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Uncertainty and volatility to remain in place as we enter 2Q 2018

Uncertainty and volatility to remain in place as we enter 2Q 2018

1Q 2018 – A Return of Volatility and Uncertainty

Last week was not only a shortened week owing to the Good Friday market holiday, but it also brought a close to what was a tumultuous first quarter of 2018. The stock market surged higher in January, hit some rocky roads in February than got even more volatile in March. All told, the S&P 500 ends the first three months of 2018 in a very different place than many expected it would in mid-January. While the four major domestic stock market indices finished March in the black, the only one to finish 1Q 2018 in the black was the Nasdaq Composite Index. Even that, however, was well off its January high. What we saw was a very different market environment than the one we’ve seen between November 2017 and the end of January 2018.

As we begin April, we have China responding to the Trump Administration’s steel and aluminum tariffs with their own on a variety of U.S. goods and President Trump suggested he was ruling out a deal with Democrats on DACA. This likely means the uncertainty and volatility in the stock market over the last several weeks will be with us as we get ready for 1Q 2018 earnings season.

In my view, this should serve as a reminder that “crock pot cooking” does not work when applied to investing — rather than just fix and forget it, there’s a need to be active investors. Not traders, but rather investors that are assessing and re-assessing data much the way we do week in, week out.

Of course, our view is thematic data points, as well as economic ones, offer a better perspective for investors. In last week’s Cocktail Investing Podcast, Lenore Hawkins, Tematica’s Chief Macro Strategist, and I explain how the combination of thematic investing and global macro analysis are the chocolate and peanut butter of investing. Coming out of the holiday weekend, I am seeing several confirming data points for our Safety & Security investing theme in the form of the data breach that hit Saks Fifth Avenue and Lord & Taylor. According to reports, Russian hackers obtained “a cache of five million stolen card numbers.” This comes just a few days after Under Armour (UAA)  disclosed that an unauthorized party acquired data associated with 150 million MyFitnessPal user accounts.

During the quarter, we selectively added shares of Rockwell Collins (ROK) and Paccar (PCAR) to the Tematica Investing Select List and recently pruned Universal Display (OLED) and Facebook (FB) shares. The former two were selected given prospects for capital spending and productivity improvement in the country’s aging plants, while Paccar is poised to benefit from the current truck shortage as well as the increasing shift toward digital commerce that is part of our Connected Society investing theme.

With Universal Display, it’s a question of expectations catching up with the current bout of digestion for organic light emitting diode display capacity. We’ll look to revisit these shares as we exit 2Q 2018 looking to buy them if not at better prices, at a better risk-to-reward tradeoff. With Facebook, while we see it benefitting from the shift to digital advertising the current privacy and user data issues are a headwind for the shares that could lead advertisers to head elsewhere. Much like OLED shares, we’ll look to revisit FB shares when the current dust-up settles and we understand how Facebook’s solution(s) change its business model. In the near-term, the verbal CEO sparring between Facebook’s Mark Zuckerberg and Apple’s (AAPL) Tim Cook over privacy, trust and business models should prove to be insightful as well as entertaining.

 

The Changing Stock Market Narrative

The narrative that has been powering the market saw a profound shift a third of the way through the quarter to one of mixed economic data, uncertainty over monetary and trade policies emanating from Washington that could disrupt the economy, and now short-lived concerns over inflation. Recently added to that list are user data and privacy concerns that have taken some wind out of the sales of FAANG stocks. This is very different than the prior narrative that hinged on the benefits to be had with tax reform.

 

 

Perhaps the best visual is found in the changes to the Atlanta Fed GDP Now forecast (see above). The forecast sat at more than 5% in January before a number of downward revisions as a growing portion of the quarter’s economic data failed to live up to expectations. And as we can see in the chart, as the economic data rolled in during late February and March, the Atlanta Fed steadily ticked its forecast lower, where it landed at 2.4% as of March 29. To be fair, we will receive March economic data that could prop up that forecast or weigh on it further. We’ll be scrutinizing that data this week, which includes the March readings for the ISM Manufacturing and Services indices, auto & truck sales and the closely watched monthly Employment Report. We’ll also get the last of the February numbers, namely the Construction and Factory Order reports.

As we digest the ISM reports, we’ll be watching the new orders line items as well as prices paid to keep tabs on the speed of the economy entering the second quarter in addition to potential inflation worries. In terms of potential inflation, we, along with the investing herd, will be closely scrutinizing the wage data in the March Employment Report. We will be sure to dig one layer deeper, denoting the difference between supervisory and non-supervisory wages. As you’ll recall, those that didn’t do that failed to realize the would-be worry found in the January Employment Report was rather misleading.

In addition to those items, we’ll also be looking at key data items for several Tematica Investing Select List positions. For example,  the March heavy-duty truck order figures that should validate our thesis on Paccar (PCAR) shares, while Costco Wholesale’s (COST) March same-store sales figures should show continued wallet share gains for Cash-strapped Consumer, and the monthly gaming data from Nevada and Macau will clue us in to how that aspect of our Guilty Pleasure investing theme did in February and March.

 

Gearing Up for 1Q 2018 Earnings Season

Last Friday we officially closed the books on 1Q 2018, and that means before too long we’ll soon be staring down the gauntlet of first-quarter earnings season. With that in mind, let’s get a status check as to where the market is trading. Current expectations for the S&P 500 call for 2018 EPS to grow 18.5% year over year to $157.70. Helping fuel this forecast is the expected benefit of tax reform, which is leading to EPS forecasts for a rise of more than 18% year over year in the first half of 2018 and nearly 21% in the back half of the year. To put some perspective around that, annual EPS growth has averaged 7.6% over the 2002-2017 period. As we parse the data, we’d point out that on a per-share basis, estimated earnings for the first quarter have risen by 5.3% since Dec. 31; historically, analysts have reduced those expectations during the first few months of the year.

 

 

What do we think?

While we remain bullish on the potential investments and incremental cash in consumer pockets because of tax reform, we have to point out the risk that tax reform-infused GDP expectations — and therefore EPS expectations — could be a tad lofty. We’ve already seen a growing number of companies use the incremental cash flow to scale up buyback programs and in some cases dividends. Also, as we’ve seen in the past, consumers, especially those wallowing in debt, may opt to lighten the debt load. Lenore made this point last week when she appeared on Fox News’s Tucker Carlson Tonight.

 

 

Again, this is a possibility and one that we’ll be monitoring as we get more data in the coming weeks and months as we look to position the Tematica Investing Select List for what’s to come in 2018 and beyond. Combined with the rising concern of tariffs and trade that could disrupt supply and goose inflation in the short to medium term, it’s going to be even more of a challenge to parse company guidance to be had in the coming weeks that could be less than clear. I’ll be sure to break out my extra decoder ring as I get my seatbelt secured for what is looking to be a bumpy set of weeks.

As I noted above, we were prudently choosey with the Tematica Investing Select List in 1Q 2018, and while we will continue to be so as share prices come in, I’ll look to take advantage of the improving risk-to-reward profiles to be had.

 

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

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

 

Key Points from this Issue:

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

 

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

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

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

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

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

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

 

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

 

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

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

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

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

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

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

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

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

 

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

 

Changes afoot at Brookdale

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

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

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

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

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

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

 

 

SPECIAL ALERT: Walking Away from Universal Display Shares… For Now

SPECIAL ALERT: Walking Away from Universal Display Shares… For Now

  • We are issuing a Sell rating on the shares of Tematica Select List resident Universal Display (OLED) as short-term headwinds mount.
  • As we exit the position, despite their 2018 performance to date we’d note OLED shares have generated a return of more than 100% since being first added to the Select List in October 2016. On a combined basis, our two Buy actions for the shares on the Select List have returned a blended return of more than 47%.
  • As we cut Universal Display (OLED) shares from the Tematica Investing Select List, we will place them on the Contender List, looking to call them back up when signs of fresh industry capacity additions emerge.

While I continue to have a long-term bullish outlook on the organic light emitting diode display opportunity and Universal Display (OLED) shares, we are seeing mounting headwinds in the short-term that will likely restrain the shares.

The latest blow is coming from news that organic light emitting diode display adopter Apple (AAPL) is developing a competing technology dubbed MicroLEDs. While that tech likely won’t be commercialized for several years, it along with other near-term headwinds like the temporary slowdown in organic light emitting diode capacity additions, have taken their toll on OLED shares.

While I continue to expect new products containing organic light emitting diode displays to be announced and hit market shelves later this year, odds are OLED shares will remain range bound at best until we have clear signs the industry is once again increasing capacity. This means watching equipment orders from the likes of Tematica Investing resident Applied Materials (AMAT) and others. The downside risk is industry adoption of the technology is slower than previously expected, which means would lead to even further downside in OLED shares. Given the shifting risk to reward profile in the shares near-term, I’m opting to exit the shares, walking away with still impressive gains in the position until we see clear signs of a rebound in demand.

Speaking of AMAT shares, later this week Micron (MU) will be reporting its quarterly results I’ll be assessing its outlook and what it means for not only our Connected Society and Disruptive Technologies investment themes, but for AMAT shares as well.

 

Weekly Issue: Looking for Trump-Proof Companies

Weekly Issue: Looking for Trump-Proof Companies

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

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

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

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

 

 

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

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

 

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

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

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

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

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

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

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

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

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

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

 

SPECIAL ALERT – Buying more shares of this beaten up Disruptive Technology company

SPECIAL ALERT – Buying more shares of this beaten up Disruptive Technology company

 

KEY POINTS FROM THIS ALERT

  • We will use the recent 35%+ drop in Universal Display (OLED) to double down on this Disruptive Technology company.
  • Our long-term price target of $225 remains intact.
  • We are suspending our $125 stop loss on OLED shares.

 

Despite crushing December-quarter expectations last week, Universal Display (OLED) shares were hard hit over the last several days. The catalyst behind this change in investor sentiment was the fact that the company offered a weaker-than-expected outlook for the near term, even though it reiterated the long-term opportunities it sees from the adoption of its proprietary organic light-emitting diode displays.

As I have shared more than a few times, the roadmap for organic light emitting diode adoption is clearly seen when we look at the light emitting diode (LED) industry. We first saw major adoption with color screens in mobile phones and TV before going on to the automotive lighting and general illumination markets. Amid Mobile World Congress 2018 in Barcelona this week, Samsung had debuted its latest flagship smartphone, the Galaxy S9, that, yes, contains an organic light emitting diode display.

 

Has the move lower in OLED shares been painful?

Yes, there is no denying that, but we also know that at least in the near term the market is especially short-term focused.

In my view, like any robust meal, we are likely seeing what is called an intermezzo course — something to cleanse the palate and offer the diner a brief respite. For the organic light-emitting diode display industry, it means digesting the rapid rise in industry capacity over the last 18-24 months that has fueled Universal’s business and its share price. While not pleasant, it’s a natural part of any rapidly rising industry.

 

How will we respond to the recent price pressure in OLED shares?

Even though we are up still up significantly in our OLED shares, we are going to take advantage of the short-term focused drop of more than 35% in the shares to our long-term advantage, by scaling into the shares at current levels. While this will dilute our cost basis, it’s the prudent thing to do as OLED shares are far better priced for such a move today than they have been in the last four months. I’d also add that as much as I enjoyed watching OLED shares rocket higher in late 2017 and in January, the shares were likely a bit ahead of themselves.

 

Are we changing our long-term price target of $225 for OLED shares?

With far more opportunities to be had as the organic light emitting diode display market expands deeper into smartphones and TVs, and enters new ones in the coming 12-24 months, our price target of $225 remains intact.

As part of adding to our OLED position, we will temporarily suspend our $125 stop loss, and look to revisit this as calmer heads prevail with OLED shares.

 

 

 

With more earnings on the way, getting ready for a shortened week for stocks

With more earnings on the way, getting ready for a shortened week for stocks

Today is all quiet when it comes to the domestic stock market as they are closed in observance of President’s Day. While never one to dismiss a long weekend, it does mean having a shorter trading week ahead of us. From time to time, that can mean a frenetic pace depending of the mixture and velocity of data to be had. This week, there are less than a handful of key economic indicators coming at us including the January Existing Home Sales report and one for Leading Indicators.

Midweek, we’ll get the report that I suspect will be the focus for most investors this week – the monthly Flash PMI reports for China, Europe and the U.S. from Markit Economics. These will not only provide details to gauge the velocity of the economy in February, but also offer the latest view on input prices and inflation. Given the inflation focus that was had between the January Employment Report and the January CPI report, this new data will likely be a  keen focus for inflation hawks and other investors. I expect we here at Tematica will have some observations and musings to share as we digest those Flash PMI reports.

On the earnings front, if you were hoping for a change of pace after the last two weeks, we’re sorry to break the news that more than 550 companies will be reporting next week. As one might expect there will be a number of key reports from the likes of Home Depot (HD) and Walmart (WMT).  For the Tematica Investing Select List, we’ll get results from four holdings:

 

MGM Resorts (MGM) on Tuesday (Feb. 20)

When this gaming and hospitality company reports its quarterly results, let’s remember the Las Vegas shooting that had a negative impact on overall industry Las Vegas gaming activity early in the December quarter. In amassing the monthly industry gaming data, while gaming revenue rebounded as the seasonally slow quarter progressed, for the three months in full it fell 5% year over year. Offsetting that, overall industry gaming revenue for the December quarter rose 20% year over year in Macau.

Putting these factors together and balancing them for MGM’s revenue mix, we’ve seen EPS and revenue expectations move to the now current $0.08 and $2.5 billion vs. $0.11 and $2.46 billion in the year ago quarter. On MGM’s earnings call, we’ll be looking to see if corporate spending is ramping down as had been predicted as well as what the early data has to say about the new Macau casino. We’ll also get insight on the potential direct and indirect benefits of tax reform for MGM’s bottom line.

  • Heading into that report our price target for MGM shares remains $37.

 

Universal Display (OLED) on Thursday (Feb. 22).

After several painful weeks, shares of Universal Display rebounded meaningfully last week following the news it re-signed Samsung to a multi-year licensing deal and an upbeat outlook from Applied Materials (AMAT)for the organic light-emitting display market. For subscribers who have been on the sidelines for this position, with the Apple (AAPL) iPhone X production news now baked in the cake we see this as the time to get into the shares. We expect an upbeat earnings report to be had relative to the December quarter consensus forecast for EPS of $0.85 on revenue of $100 million, up 55% and 34%, respectively, year over year.

Based on what we’ve heard from Applied as well as developments over organic light emitting diode TVs and other devices at CES 2018, we also expect Universal will offer a positive outlook for the current as well as coming quarters.

  • Our price target on OLED shares remains $225.

 

 

Applied served up another winning quarter, that’s good for OLED shares too

Applied served up another winning quarter, that’s good for OLED shares too

 

KEY POINTS FROM THIS ALERT:

  • Our price target on Applied Materials (AMAT) shares remains $70.
  • Our price target on Universal Display (OLED) shares remains $225.

 

Midweek, we saw yet another dynamite earnings report from Tematica Investing Select List company Applied Materials (AMAT).   The company simply walked right over expectations and not only raised its outlook, but also boosted its quarterly dividend and share repurchase program. Simply put, it was a picture-perfect earnings report from top to bottom, and in keeping with increasing presence of our Connected Society investing theme, Applied’s management team shared a number of reasons why as I like to say, “chips are the fabric of our digital lives.”

While many of the talking heads are bemoaning slower growth prospects for the smartphone market, the devices continue to pack more functionality and storage inside their packages, and this is before 5G. Voice recognition technology and greater processing power to handle that as well as augmented reality, virtual reality technologies are leading to greater chip dollar content in these devices despite slower unit growth. Per Applied average semiconductor content per smartphone rose 30% in 2017.  To use the investing lingo, we are seeing rising average dollar content per device that is poised to step up again in 2019-2020 as those aforementioned 5G chips make their way into smartphones as AT&T (T), Verizon (VZ), Sprint (S) and T-Mobile USA (TMUS) all launch 5G commercial networks.

We’re also hearing quite a bit about the growing voice assistant market as Apple (AAPL) launches its Home Pod and Amazon (AMZN) touted 2017 was a banner year for its Alexa powered devices. What’s not really talked about, however, is the typical voice assistant has around 30 chips and a total of 200 square millimeters of silicon, roughly twice the area of a smartphone application processor. Now let’s think about not only the new types of voice assistants we are seeing from Amazon with video screens, but how these digital assistants are being embedded in other devices ranging from TVs to a road map that includes home appliances and autos. All of these digital assistants are connected back to servers like Amazon Web Services and the artificial intelligence workloads require server architectures that have up to eight times more logic and four times more memory content by area than traditional enterprise servers.

The bottom line is the Internet of Things, big data, augmented reality, artificial intelligence, data centers and storage are driving incremental chip demand. This tailwind of our Connected Society investment theme is leading Applied to raise its wafer spending forecast among its customer base to $100 billion over 2018-2019, up from $90 billion in 2017-2018. One of the wild cards for potential upside to that forecast is China, which continues to add domestic capacity, which is benefitting Applied given its leading market share position in the region.

Turning to Applied’s Display business, which is benefitting from larger format TVs as well as the ramp in organic light emitting diode (OLED) display capacity. These drivers have led Applied to forecast more than 30% growth in its Display business in 2018, which follows nearly 60% growth in 2017. Digging into the company’s comments on the earnings conference call, it is not only seeing rising OLED demand, but also a diversification in its customer base which in my view reinforces the

Previously, one customer (most likely Samsung) was more than 50% of its OLED business, and now more than 50% of Applied’s OLED business, but that has flip-flopped and now more than 50% is coming from multiple customers. That widening in demand is not only good for Applied, but it also points to an expanding market for Universal Display’s (OLED) chemical and IP licensing business as well.

On the dividend and share repurchase fronts, Applied Material’s Board of Directors approved a doubling of the quarterly cash dividend on the company’s common stock to $0.20 per share. That new dividend will be payable on June 14, to shareholders of record as of May 24. Ahead of that, Applied will pay its next cash dividend of $0.10 per share on March 14. The Board also approved a new $6.0 billion share repurchase authorization that is in addition to the $2.8 billion remaining under its previously approved authorization. I see these two offering a combination of support for our $70 price target on AMAT shares, while also providing support for the shares. At the current share price, the combined $8.8 billion in repurchasing power equates to roughly 166 million shares, roughly 15% of the company’s overall share count. Do I expect it to happen in one fell swoop? Nope, but it’s a factor that offers a way for the company to continue to meet and potentially beat Wall Street EPS expectations.

Given the consequences a company faces should it miss a dividend payment or find itself in the position to cut it, it’s not a simple decision for a company to boost its dividend, let alone double the existing quarterly payment. In my opinion, that alone says volumes about Applied’s confidence in its business over the coming years, and the additional and upsized buyback program only adds to that.

  • Our price target on Applied Materials (AMAT) shares remains $70.
  • Our price target on Universal Display (OLED) shares remains $225.

 

 

WEEKLY ISSUE: Is Inflation Rearing Its Ugly Head or Not?

WEEKLY ISSUE: Is Inflation Rearing Its Ugly Head or Not?

Today is the day that we here at Tematica, and other investors as well, have been waiting for to make some semblance of the recent stock market volatility. Earlier this morning we received the January Consumer Price Index (CPI), one of the closely watched measures of that now dirty word – inflation. As a quick reminder, the market swings over the last two weeks were ignited by the headline wage data in the January Employment Report, as well as other signs, such as rising freight costs that led us to add shares of Paccar (PCAR) to the Tematica Investing Select List earlier this week. This topic of resetting inflation expectations and what it may mean for the Fed and interest rates has been a topic of conversation on recent Cocktail Investing Podcast between Tematica’s Chief Macro Strategist Lenore Hawkins and myself.

 

What the January CPI Report Showed and Its Impact on AMZN, COST and UPS

The headline figures from the January CPI report showed the CPI rose 0.5% month over month in January, which equates to a 2.1% increase year over year. Keeping in sync with the headline figure, which includes all categories, the consensus expectation was for a 0.3% month over month increase. The driver of the hotter than expected headline print was the energy index rose, which climbed 3.0% in January, and we’ve witnessed this first hand in the gasoline price jump of late. Excluding the volatile food and energy components, the “core” CPI index was up 0.3% month over month in January, coming in a bit ahead of the expected 0.2% increase. On a year over year basis, that core figure rose 1.8%, which is in keeping with the 1.7%-1.8% over the last eight months. Month over month gas and fuel prices were up 5.7% and 9.5%, respectively.

Late yesterday, the American Petroleum Institute released data showing a 3.9 million barrel increase in crude stockpiles for the week ended Feb. 9, along with a 4.6 million barrel rise in gasoline stocks and a 1.1 million barrel build in distillates. With crude inventories once again on the rise as US oil production has risen in response to the recent surge in oil prices from September to late January, we’ve seen oil prices retreat to December levels and odds there is more relief to come.

As we wait for others, who if you’ve seen the whipsaw in stock market futures today are simply reacting to the January headline CPI figure, to get some clearer heads about themselves and digest the internals of the report, I’ll share our thoughts on the January Retail Sales report that was also published this morning.

Staring with the headline figure, January Retail Sales came in at -0.3% month over month, falling short of the 0.2% consensus forecast. Excluding auto and food, January core retail sales fell 0.3% month over month; on a year over year basis, retail sales rose 3.9% with nonstore sales leading the way (up 10.2%) followed by gas stations sales (up 9.0% year over year), which is of little surprise given our January CPI conversation above. We do see that nonstore figure as further confirmation for not only our Amazon (AMZN) and United Parcel Service (UPS) shares, but also our Costco Wholesale (COST) ones as it continues to embrace our Connected Society theme.

  • Our price target on Amazon (AMZN) shares remains $1,750
  • Our price target on Costco Wholesale (COST) shares remains $200
  • See my comments below for my latest thoughts on UPS shares

 

Market’s Knee-Jerk Reaction to January Retail Sales Offered Opportunity in PCAR, Not BGFV

Despite the 3.9% year over year January Retail Sales print, the market is focusing on the month over month drop, which was one of the weakest prints in some time. Here’s the thing, we here at Tematica have been talking about the escalating level of debt that consumers have been taking on as a headwind to consumer spending and despite the post-holiday sales, consumers tend to ramp spending down after the holidays. Odds are these two factors led to that month over month decline, but even so up 3.9% year over year is good EXCEPT for the fact that gas station sales are bound to fall as gas prices decline.

If we look at these two reports, my take on it is a skittish stock market is once again knee-jerk reacting to the headline figures rather than understanding what is really going on. The initial reaction saw Dow stock market futures fall from +150 to -225 or so before rebounding to -125. As data digestion occurs, odds are concerns stoked by the initial reactions will fade as well

With market anxiety still running higher compared to this time last year or even just six months ago, I expect the market to cue off the major economic data points to be had in the coming weeks building to the Fed’s next FOMC meeting on March 20-21. As I pointed out on this week’s podcast, at that meeting we’ll get the Fed’s updated economic forecast and I expect that will have chins wagging over the prospects of three or four rate hikes to be had in 2018.

In the meantime, I’ll continue to look for opportunities like I saw with Paccar (PCAR) shares on Monday, and avoid pitfalls like the one I mentioned yesterday with Big Five Sporting Goods (BGFV). And for those wondering, per the January Retail Sales Report, sporting goods sales 7.1% in January. Ouch! And yes, I always love it when the data confirms my thesis.

  • Our price target on Paccar (PCAR) shares remains $85

 

Waiting on Applied Materials Earnings Announcement

After today’s market close, Applied Materials (AMAT) will share its latest quarterly results, and update its outlook. As crucial as those figures are, in recent weeks we’ve heard positive things from semi-cap competitors, which strongly suggests Applied should deliver yet another good quarter and a solid outlook. Buried inside those comments, we’ll get a better sense as to the vector and velocity for its products, both for chips as well as display equipment.

Those comments on the display business will also serve as an update for the currently capacity constrained organic light emitting diode market, one that we watch closely given the position in Universal Display (OLED) shares on the Tematica Investing Select List. I see this morning’s announcement by Universal that it successfully extended its agreement with Samsung though year-end 2022 with an optional 2-year extension as reminding investors of Universal’s position in the rapidly growing technology. With adoption poised to expand dramatically in 2018, 2019 and 2020, I continue to see OLED shares as a core Disruptive Technologies investment theme holding.

  • Our price target on Applied Materials (AMAT) shares remains $70
  • Our price target on Universal Display (OLED) shares remains $225

 

 

Should We Be Concerned About UPS Amid Amazon Announcement?

Several paragraphs above I mentioned United Parcel Service (UPS) shares, and as one might expect the headline reception to the January Retail Sales Report has them coming under further pressure this morning. That adds to the recent news that our own Amazon (AMZN) would be stepping up its business to business logistics offering and competing with both UPS and FedEx (FDX). Of course, this will take time to unfold, but these days the market shoots first and asks questions later. At the same time, we are entering into a seasonally slower time of year for UPS, and while yes consumers will continue to shift toward digital shopping as we saw in today’s retail sales report, the seasonal leverage to be had from the year-end holidays is now over.

 

 

While it may sound like we are getting ready to give UPS shares the ol’ heave ho’, along with the February market gyrations, it’s been a quick ride to the $106 level from $130 for UPS shares, and this has placed them into the oversold category. From a share price perspective, the shares are back to levels last seen BEFORE both the 2017 Back to School and year-end holiday shopping seasons. With prospects for digital shopping to account for an even greater portion of consumer wallets in 2018 and 2019 vs. 2017, we’re going to be patient with UPS shares in the coming months as we wait for the next seasonal shopping surge to hit.

  • Our long-term price target on UPS shares remains $130.

 

WEEKLY ISSUE: The Shakeout from Market Volatility on the Select List

WEEKLY ISSUE: The Shakeout from Market Volatility on the Select List

 

 

It’s Wednesday, February 7, and the stock market is coming off one of its wild rides it has seen in the last few days. I shared my thoughts on the what’s and why’s behind that yesterday with subscribers as well as with Charles Payne, the host of Making Money with Charles Payne on Fox Business – if you missed that, you can watch it here.

As investors digest the realization the Fed could boost interest rates more than it has telegraphed – something very different than we’ve experienced in the last several years – the domestic stock market appears to be finding its footing as gains over the last few days are being recouped. Lending a helping hand is the corporate bond market, which, in contrast to the turbulent moves of late in the domestic stock market, signals that credit investors remain comfortable with corporate credit fundamentals, the outlook for earnings and the ability for companies to absorb higher interest rates.

My perspective is this expectation reset for domestic stocks follows a rapid ascent over the last few months, and it’s removed some of the froth from the market as valuations levels have drifted back to earth from the rare air they recently inhabited.

 

Among Opportunity This New Market Dynamic Brings, There Have Been Casualties

While this offers some new opportunities for both new positions on the Tematica Investing Select List as well as the opportunity to scale into some positions at better prices once the sharp swings in stocks have abated some, it also means there have been some casualties.

We were stopped out of our shares in Cashless Consumption investment theme company, USA Technologies (USAT) when our $7.50 stop loss was triggered yesterday. While the shares snapped back along with the market rally yesterday, we were none the less stopped out, with the overall position returning more than 65% since we added them to the Select List last April. For those keeping track, that compares to the 15.3% return in the S&P 500 at the same time so, yeah, we’re not exactly broken up over things. We will put USAT shares on the Tematica Contender List and look to revisit them after the company reports earnings tomorrow (Thursday, Feb. 8).

That’s the second Select List position to have been stopped out in the last several days. The other was AXT Inc. (AXTI) last week, and as a reminder that position returned almost 27% vs. a 15% move in the S&P 500. Again, not too shabby!

The last week has brought a meaningful dip in shares of Costco Wholesale (COST). On recent episodes of our Cocktail Investing Podcast, Tematica Chief Macro Strategist Lenore Hawkins and I have discussed the lack of pronounced wage gains for nonsupervisory workers (82% of the US workforce) paired with rising credit card and other debt. That combination likely means we haven’t seen the last of the Cash-Strapped Consumer investment theme — of the key thematic tailwinds we see behind Costco’s business. While COST shares are still up more than 15% since being added to the Select List, we see the recent 5% drop in the shares as an opportunity for those who remained on the sidelines before the company reports its quarterly earnings in early March.

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

 

 

Remaining Patient on AMAT, OLED and AAPL

Two other names on the Tematica Investing Select List have fallen hard of late, in part due to the market’s gyrations, but also over lingering Apple (AAPL) and other smartphone-related concerns. We are referring to Disruptive Technologies investment theme companies Applied Materials (AMAT) and Universal Display (OLED). As we shared last week, it increasingly looks that Apple’s smartphone volumes, especially for the higher priced, higher margin iPhone X won’t be cut as hard as had been rumored. Moreover, current chatter suggests Apple will once again introduce three new iPhone models this year, two of which are slated to utilize organic light emitting diode displays.

Odds are iPhone projections will take time to move from chatter to belief to fact. In the meantime, we are seeing other smartphone vendors adopt organic light emitting diode displays, and as we saw at CES 201 TV adoption is going into full swing this year. That ramping demand also bodes for Applied Materials (AMAT), which is also benefitting from capital spending plans in China and elsewhere as chip manufacturers contend with rising demand across a growing array of connected devices and data centers.

  • Our price target on Apple (AAPL) remains $200
  • Our price target on Universal Display (OLED) remains $225
  • Our price target on Applied Materials (AMAT) remains $70

 

The 5G Network Buildout is Gaining Momentum – Good News for NOK and DY

This past week beleaguered mobile carrier, Sprint (S), threw its hat into the 5G network ring announcing that it will join AT&T (T), Verizon (VZ), and T-Mobile USA (TMUS) in launching a commercial 5G network in 2019. That was news was a solid boost to our Nokia (NOK) shares, which rose 15% last week. The company remains poised to see a pick-up in infrastructure demand as well as IP licensing for 5G technology, and I’ll continue to watch network launch details as well as commentary from Contender List resident Dycom Industries (DY), whose business focuses on the actual construction of such networks.

Several months ago, I shared that we tend to see a pack mentality with the mobile carriers and new technologies – once one makes a move, the others tend to follow rather than risk a customer base that thinks they are behind the curve. In today’s increasingly Connected Society that chews increasingly on data and streaming services, that thought can be a deathblow to a company’s customer count.

  • Our price target on Nokia (NOK) shares remains $8.50
  • I continue to evaluate upgrading Dycom (DY) shares to the Select List, but I am inclined to wait until we pass the winter season given the impact of weather on the company’s construction business.

 

Disney Offers Some Hope for Its ESPN Unit

Last night Disney (DIS) announced its December quarter results while the overall tone was positive, the stand out item to me was the announcement of the new ESPN streaming service being introduced in the next few months that has a price tag of $4.99 a month. For that, ESPN+ customers will get “thousands” of live events, including pro baseball, hockey and soccer, as well as tennis, boxing, golf and college sports not available on ESPN’s traditional TV networks. Alongside the service, Disney will unveil a new, streamlined version of the ESPN app, which is slated to include greater levels of customization.

In my view, all of this lays the groundwork for Disney’s eventual launch of its own Disney streaming content service in 2019, but it also looks to change the conversation around ESPN proper, a business that continues to lose subscribers. Not surprising, given that Comcast (CMCA) continues to report cable TV subscriber defections. One of the key components to watch will be the shake-out of the rights to stream live games from the major professional leagues — the NFL, Major League Baseball, the NBA. Currently, ESPN is on the hook for about $4 billion a year in rights fees to those three leagues alone — not to mention the rights fees committed to college athletics. Those deals, however, include only the rights to broadcast those games on cable networks or on the ESPN app to customers that can prove they have a cable subscription, not cord-cutters. So the question will be how quick will customers jump on board to pay $5 a month for lower-level games, or will they be able to cut deals with the major professional sports leagues to include some of their games as well.

Nevertheless, I continue to see all of these developments as Disney moving its content business in step with our Connected Society investing theme, which should be an additive element to the Content is King investment theme tailwind Disney continues to ride. With that in mind, we are seeing rave reviews for the next Marvel movie – The Black Panther – that will be released on Feb. 16. The company’s more robust 2018 movie slate kicks off in earnest a few months later.

  • We will continue to be patient investors with Disney, and our price target on the shares remains $125

 

 

 

Earnings from Apple, Amazon, Alphabet and UPS lead to several price target changes… and not all of them are moving higher

Earnings from Apple, Amazon, Alphabet and UPS lead to several price target changes… and not all of them are moving higher

 

In the last 24 hours we’ve had four Tematica Investing Select List positions – United Parcel Service (UPS) Amazon (AMZN), Alphabet (GOOGL) and Apple (AAPL) – report their quarterly earnings. Across the four companies, it was a mixed bag — on one hand, we have solid performance and profits at Amazon and Apple, while on the other hand, both United Parcel Service and Alphabet lagged in converting their respective topline strength into profits. We’re going to dig into company specifics below, but in summary:

  • We are increasing our long-term price target on Amazon shares to $1,750 from $1,400, which keeps our Buy rating on the shares in place. As a quick reminder, we continue to see Amazon as a company to own not trade
  • We are maintaining our $200 price target on Apple, which also keeps our Buy rating intact.
  • With Alphabet shares, we are now boosting our price target to $1,300 from $1,150, which offers upside of 15% from current levels. Subscribers that are underweight GOOGL shares are advised to let the full impact of last night’s earnings announcement be had and wade into the shares in the coming days.
  • We are trimming our United Parcel Service price target to $130 from $132.

 

United Parcel Service

Shares of United Parcel Service slumped throughout the early part of the day yesterday, and while they did recover off their lows, the day ended with the shares down just over 6% following the company’s December quarter earnings report. Inside that report, the company reported slightly better than expected top-line results of $18.83 billion, up 11.2% year over year, vs. the expected $18.2 billion. The issue that pressured UPS shares was revealed in the 2.5% year over year increase in EPS to $1.67 even though that figure was slightly ahead of expectations. Comparing those two growth rates as well as looking at the year over year drop in operating margin for the quarter to 12.2% from 13.1%, we find UPS’s network capacity was once again overwhelmed by the shift to digital shopping in the US. Outside of that business, its profits climbed at its International business as well as Supply Chain and Freight Segment.

Near-term following the year-end holiday shopping season we are entering the seasonally slower part of the year for UPS’s business. If historical patterns repeat, we’re likely to see the shares range-bound over the coming months with them trending higher as more data shows the continued shift toward digital shopping that is powering its UPS Ground business. With more pronounced share gains likely to reveal themselves in the shopping-heavy back half of the year, we’re inclined to be patient investors with UPS, reaping the rewards as more companies continue to embrace the direct-to-consumer business model either on their own or through partnerships with other companies, like Amazon. We will continue to monitor oil and at the pump gas prices, which could be a headwind to UPS’s efforts to improve margins at its US Domestic business in the coming months. In terms of the company’s 2018 outlook, it guided EPS between $7.03-$7.37 billion, a 20% increase year over year at the midpoint, which is in line with expectations.

 

Apple

After the market close yesterday, Apple reported December quarter results that bested Wall Street expectations on the top and bottom line even though iPhone shipments fell short of expectations and dipped year over year. More specifically, the company served up EPS of $3.89 per share, $0.04 ahead of consensus expectation on revenue of $88.29 billion, which edged out expectations of $87.6 billion. While Apple once again bested expectations, the truly revealing revenue and EPS comparisons are had versus the December 2016 quarter as revenue rose 12.6% year over and EPS 16%.

Year over year revenue improvement was had in the iPad and Services business — the latter benefitting from Apple’s continued growth in active devices, which hit 1.3 billion in January, up from 1.0 billion just two years ago. Mac sales, in terms of revenue and units, edged lower year over year and Apple Watch volumes rose 50% year over year on the strength of Apple Watch 3.  Despite the 1.2% year over year drop in iPhone shipments, the higher priced newer models drove the average selling price in the December 2017 quarter to hit roughly $795 up from $695 in the year ago quarter. That pricing surge led iPhone revenue to climb 12.5% to $61.6 billion. Digging into the results, we find the year over year improvements even more impressive when we consider iPhone X didn’t go on sale until early November and the December 2017 quarter had one less week compared to the December 2016 one.

All in all, it was a solid December quarter for Apple, and as we all know, there has been much speculation over iPhone production levels in the first half of the year, particularly for iPhone X. While Apple did issue its take on the March quarter – revenue between $60-$62 billion (vs. $52.9 billion in the March 2017 quarter), gross margin between 38%-38.5% and operating expenses $7.6-$7.7 billion – it was its usual tight-lipped self when it came to device shipments.

Let’s remember chatter over the last few weeks was calling for steep cuts to iPhone X shipments, but Apple ended the December quarter with channel inventories near the lower end of its 5-7-week target range. On the earnings call, Apple shared that iPhone should be up double digits year over year in the March 2018 quarter with the non-iPhone businesses up double digits as well. If we assume iPhone average selling prices remain relatively flat quarter over quarter, back of the envelope math suggests Apple is likely to ship 48-49 million iPhone units – roughly a 3%-5% drop in shipments year over year. That is far less than the talking heads were talking about over the last few weeks and explains why Apple shares rallied in aftermarket trading.

We see this as a positive for our Universal Display (OLED) shares as well – our price target on those remains $225.

From our perspective, the Apple story remains very much intact and with several positives to be had in the coming quarters. When Apple reports its March quarter results, we expect a clearer picture of how Apple plans to leverage the benefits of tax reform on its capital structure and share potential dividend and buyback plans. Next week, Apple’s HomePod will be released and before too long we expect to hear more about iPad and other product refreshes before the talk turns to WWDC 2018. Along the way, we hope to hear more concrete plans over Apple’s push into original content, a move we continue to think will make its ecosystem even stickier and likely result in even more people switching to Apple devices.

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

 

Amazon

Turning to Amazon, we were expecting a strong quarter given all the data points we received over the accelerated shift to digital shopping during the 2017 holiday season and we were not disappointed. For the December quarter, Amazon’s net sales increased 38% to $60.5 billion. Excluding the $1.1 billion favorable impact from year-over-year changes in foreign exchange rates, the quarter’s net sales still increased a robust increased 36% year over year. By reporting segments, North America revenues rose an impressive 42% year over year, International by 29% and Amazon Web Services (AWS) just under 45%.

More impressive than the segment revenue results was the year over year move in operating income in North America, which rose 107% for the quarter, and the increase in sales in AWS (Amazon’s cloud computing division), with sales increasing 46% for the quarter. That led the company’s overall operating income to climb to $2.1 billion in the quarter, up significantly from $1.3 billion in December 2016 quarter. In our view, after delivering 11 quarters of profitability, Amazon has shown the naysayers that it can prudently invest to drive profitable growth and innovation. Period.

The seasonally strong shopping quarter resulted in Amazon’s North America division being the largest generator of profit for the quarter, a role that is usually had by AWS. Looking at the profit picture for the full year 2017, we find AWS generated nearly all of the company’s operating profit. We continue to be impressed by Amazon’s ability to win not just profitable cloud market share but fend off margin erosion as players like Alphabet and Microsoft (MSFT) look to win share in this market.

If we had to find one issue to pick with Amazon’s December quarter report it would be the continued losses at its International business. Those losses tallied $0.9 billion in the December 2017 quarter and $3.06 billion for all of 2017.  We understand Amazon continues to expand its footprint in Europe and Asia, replicating the Prime and content investments it has made in the US, to drive long-term growth. As we have said before, Amazon is leveraging its secret weapon, AWS (10% of 2017 sales but more than 100% of 2017 operating profits), and its cash flow to fund these long-term investments and as patient investors, we accept that. We would, however, like to have a better understanding what the timetable is for bringing the International business up to at least to break even so it’s no longer a drag on the company’s bottom line.

In typical Amazon fashion, Amazon’s earnings press release contained a plethora of highlights across its various businesses, but the few that jumped out at us were:

  • In 2017, more than five billion items shipped with Prime worldwide.
  • More new paid members joined Prime in 2017 than any previous year — both worldwide and in the U.S.
  • Amazon Web Services (AWS) announced several enterprise customers during the quarter: Expedia, Ellucian, and DigitalGlobe are going all-in on AWS; The Walt Disney Company and Turner named AWS their preferred public cloud provider; Symantec will leverage AWS as its strategic infrastructure provider for the vast majority of its cloud workloads; Expedia, Intuit, the National Football League (NFL), Capital One, DigitalGlobe, and Cerner announced they’ve chosen AWS for machine learning and artificial intelligence; and Bristol-Myers Squibb, Honeywell, Experian, FICO, Insitu, LexisNexis, Sysco, Discovery Communications, Dow Jones, and Ubisoft kicked off major new moves to AWS
  • AWS continues to accelerate its pace of innovation with the release of 497 significant new services and features in the fourth quarter, bringing the total number of launches in 2017 to 1,430.

 

Those are but a few of the three-plus pages of highlights contained in the December quarter’s earnings press release. These and others show Amazon continues to expand its reach, laying the groundwork for further profitable growth in the coming quarters.

In characteristic fashion, Amazon issued revenue guidance for the current quarter that was in line with expectations – $47.75 – $48.7 billion – that equates to year over year growth between 34%-42%. Per usual, the company also issued it “you could drive a truck through it” operating income forecast calling for $0.3-$1.0 billion for the quarter.

  • We are boosting our price target on Amazon (AMZN) shares to $1,750 from $1,400 and we continue to view them as ones to own for the long-term as the company continues to disrupt the retail industry and is poised to make inroads into others.

 

Alphabet/Google

Rounding out yesterday’s earnings blitzkrieg, was Alphabet, which delivered yet another 20% plus increase in revenue for the December quarter. The performance bested Wall Street expectations, but the company’s bottom line disappointed and missed the consensus by $0.37 per share.

For the record, Alphabet reported December quarter EPS of $9.70 vs. the expected $10.07 on revenue of $32.32 billion. At 85% of overall revenue for the quarter, advertising remains the core focus of revenue. Year over year in the quarter, the company’s advertising revenue rose 22% with growth compared to the year ago quarter also had at its Network Members’ properties and other revenue segments.

The difference between the company’s top line beat and bottom line miss can be traced primarily to its Traffic Acquisition Costs (TAC) — the fees it pays to partner websites that run Google ads or services. Those fees climbed 33% year over year to resemble 24% of advertising revenue vs. 22% in the December 2016 quarter. The continued rise in TAC reflects the ongoing shift in the company’s mix toward mobile, which makes the increase not a surprising one as mobile search and content consumption continues to grow faster than desktop.

On a positive note, the company prudently managed operating expenses, which accounted for 26.6% of revenue in the quarter down from 27% a year ago. The net effect led Alphabet’s overall operating margin for the quarter to slip to 24% from 25% in the December 2016 quarter.

Outside of the core advertising business, the company continues to make progress on its other initiatives better known as Google Other, which includes cloud, its Pixel phones and Google Play. On the earnings call, the management team called out that Google Cloud has surpassed $1 billion, a notable achievement but to be fair the company lags considerably behind Amazon in the space. That said, ongoing cloud adoption leaves ample room for future growth in the coming quarters.

Turning to the company’s Other Bets segment, which houses its autonomous vehicle business Waymo, Google Fiber, home security and automation business Nest and its Verily life sciences business units, it continues to be a drag on overall profits given the operating loss of $916 million on revenue of $409 million. The positive to be had is the unit’s revenue climbed 56% year over year and size of the operating drag compressed 16% vs. the year-ago quarter and was less than $940 million it was Wall Street expected it to be. We see that as progress given the less than mature nature of the businesses housed in Other Bets. As they mature further, we expect them to be less of a drag on overall profits with several of them potentially adding to the valuation argument to be had for the shares as they become a more meaningful piece of the overall revenue mix.

On the housekeeping front, the company’s Board authorized the repurchase up to an additional $8.6 billion of its Class C capital stock. With more than $101 billion on the balance sheet in cash and equivalents exiting 2017 the company has ample funds to opportunistically repurchase shares.

  • The net impact of Alphabet’s bottom line miss looks to have the shares open lower this morning, which when paired with our new $1,300 price target (up from $1,150) offers some 15% upside to be had. That along with our view the company’s search and advertising businesses make it a core holding even as it grapples with the transition to mobile from desktop.