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Investing herd continues to catch up to us

Investing herd continues to catch up to us

Over the weekend I was doing my usual reading and noticed our positions in both Costco Wholesale (COST) and Applied Materials (AMAT) received favorable mentions in Barron’s. I always say it’s nice to see the herd catching up to what we’ve been seeing and saying, and these two articles are just the latest. As we shared in this week’s Monday Morning Kickoff, we are heading hip deep into 3Q 2017 earnings season. Thus far, we have been observers, but that will change this week when a number of companies on the Tematica Investing Select List report their quarterly results and update their outlook for the current quarter.

 

Costco Wholesale – Oppenheimer misses the real EPS generator

In Costco: 5 Reasons to Load Up digs into Oppenheimer’s Buy rating on COST shares and its $185 price target, which is in line with our price target. Candidly, while we agree with several of the presented points, we find it somewhat confounding that Costco’s continued footprint expansion, a key driver of very profitable membership fee income was not mentioned. While we could chalk it up to not really understanding how the company derives its overall profits and EPS, we’ll take the high road and say they did focus on reasons why the recent pullback in COST shares due to the perception of e-commerce threats is overblown.

 

 

Applied Materials – Semi-cap is strong, but let’s not forget about Display

Turning to Applied Materials, it was included in 4 Cheap Stock Picks for the Impatient article even though AMAT shares have been on a tear throughout 2017. The article rightly discussed one of the key drivers of rising semiconductor capital equipment demand:

It bodes well that China is rapidly building a chip industry, and must stock its factories with new machines, while new applications, including artificial intelligence and machine learning, are expanding the world-wide market for chips.

But, the article failed to mention the growing demand for Applied’s Display Business that is benefitting from the ramp in organic light emitting diode displays, which is also benefitting our Universal Display (OLED) shares. With both businesses firing, and following an upbeat outlook from semi-cap competitor Lam Research (LRCX), we remain bullish on AMAT shares. Our price target now stands at $65, but we suspect that as demand for its products continues to climb in 2018 there is likely another price increase to be had in the coming months.

  • Our price target on Applied Materials (AMAT) shares is $65.
  • Our price target on Universal Display (OLED) shares is $175.

 

This week’s earnings calendar

As I mentioned above, we are no longer passive observers this earning season as we have 6 companies on the Tematica Select List reporting this week. Here’s a quick rundown of when those companies will report and current consensus expectations. As you might expect, we’ll have color commentary on these reports, especially those that require us to take any action.

Tuesday, October 24

Corning (GLW; Disruptive Technology) – Consensus expectations call for this glass company that serves display and fiber markets to deliver EPS of $0.41 on revenue of $2.6 billion. Our price target is $37.

 

Wednesday, October 25

AXT Inc. (AXTI; Disruptive Technologies): Consensus expectations call for the RF semiconductor and fiber building block company to deliver EPS of $0.09 on $27 million in revenue. Our price target is $11

 

Thursday, October 26

Alphabet (GOOGL; Asset-Lite) – Consensus expectations have this internet search and digital advertising company earnings EPS of $8.33 on revenue of $27.2 billion for the quarter. Our price target is $1,050.

Amazon (AMZN; Connected Society) – Consensus expectations for the company we consider the poster child for thematic investing to deliver EPS of $0.03 on revenue of $42 billion, up almost 29% year over year. Our price target is $1,150.

Nokia Corp. (NOK: Asset-Lite – Consensus expectations have this wireless infrastructure, connected device and intellectual property company earnings EPS of $0.06 on revenue of $6.35 billion for 3Q 2017. Our price target stands at $8.50.

United Parcel Service (UPS; Connected Society) – This e-commerce delivery solutions company is slated to deliver EPS of $1.45 on revenue of $15.6 billion. Our price target on UPS shares remains $130.

 

 

WEEKLY ISSUE: Some Underperformers Set to Come out from the Shadows

WEEKLY ISSUE: Some Underperformers Set to Come out from the Shadows

Monday was one of those sort-of holidays that saw banks, the post office and schools closed, but domestic stock markets and a number of other businesses open. The result was once again a more subdued start to the week that leads into what is poised to be a focal point for the stock market as 3Q 2017 earnings kickoff. Over the last several days, we saw through earnings from restaurant company Darden (DRI) and Cal-Maine Foods (CALM) and this week the negative 2017 reset from coatings company Axalta Coating Systems (AXTA). This tells me that not only has Wall Street underestimated the impact of September’s hurricane trifecta — a fact we saw in last Friday’s September Employment Report — but it has likely overestimated the current speed of the economy as well.

The next few days will give way to several economic reports that will more fully shine a light on the true speed of the economy, and they will help set the table for what is to come over the next few weeks as literally thousands of companies report. As subscribers, you know through our weekly Thematic Signals and our Cocktail Investing Podcast that I co-host with our Chief Macro Strategist Lenore Hawkins, we are constantly scrutinizing data points with our thematic lens and assessing the market.

Now let’s take a look at our overall market view, which is one of the key backdrops when it comes to investing – thematic or otherwise. As we shared on last week’s podcast, the domestic stock market continues to grind its way higher ahead of 3Q 2017 earnings. This march higher is being fueled in part by the return of investor greed as measured by CNNMoney’s Fear & Greed Index. The question we are increasingly pondering is what are those late to the party seeing that allows them to get comfortable with enough upside to now jump into a market that is trading at more than 19x expected 2017 earnings?

With the market priced to perfection and expectations running high, odds are we are bound to see some disappointment. The fact that margin debt is running at record levels is not lost on us here at Tematica, and it has the potential to exacerbate any near-term bump or pullback in the market.

This has us holding steady with the Tematica Select List, but it doesn’t mean we are being idle. Rather, we are scrutinizing contenders and revisiting price points at which we would scale into existing positions. Not quite our 2017 holiday shopping list, but one that as we approach Halloween could be ripe for harvesting.

 

 

Checking in on some of our outperformers

We’ve benefitted from this push higher as the Select List’s positions in LSI Industries (LYTS), Amplify Snacks (BETR), USA Technologies (USAT), Amazon (AMZN), Alphabet (GOOGL) and International Flavors & Fragrances (IFF) have outperformed the month to date move in the S&P 500. With USAT shares, this has them closing in on our $6.50 price target, while the others have ample upside to our respective price targets.

We continue to rate these stocks as follows:

  • Our price target on LSI Industries (LYTS) remains $10.00
  • Our price target on Amplify Snacks (BETR) remains $10.50
  • Our price target on Amazon (AMZN) remains $1,150
  • Our price target on Alphabet (GOOGL) remains $1,050

With USA Technologies (USAT) shares, we will continue to keep them on the Select List and as we reassess our Thematic Signals and other data points for additional upside to be had relative to our $6.50 price target.

The same is true with International Flavors & Fragrances (IFF), given the accelerating shift away from sugar toward food that is good for you vs. the modest upside to our current $150 price target.

 

It’s not all bad news for the underperformers however

While we like to focus on the outperformers, we tend to spend as much, if not more time, on the ones that are underperforming. Currently, that means shares of Costco Wholesale (COST), Nokia (NOK), MGM Resorts (MGM) and recently added United Parcel Service (UPS).

In reverse order, shares of Connected Society derivative company UPS shares came under pressure following comments that Amazon is once again flirting with expanding its own logistics business. While this may happen, it will take years to replicate the hub and spoke to home delivery service currently offered by UPS that is poised to benefit from the accelerating shift to digital commerce this holiday shopping season. We remain bullish on this position and expect the shares to rebound as we move into the 2017 holiday shopping season. We will look to scale into UPS shares closer to $110 should such a pullback in the shares emerges this earnings season.

Shares of Guilty Pleasure company MGM Resorts continue to languish following the recent Las Vegas shooting. In our view, it will take some time for the perception of the business to recover. As that time elapses, we’ll look to improve our cost basis following the better than expected August Nevada gaming data. Below $30 is where we are inclined to make our move, and our price target stands at $37.

We continue to see favorable data on 5G testing and deployments that bode very well for Nokia’s intellectual property business as well as its communications infrastructure business. Much like MGM shares we will be patient and look to opportunistically improve the cost basis on this Disruptive Technologies Select List position.

We have a more detailed look at Cash-Strapped Consumer company Costco down below, but as you’ll soon read we continue to favor the shares despite some concerning developments.

 

So, what’s up with Costco Wholesale?

As we mentioned above Costco is one of the recent underperformers and it comes following last week’s better than expected quarterly earnings results. The issue is that its the earnings call Costco shared that it is seeing a slowdown in membership rates, which Wall Street took to mean “Here comes Amazon!” While we agree that Amazon is set to continue disrupting traditional retail as it leverages Whole Foods into grocery and meal kits, and continues to focus on apparel, Costco’s issue is it opened 16 new warehouses during the first 9 months of its recently completed fiscal year, so odds are it would see some slowing in membership growth.

For those not convinced that Costco’s business is thriving we would point out the following:

  • September 2017: Net sales up 12%
  • August 2017: Net sales up 10.0% year over year with comparable stores sales up 7.3% (up 5.9% excluding gasoline prices and foreign exchange)
  • July 2017: Net sales up 8.8 percent year over year with comparable store sales up 6.2% (up 5.3% excluding gasoline prices and foreign exchange)
  • June 2017: Net sales up 7.0% year over year with comparable store sales up 6.0% (up 6.5% excluding gasoline prices and foreign exchange)

Looking at that data, we see Costco not only as a company that has continued to improve net sales month over month, but one that is hardly suffering the same fate as traditional brick & mortar retailers. Moreover, we would point out the company had 741 warehouses in operation during the August 2017 quarter, up from 715 a year ago. This led to a 13% increase in its high margin Membership Fee revenue, which accounted for nearly all of its net income during the quarter.

As we have said before, the power in Costco’s business model is the warehouses and membership fee income, and we see this continuing to be the case. As part of our Connected Society theme, we will continue to monitor consumer acceptance of delivered grocery. This includes Costco’s new two-day delivery services for both dry groceries and fresh foods that will be free for online orders exceeding $75 from 376 U.S. Costco stores. Unlike many brick & mortar retailers, Costco is not standing around and watching its competitors outflank it, rather it is responding. To us, this suggests the recent pullback is overdone.

  • We continue to have a Buy on Costco Wholesale (COST) shares, and our price target remains $190.

 

 

 

 

Adding this Missing Link Connected Society Stock to the Tematica Select List

Adding this Missing Link Connected Society Stock to the Tematica Select List

This morning we are adding shares of delivery and logistics company United Parcel Service (UPS) to the Tematica Select List with a price target of $122. We’ve often referenced UPS and its business as the missing link in the digital shopping aspect of our Connected Society investing theme. Year to date, UPS shares have fallen 6 percent, which we attribute in part to the seasonal slowdown in consumer spending. As we pointed out in our analysis of the January Retail Sales report last week, the shift toward digital commerce continues to accelerate and we see that a positive tailwind for UPS’s business and comments from UPS’s annual investor day held yesterday confirm our view.

As of last night’s market close UPS shares stood near $108, which when compared to our $122 price target offers 14 percent upside before we factor in the 3.1 percent dividend yield. Including the quarterly dividend of $0.83 per share into our thinking, we see 17 percent upside from current levels to our price target. As such we are adding UPS shares to the Tematica Select List with a Buy rating. Should the shares drift toward the $100 level, we are inclined to get more bullish on the shares given the business fundamentals as historical dividend yield valuation metrics.

 

A Look Ahead to 2018-19 for UPS

Yesterday, at its annual investor day United Parcel Service shared its 2018-2019 financial targets, expanded delivery and pick-up schedule, and continued buybacks. In reviewing those details, we continue to see the accelerating shift toward digital commerce at the expense of brick & mortar retail powering the company’s business. While most tend to focus on Amazon (AMZN) when we think of digital shopping, the reality is we see a far more widespread push toward it from the likes of Wal-Mart (WMT) as well as traditional retailers and consumer product companies. Wal-Mart, in particular, is shared on its earnings call yesterday that it would expand its online efforts to include grocery and called out both mobile and online as part of is efforts to “provide customers with a better offer.”

What all of this tells us is we have reached the tipping point for digital commerce, and like a tanker that is turning, once it hits the tipping point it tends to pick up speed. We see that in the coming quarters as retailers that lagged behind are now forced to invest to stay relevant with consumers.

In response to that accelerating shift, UPS is planning to expand its delivery and pickup schedule to six days for ground shipments, including Saturdays. In tandem, UPS will continue to invest in its logistics network, which signals it is preparing for the continued transformation in how consumers shop. That transformation is leading UPS to forecast revenue growth in the range of 4-6 percent over the 2018-2019 period, which means no slowdown in revenue growth from 2017 is expected. UPS also shared it intends to repurchase between $1-$1.8 billion in share repurchase during 2018-2019, which should allow it o grow EPS faster than revenue. UPS expects EPS during 2018-2019 to grow 5-10 percent, which is at the upper end of current expectations. As such, we expect to see Wall Street boosting price targets today and tomorrow up from the current consensus of $115 to something more inline with our $122 price target.

 

Embracing Technology of the Future

 

A drone demonstrates delivery capabilities from the top of a UPS truck during testing in Lithia, Florida, U.S. February 20, 2017. REUTERS/Scott Audette

UPS also shared it continues to test drone deliveries, including launching the drone from the top of a UPS van that is outfitted with a recharging station for the battery-powered drone. Granted this in testing, but in our view, the hub and spoke method of deploying drones from UPS trucks makes sense given that drones, especially those carrying packages, are like to operate for limited time frames due in part to battery power demands. In UPS’s tests, the battery-powered drone recharges while it’s docked. It has a 30-minute flight time and can carry a package weighing up to 10 pounds.

Again, we find this interesting, but odds are we will not see any pronounced impact on UPS’s delivery business for at least several quarters. Longer-term, initiatives such as these could spur further productivity and margin improvements.

 

The Bottomline on United Parcel Service (UPS)
  • We are adding shares of United Parcel Service (UPS) to the Tematica Select List with a price target of $122.
  • Should the shares drift toward the $100 level, we are inclined to get more bullish on the shares given the business fundamentals as historical dividend yield valuation metrics.

 

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

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

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

So what did the December report show?

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

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

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

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

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

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

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

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

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