of us. To jog memories, these include the next round of budget talks between Italy and EU, which should occur next week; continued rate hikes by the Fed as it looks to stave off inflation and get more tools back for the next eventual recession; and upcoming trade talks between the US-China.

While we like the mid-week, market rebound and what it did for the Thematic Leaders as well as positions on the Select List, the upcoming events outlined above suggest near-term caution is still warranted. Shares of McCormick & Co. (MKC) International Flavors & Fragrances (IFF) as well as Altria (MO), AMN Healthcare (AMN) and Costco Wholesale (COST) have been on a tear of late. Earlier this week, Costco reported its October same-store sales results, which once again confirmed this Middle-class Squeeze company is taking wallet share.

Yesterday, mobile infrastructure company Ericsson (ERIC) held its annual Capital Markets event at which it spoke in a bullish tone over 5G rollouts, so much so that it raised its 2020 targets. I see that along with other similar comments in the last few weeks as very positive for our positions in Digital Infrastructure leader Dycom (DY) and Disruptive Innovator Nokia Corp. (NOK) as well as AXT Inc. (AXTI) shares.

 

Axon’s – September quarter earnings and an upgrade

Over the last few weeks, share of Safety & Security Thematic Leader Axon Enterprises (AAXN) have come under considerable pressure, but on Tuesday night the company reported September quarter earnings of $0.20 per share, crushing the consensus view of $0.13 per share as both revenue and earnings before interest, taxes, depreciation, and amortization (EBITDA) soared. Axon then reiterated its full-year guidance which hinged on the continued adoption of its Axon camera and cloud-storage business. Year over year, the number of cloud seats booked by customers rose to 325,200 exiting September up from 187,400 twelve months earlier. The combination of the 25% pullback in the shares quarter to date and that upbeat outlook led JPMorgan Chase to upgrade the shares to Overweight from Neutral.

Yes, we are down with the shares, but as the market settles out I’ll look to add to the position and improve our cost basis along the way. I continue to expect Axon will eventually acquire rival Digital Ally (DGLY) and its $31 million market cap, removing the current legal overhang on the shares. Our price target remains $90.

 

Disney earnings on deck tonight

After tonight’s market close, Disney (DIS) will report its quarterly results, and while we are not expecting any surprises for the September quarter, it’s the comments surrounding the company’s streaming strategy and integration of the Fox assets that will be in focus. Expectations for the September quarter are EPS of $1.34 on revenue of $13.73 billion. Our position on Disney has been and continues to be that based on the success of its streaming services, investors will need to revisit how they value DIS shares as it goes direct to the consumer with a cash-flow friendly subscription business model. Our price target for DIS shares remains $125.

 

Del Frisco’s earnings to follow next week

Monday morning, Del Frisco’s Restaurant Group (DFRG) also postponed its quarterly earnings report from until Tuesday, Nov. 13, citing “additional time required to finalize the accounting and tax treatment of our acquisition of Barteca Restaurant Group, disposition of Sullivan’s Steakhouse, a secondary offering of common stock and debt syndication.”

Coincidence? Perhaps, but it raises questions over the bench strength of these companies as they reshape their business. If you’ve ever been in a negotiation, you know things can slip, but following GNC’s postponement, we are at heightened alert levels with Del Frisco’s. We knew this was going to be a sloppy earnings report and we clearly have confirmation; our only question is why didn’t the management team wait to announce its earnings date until it had dotted its Is and crossed its Ts on all of these items?

To some extent, I am expecting a somewhat messy report in light of the sale of its Sullivan’s business and its common stock offering early in the quarter that raised more than $90 million. In parsing the company’s report, I will be focusing on revenue growth for the ongoing business as well as its profit generation considering that earnings-per-share comparisons could be challenging if not complicated versus the year-ago quarter. Nonetheless, the reported quarterly results will be gauged at least initially against the consensus view, which heading into the weekend sat at a loss per share of $0.25 on revenue of $120 million. For the December quarter, one of the company’s seasonally strongest, Del Frisco’s is expected to guide to EPS near $0.23 on revenue of $144 million.

So far this earnings season we’ve heard how restaurant companies including Bloomin’ Brands Inc. (BLMN), Ruth’s Hospitality Group (RUTH), Del Taco Restaurants Inc. (TACO), Chipotle Mexican Grill Inc. (CMG) and more recently Wingstop Inc. (WING) are seeing their margins benefitting from food deflation. Along with a pickup in average check size owing to prior price increases, these companies have delivered margin improvement and expanding EPS. I expect the same from Del Frisco’s. When coupled with an expected uptick in holiday spending and consumer sentiment running at high levels, we remain bullish on DFRG shares heading into Monday’s earnings report. Our price target on DFRG shares remains $14.

 

What to Watch Next Week

On the economic front, we’ll get more inflation data in the form of the October CPI report next week, which follows tomorrow’s October PPI one. In both we hear at Tematica will be scrutinizing the year over year comparisons and given the growing number of companies issuing price increases we expect to see those reflected in these October as well as November inflation reports. If the figures come in hotter than expected, expect that to reignite Fed rate hike concerns. Also, next week, we have the October reports for Retail Sales and Industrial Production as well as the first look at November with the Empire Manufacturing and Philly Fed indices.

With the October Retail Sales report, we’ll be once again parsing it to compare against the October same-store sales reported yesterday by Costco Wholesale (COST), which were up 8.6% year over year (+6.6% core). Odds are we will once again have formal confirmation that Costco is taking consumer wallet share.

Compared to the more than 1,200 earnings reports we had this week, the 345 or so next week will be a proverbial walk in the park. there will be several key reports to watch including Home Depot (HD), Macy’s (M), JC Penney (JCP), Williams Sonoma (WSM), and WalMart (WMT). We’ll be matching their forecasts for the current quarter up against the 2018 holiday shopping forecasts from the National Retail Federation, Adobe (ADBE) and others that call for overall holiday shopping to rise 4.0%-5.5% with online shopping climbing more than 15% year over year. I continue to see that as very positive for our shares in Amazon (AMZN), Costco and United Parcel Service (UPS) as well as McCormick & Co. (MKC).

Perhaps the biggest wild card next week will be the Italian budget and as we near the end of this week, things are already getting heated on that front. Today, the Italian government said it is sticking with its plan to rapidly increase public spending despite the budget dispute with the European Union, and it has no intention of revising its plan by next week. As background, Italy is the third largest economy in the EU, and if a joint resolution is not reached we expect this to reignite talk of “Italeave,” which will stoke once again questions over the durability of the EU. Given its size compared to Greece, the Italian situation is one we will be watching closely in the coming days.

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

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

Key Points from this Issue:

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

 

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

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

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

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

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

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

 

UPDATES TO The Thematic Leaders and Select List

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

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

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

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

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

 

Downgrading Universal Display shares to the Select List

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

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

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

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

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

 

Clean Living signals abound

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

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

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

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

 

Turning to next week

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

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

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

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

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

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

 

 

 

 

Adding more Del Frisco’s to our plate following several bullish data points

Adding more Del Frisco’s to our plate following several bullish data points

Key points inside this issue

  • We are scaling into shares of Del Frisco’s Restaurant Group (DFRG) following several bullish data points from last week. Our price target for DFRG shares remains $14.
  • Our price target on Amazon (AMZN) remains $2,250
  • Our price target on United Parcel Service (UPS) shares remains $130
  • Our price target on Chipotle Mexican Grill (CMG) shares remains $550
  • Our price target on Costco Wholesale (COST) remains $250
  • I am reviewing our current price target of $130 for shares of McCormick & Co.
  • Last week’s podcast – Lithium Ion Batteries: The Enabler of the Digital Lifestyle
  • Last week’s Thematic Signals

Last Friday we received a number of positive data points for restaurant spending, which coupled with the latest US Department of Agriculture report on falling beef prices has me using the recent weakness in our Del Frisco’s Restaurant Group (DFRG) shares to improve our cost basis. Since adding DFRG shares to the portfolio, they’ve fallen nearly 10% since the end of August and just over 3% since we added them to our holdings despite favorable economic and industry reports. Part of that downward pressure came from Stephens throwing in the towel on its bullish stance on the shares last Wednesday. It would appear that Stephens jumped the gun given the favorable data that emerged later in the week.

Let’s review all of those data points…

 

August Retail Sales

The August Retail Sales report saw its headline figure come in at +0.1% month over month missing expectations of +0.4% and marked the slowest gain since February suggesting persistently high gas prices could be taking a bite out of consumer spending. With prospects for higher gas prices ahead following last week’s greater than expected crude inventory drawdown reported by the Department of Energy and the greater than expected jump in Total Consumer Credit for January, it would appear that Middle-Class Squeeze consumers slowed their spending in August vs. July. Hat tip to Tematica’s Chief Macro Strategist, Lenore Hawkins, and her coverage of those data points in last Friday’s Weekly Wrap. If I’m reading it, so should you.

Turning to the year over year view, August retail sales rose 6.2%, led by a more than 20% increase in gas station sales due to the aforementioned gas prices, and continued gains in Nonstore retailers (+10.4%) and food services & drinking places (+10.1%). Over the last three months, these last two categories are up 9.9% and 9.5% year over year, even as gas station sales are up nearly 21% by comparison. Those figures bode extremely well for our Digital Lifestyle positions in Amazon (AMZN) and United Parcel Service (UPS), our Clean Living holding that is Chipotle Mexican Grill (CMG) and Del Frisco’s Restaurant Group, a Living the Life company.

The report also offered confirming context for our shares in Costco Wholesale (COST) as its August same-store sales handily beat those contained in the August Retail Sales report. Also inside this latest missive from the U.S. Department of Commerce, grocery store sales rose 4.3% year over year in August, which keeps me bullish on our shares of McCormick & Co. (MKC) even as they hover over our current $130 price target.

In terms of areas reporting declines in August Retail Sales Report, we continue to see pressure at Sporting goods, hobby, musical instrument, & bookstores (-3.9%) and Department Stores (-0.7%), continuing the trend of the last few months. With Amazon continuing to flex its business model as well as its own line of private label products, including fashion, sportswear, and apparel, as well as continued digital commerce gains at Walmart (WMT) and its Bonobos brand, we see these retail categories remaining challenged in the coming months.

 

August restaurant data from TDN2K

On Friday we also received figures from TDn2K’s Black Box Intelligence that showed August same-store restaurant sales rose +1.8%, the best highest since 2015. TDn2K’s data is based on weekly sales from over 30,000 locations representing more than 170 brands and nearly $70 billion in annual sales. More positives for our positions in Chipotle and Del Frisco’s. I’ll tuck this data point away as well as the July and eventual September one to compare them against same-store sales quarterly results for out two restaurant holdings.

 

US Department of Agriculture

The most recent data published on Friday by the US Department of Agriculture showed cow prices were down 13.6% year over year in July, continuing the trend of double-digit year over year declines that began this past May. I see this as confirmation of deflationary beef prices that bode well for both margins and EPS gains at both Del Frisco’s and to a lesser extent Chipotle.

Later this week, I’ll look for further confirmation of beef deflation leverage when Darden Restaurants (DRI), the parent of Capitol Grill reports its quarterly earnings.

 

Scaling into Del Frisco’s shares

The net result of these three Friday data points has me adding to our Del Frisco’s Restaurant Group shares at current levels. If our Chipotle shares were lower than our entry point, I’d be doing the same, but they aren’t – if they do fall below the $473 layer, all things being equal I’d look to repeat today’s actions but with CMG shares.

  • We are scaling into shares of Del Frisco’s Restaurant Group (DFRG) following several bullish data points from last week. Our price target for DFRG shares remains $14.
WEEKLY ISSUE: Scaling deeper into Dycom shares

WEEKLY ISSUE: Scaling deeper into Dycom shares

Key points from this issue:

  • We are halfway through the current quarter, and we’ve got a number of holdings on the Tematica Investing Select List that are trouncing the major market indices.
  • We are using this week’s pain to improve our long-term cost basis in Dycom Industries (DY) shares as we ratchet back our price target to $100 from $125.
  • Examining our Middle-Class Squeeze investing theme and housing.
  • A Digital Lifestyle company that we plan on avoiding as Facebook attacks its key market.

 

As the velocity of June quarter earnings reports slows, in this issue of Tematica Investing we’re going to examine how our Middle-Class Squeeze investing theme is impacting the housing market and showcase a Digital Lifestyle theme company that I think subscribers would be smart to avoid. I’m also keeping my eyes open regarding the recent concerns surrounding Turkey and the lira. Thus far, signs of contagion appear to be limited but in the coming days, I suspect we’ll have a much better sense of the situation and exposure to be had.

With today’s issue, we are halfway through the current quarter. While the major market indices are up 2%-4% so far in the quarter, by comparison, we’ve had a number of strong thematic outperformers. These include Alphabet (GOOGL), Amazon (AMZN), Apple (AAPL), AXT Inc. (AXTI), Costco Wholesale (COST),  Habit Restaurant (HABT), Walt Disney (DIS), United Parcel Service (UPS), Universal Display (OLED) and USA Technologies (USAT).  That’s an impressive roster to be sure, but there are several positions that have lagged the market quarter to date including GSV Capital (GSVC), Nokia (NOK), Netflix (NFLX), Paccar (PCAR) and Rockwell Automation (ROK). We’ve also experienced some pain with Dycom (DY) shares, which we will get to in a moment.

Last week jettisoned shares of Farmland Partners (FPI) following the company taking it’s 3Q 2018 dividend payment and shooting it behind the woodshed. We also scaled into GSVC shares following GSV’s thesis-confirming June quarter earnings report, and I’m closely watching NFLX shares with a similar strategy in mind given the double-digit drop since adding them to the Tematica Investing Select List just over a month ago.

 

Scaling into Dycom share to improve our position for the longer-term

Last week we unveiled our latest investing theme here at Tematica – Digital Infrastructure. Earlier this week, Dycom Industries (DY), our first Digital Infrastructure selection slashed its outlook for the next few quarters despite a sharp rise in its backlog. Those shared revisions are as follows:

  • For its soon to be reported quarter, the company now sees EPS of $1.05-$1.08 from its previous guidance of $1.13-$1.28 vs. $1.19 analyst consensus estimate and revenues of $799.5 million from the prior $830-$860 million vs. the $843 million consensus.
  • For its full year ending this upcoming January, Dycom now sees EPS of $2.62-$3.07 from $4.26-$5.15 vs. the $4.63 consensus estimate and revenues of $3.01-$3.11 billion from $3.23-$3.43 billion and the $3.33 billion consensus.

 

What caught my eyes was the big disparity between the modest top line cuts and the rather sharp ones to the bottom line. Dycom attributed the revenue shortfall to slower large-scale deployments at key customers and margin pressure due to the under absorption of labor and field costs – the same issues that plagued it in its April quarter. Given some of the June quarter comments from mobile infrastructure companies like Ericsson (ERIC) and Nokia (NOK), Dycom’s comments regarding customer timing is not that surprising, even though the magnitude to its bottom line is. I chalk this up to the operating leverage that is inherent in its construction services business, and that cuts both ways – great when things are ramping, and to the downside when activity is less than expected.

We also know from Ericsson and Dycom that the North American market will be the most active when it comes to 5G deployments in the coming quarters, which helps explain why Dycom’s backlog rose to $7.9 billion exiting July up from $5.9 billion at the end of April and $5.9 billion exiting the July 2017 quarter. As that backlog across Comcast, Verizon, AT&T, Windstream and others is deployed in calendar 2019, we should see a snapback in margins and EPS compared to 2018.

With that in mind, the strategy will be to turn lemons – Monday’s 24% drop in DY’s share price – into long-term lemonade. To do this, we are adding to our DY position at current levels, which should drop our blended cost basis to roughly $80 from just under $92. Not bad, but I’ll be inclined to scale further into the position to enhance that blended cost basis in the coming weeks and months on confirmation that 5G is moving from concept to physical network. Like I said in our Digital Infrastructure overview, no 5G network means no 5G services, plain and simple. As we scale into the shares and factor in the revised near-term outlook, I’m also cutting our price target on DY shares to $100 from $125.

  • We are using this week’s pain to improve our long-term cost basis in Dycom Industries (DY) shares as we ratchet back our price target to $100 from $125.

 

Now, let’s get to how our Middle-Class Squeeze investing theme is hitting the housing market, and review that Digital Lifestyle company that we’re going to steer clear of because of Facebook (FB). Here we go…

 

If not single-family homes, where are the squeezed middle-class going?

To own a home was once considered one of the cornerstones of the American dream. If we look at the year to date move in the SPDR S&P Homebuilders ETF (XHB), which is down nearly 16% this year, one might have some concerns about the tone of the housing market. Yes, there is the specter of increasing inflation that has and likely will prompt the Federal Reserve to boost interest rates, and that will inch mortgage rates further from the near record lows enjoyed just a few years ago.

Here’s the thing:

  • Higher mortgage rates will make the cost of buying a home more expensive at a time when real wage growth is not accelerating, and consumers will be facing higher priced goods as inflation winds its way through the economic system leading to higher prices. During the current earnings season, we’ve heard from a number of companies including Cinemark Holdings (CNK), Hostess Brands (TWNK), Otter Tail (OTTR), and Diodes Inc. (DIOD) that are expected to pass on rising costs to consumers in the form of price increases.
  • Consumers debt loads have already climbed higher in recent years and as interest rates rise that will get costlier to service sapping disposable income and the ability to build a mortgage down payment

 

 

And let’s keep in mind, homes prices are already the most expensive they have been in over a decade due to a combination of tight housing supply and rising raw material costs. According to the National Association of Home Builders, higher wood costs have added almost $9,000 to the price of the average new single-family since January 2017.

 

 

Already new home sales have been significantly lower than over a decade ago, and as these forces come together it likely means the recent slowdown in new home sales that has emerged in 2018 is likely to get worse.

 

Yet our population continues to grow, and new households are being formed.

 

This prompts the question as to where are these new households living and where are they likely to in the coming quarters as homeownership costs are likely to rise further?

The answer is rental properties, including apartments, which are enjoying low vacancy rates and a positive slope in the consumer price index paid of rent paid for a primary residence.

 

There are several real estate investment trusts (REITs) that focus on the apartment and rental market including Preferred Apartment Communities, Inc. (APTS) and Independence Realty Trust (IRT). I’ll be looking at these and others to determine potential upside to be had in the coming quarters, which includes looking at their attractive dividend yields to ensure the underlying dividend stream is sustainable. More on this to come.

 

A Digital Lifestyle company that we plan on avoiding as Facebook attacks its key market

As important as it is to find well-positioned companies that are poised to ride prevailing thematic tailwinds that will drive revenue and profits as well as the share price higher, it’s also important to sidestep those that are running headlong into pronounced headwinds. These headwinds can take several forms, but one of the more common ones of late is the expanding footprint of companies like Alphabet (GOOGL), Amazon (AMZN) and Facebook (FB) among others.

We’ve seen the impact on shares of Blue Apron (APRN) fall apart over the last year following the entrance of Kroger (KR) into the meal kit business with its acquisition of Home Chef and investor concerns over Amazon entering the space following its acquisition of Whole Foods Market. That changing landscape highlighted one of the major flaws in Blue Apron’s subscription-based business model –  very high customer acquisition costs and high customer churn rates. While we warned investors to avoid APRN shares back last October when they were trading at north of $5, those who didn’t heed our advice are now enjoying APRN shares below $2.20. Ouch!

Now let’s take a look at the shares of Meet Group (MEET), which have been on a tear lately rising to $4.20 from just under $3 coming into 2018. The question to answer is this more like a Blue Apron or more like USA Technologies (USAT) or Habit Restaurant (HABT). In other words, one that is headed for destination @#$%^& or a bona fide opportunity.

According to its description, Meet offers  applications designed to meet the “universal need for human connection” and keep its users “entertained and engaged, and originate untold numbers of casual chats, friendships, dates, and marriages.” That sound you heard was the collective eye-rolling across Team Tematica. If you’re thinking this sounds similar to online and mobile dating sites like Tinder, Match, PlentyOfFish, Meetic, OkCupid, OurTime, and Pairs that are all part of Match Group (MTCH) and eHarmony, we here at Tematica are inclined to agree. And yes, dating has clearly moved into the digital age and that falls under the purview of our Digital Lifestyle investing theme.

Right off the bat, the fact that Meet’s expected EPS in 2018 and 2019 are slated to come in below the $0.39 per share Meet earned in 2017 despite consensus revenue expectations of $181 in 2019 vs. just under $124 million in 2017 is a red flag. So too is the lack of positive cash flow and fall off in cash on the balance sheet from $74.5 million exiting March 2017 to less than $21 million at the close of the June 2018 quarter. A sizable chunk of that cash was used to buy Lovoo, a popular dating app in Europe as well as develop the ability to monetize live video on several of its apps.

Then there is the decline in the company’s average total daily active users to 4.75 million in the June 2018 quarter from 4.95 million exiting 2017. Looking at average mobile daily active users as well as average monthly active user metrics we see the same downward trend over the last two quarters. Not good, not good at all.

And then there is Facebook, which at its 2018 F8 developer conference in early May, shared it was internally testing its dating product with employees. While it’s true the social media giant is contending with privacy concerns, CEO Mark Zuckerberg shared the company will continue to build new features and applications and this one was focused on building real, long-term relationships — not just for hookups…” Clearly a swipe at Match Group’s Tinder.

Given the size of Facebook’s global reach – 1.47 billion daily active users and 2.23 billion monthly active users – it has the scope and scale to be a force in digital dating even with modest user adoption. While Meet is enjoying the monetization benefits of its live video offering, Facebook has had voice and video calling as well as other chat capabilities that could spur adoption and converts from Meet’s platforms.

As I see it, Meet Group have enjoyed a nice run thus far in 2018, but as Facebook gears into the digital dating and moves from internal beta to open to the public, Meet will likely see further declines in user metrics. So, go user metrics to go advertising revenue and that means the best days for MEET shares could be in the rearview mirror. To me this makes MEET shares look more like those from Blue Apron than Habit or USA Technologies. In other words, I plan on steering clear of MEET shares and so should you.

 

 

Weekly Issue: Booking a Tasty Gain in this Guilty Pleasure Stock

Weekly Issue: Booking a Tasty Gain in this Guilty Pleasure Stock

Key points inside this issue

  • Earnings continue to roll in as trade tensions remain and economic data is in conflict.
  • We are selling half the position in Habit Restaurant (HABT) shares on the Tematica Investing Select List, booking a hefty win in the process, and boosting our price target on the remaining shares to $16 from $12.
  • Our price target on Costco Wholesale (COST) shares remains $230
  • Our price target on United Parcel Service (UPS) shares remains $130.

 

We are now more than one-third of the way through the September quarter, and firmly into the month of August, a time that is traditionally one of the slowest times of the year. Corporate earnings for the June quarter continue to come in and the United States has reimposed sanctions on Iran with additional measures potentially later this year as the Trump administration looks to pressure the Tehran regime to negotiate or step aside.

In response to President Trump instructing U.S. Trade Representative Lighthizer to consider raising proposed tariffs on $200 billion in Chinese goods to 25% from 10%, the Chinese government on Friday shared a list of 5,207 U.S. products (meat, coffee, nuts, alcoholic drinks, minerals, chemicals, leather products, wood products, machinery, furniture and auto parts) on which it would impose tariffs between 5% to 25% if the U.S. followed through on proposed tariffs.

The stock market’s performance this week suggests it is shrugging off some of these geopolitical concerns, however, the longer they play out the more likely we are to see them have an impact to earnings expectations. The word “tariff” was mentioned 290 times in S&P 500 conference calls in the first quarter. So far this quarter that number is up to 609, and we have yet to finish the current season. We take this to mean that while many are hopeful when it comes to trade, companies are factoring potential pain into their planning. This could set the stage for a stronger finish to the year if the president is able to deliver on trade. We’ll continue to watch the developments and position the our holdings in the Tematica Select list accordingly.

As we move through the dog days of summer, I’ll continue to chew through the data and heed the messages from all the thematic signals that are around us each and every week.

 

Taking some profits in Habit after a smoking run

Even ahead of last week’s better than expected June quarter results, our shares of Habit Restaurant (HABT) have been rocking and rolling as they climbed just shy of 60% since we added them to the Tematica Investing Select List in early May.

Helping pop the shares over the last few days, Wall Street analysts boosted their forecasts for Habit following strong top and bottom line June quarter results that were driven by several pricing factors and better-than-expected volume, and an outlook that was ahead of expectations. On the pricing front, there were two items worth mentioning. First was the 3.9% increase taken in mid-May to offset California labor pressures, followed by the premium pricing associated with third-party delivery with the likes of DoorDash. As Habit rolls out third-party delivery in other locations and with other partners, such as Seamless with whom it is currently in testing, we are likely to see further pricing benefits that should drop to the bottom line.

Underlying this, our core thesis for the company, which centers on Habit’s geographic expansion outside of its core California market, remains intact. During the June quarter, it opened seven new company-operated restaurants, three of which were drive-thrus. While there were no new East Coast locations during the quarter, Habit remains committed to opening a total of 30 new locations in 2018 with 20% of them on the East Coast — one of which will be right near Tematica in Northern Virginia! Franchisees will add an additional seven to nine locations in 2018, with recently opened ones including Seattle and the second location in China.

In response, we are going to do two things. First, I am boosting our price target for HABT shares to $16, which offers modest upside from the current share price. As we do this, we will prudently book some of those hefty profits to be had given the move in the shares over the last three months, which has them in overbought territory. We will do this by selling half the HABT position on the Tematica Investing Select List, and keep the other half intact to capture the incremental upside. I’ll also continue to monitor the company to gauge its progress relative to revised expectations to determine if another beat is in the cards.

  • We are selling half the position in Habit Restaurant (HABT) shares on the Tematica Investing Select List, booking a hefty win in the process, and boosting our price target on the remaining shares to $16 from $12.

Costco shares get another boost

I recently boosted our price target on Costco Wholesale (COST) shares to $230 from $220. Over the last few weeks the shares have climbed, bringing their return on the Tematica Investing Select List to more than 40%. Yesterday a similar move was had at Telsey Advisory Group (TAG), which raised its COST price target to $230 from $220. The similarities don’t end there as TAG also sees Costco to be a share gainer that should see double-digit growth in earnings per share this year. I’ve said it before, and odds are I’ll say it again, I love it when the herd comes around to our way of thinking.

Later this week, we should receive Costco’s July same-store sales metrics, which should confirm continued wallet share gains but also update us as to the number of open warehouse locations. As a reminder, more open warehouses drive the high margin membership fee income that is a key driver of Costco’s EPS.

  • Our price target on Costco Wholesale (COST) shares remains $230

 

UPS keeps on trucking

Quarter to date, our shares of United Parcel Service (UPS) have soared 13%, bringing the return for us to more than 18%. In my view, the company is clearly benefiting from the improving economy and consumer spending, particularly that associated with our Digital LifeStyle investing theme. As we head into the thick of Back to School spending, let’s remember that UPS is well positioned to benefit not only from Amazon’s (AMZN) Prime Day 2018 but also march toward the year-end holiday spending bonanza that spans from Halloween through New Year’s. Over the last several years, we’ve seen digital shopping win a growing piece of consumer wallets and I see no reason why that won’t continue yet again this year.

  • Our price target on United Parcel Service (UPS) shares remains $130.

 

Weekly Issue: Trade Meetings and Earnings Reshape Market Outlook

Weekly Issue: Trade Meetings and Earnings Reshape Market Outlook

Key points from this issue:

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

 

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

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

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

 

 

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

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

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

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

 

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

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

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

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

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

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

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

 

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

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

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

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

 

Farmland Partners fights back

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

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

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

 

Paccar delivers on the earnings front, boosts its dividend

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

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

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

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

 

A quick note on United Parcel Service earnings

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

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