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WEEKLY ISSUE: The Impact of Tariffs and Continued Rundown of Select Positions

WEEKLY ISSUE: The Impact of Tariffs and Continued Rundown of Select Positions

 

Our Latest Thoughts on Trump Tariffs

The stock market roller coaster of the last few weeks is clearly continuing. This week we have President Trump’s potential steel and aluminum tariffs take center stage, shifting the attention away from Fed Chief Jerome Powell last week. When I shared with you my view the market would trade data point to data point until the end of the Fed’s Mar. 20-21 monetary policy meeting, I certainly didn’t expect let alone anticipate these tariffs and their escalating conversation to be a part of it. In a post earlier this week, I shared my view that Trump is once again utilizing the negotiating strategy he laid out in his book, Art of the Deal. In another one today, I gamed out what is likely to happen should Trump go forward with the tariffs.

Last night’s resignation of Trump economic advisor Gary Cohn has certainly fanned the flames of uncertainty over the tariffs, with more people thinking that Trump is “serious.” In an effort to counterbalance that resignation, this morning Commerce Secretary Wilbur Ross shared that Trump “has indicated a degree of flexibility on tariffs for Canada and Mexico.” That Cohn-related walk-back by Secretary Ross, combined with comments made yesterday by Treasury Secretary Steven Mnuchin that indicated that “once a new NAFTA deal is reached, the trading partners wouldn’t be subject to the tariffs” confirms my view that Trump remains on the Art of the Deal negotiation path.

In my post earlier this morning about the tariffs, I shared that we will likely see choppy waters as this issue comes to a resolution and leads up to the Fed’s next monetary policy meeting conclusion on March 21. Expect volatility to remain in place and the coming economic data will either amplify or quell its magnitude. Barring any breaking news, I’ll be on The Intelligence Report with Trish Regan on FOX Business to discuss all of this at 2 PM ET today.

While many fret over the market swings, my perspective is that the domestic economy remains on firm footing and barring a trade war volatility will allow us to pick up thematically well-positioned companies at better prices. A great example of this was had earlier this week with the February heavy truck orders that served to confirm my thesis behind Paccar (PCAR) shares.

When Costco Wholesale (COST) reports its quarterly results after the market close, we should see similar confirmation in the form of not only wallet share gains via its top line results, but also in rising membership fees as more consumers look to stretch the disposable income they do have, a key component of our Cash-Strapped Consumers investment theme.

To set the stage for Costco’s report tonight, consensus expectations for the quarter sit at EPS of $1.46 on revenue of $32.7 billion, up from $1.17 and $29.8 billion in the year-ago quarter. As a reminder, one of the key differentiators for Costco is the high margin membership fees that are poised to grow as the company continues to open new warehouses. This means, at least for me, that roadmap, will be one of the areas of focus on the company’s post-earnings conference call. I’ll also be listening to see the impact of tax reform on the company’s outlook for 2018.

  • Our price target on Paccar (PCAR) shares remains $85.
  • Our price target on Costco Wholesale (COST) shares remains $200.

 

 

Getting back to the Tematica Investing Select List

In last week’s issue, I began sharing some much-needed updates across the Select List, and I’m back at it again this week with a few more. Over the next few weeks, I’ll look to round out the list before we break at the end of March and get ready to gear up for 1Q 2108 earnings season.

Yes… I know… before too long it will once again be time for that zaniness.

All the more important to share these updates with you so we set the table for the earnings meal to be had.

 

Amazon (AMZN),  Connected Society

Simply put, Amazon shares have been a champ so far in 2018 rising more than 30%, which brings the return on the Select List to more than 100% since being added back in 2016. I’ve said these shares are ones to own, not trade given the accelerating shift to digital commerce, and growing adoption of the high margin, secret sauce that is Amazon Web Services as more businesses turn to the cloud. As filled with creative destruction as those two businesses are, it looks like Amazon is poised to offer further disruption in the healthcare and financial services business given conversations with JPMorgan (JPM), Berkshire Hathaway (BRK.A), Capital One (COF) and others.

I’ve raised our price target several times on AMZN shares, and it increasingly looks like that will have to happen again and then some depending on how soon these new layers of disruption materialize.

  • Our price target on Amazon (AMZN) shares remains $1,750.

 

Starbucks (SBUX), Guilty Pleasure

Year to date, Starbucks shares are essentially unchanged compared to where they were trading as we exited 2017. And the same is true if we look at the shares over the last year – they are up modestly. What we are dealing with here is a company that is once again in transition as it looks to invigorate its domestic business while growing its presence in still underserved markets outside the US like China and Italy. One of the central strategies in both areas is to leverage its high-end Reserve Roastery concept, which keeps the company very much in tune with our Guilty Pleasure investing theme.

Historically speaking, Starbucks has been a company that has been able to successfully pivot its business when it has stumbled, and in our view, that merits some patience with the shares. Helping fuel that patience is the knowledge that Starbucks intends to return $15 billion to shareholders over the next three years in the form of dividends and buybacks.

  • Our price target on Starbucks (SBUX) shares remains $68

 

Disney (DIS), Content is King

Disney shares have traded off some 3% thus far in 2018, which is not unsurprising given we are in the seasonally weakest part of the year for the company. That said, the latest Marvel film, The Black Panther, is crushing it at the box office and ups the ante for the next Avengers film that will hit theaters in a few months. Disney continues to leverage these and other characters as it revamps its theme parks and hotels, which should drive attendance despite yet another round of price increases.

The big “wait and see” for Disney over the coming months will be its move into its own streaming services for both ESPN and eventually a Disney content-centric service. While I see this as Disney making the right moves to address the chord cutting headwind that is part of our Connected Society investing theme, to paraphrase the great film Bull Durham, just because Disney builds it doesn’t mean people will stream it. In a positive move, Disney installed James Pitaro as the new president of ESPN. Mr. Pitaro’s background as chairman of Disney Consumer Products and Interactive Media, as well as the head of Yahoo! Media, sends investors the signal that getting the streaming services in place will be a top priority going forward for ESPN.

The next catalyst to be had for Disney will be spring break and then the summer movie season. Between now and then, I expect Disney will continue to put its massive buyback program to work.

  • Our price target on Disney (DIS) shares remains $125

 

United Parcel Service, Connected Society

Our UPS shares were hard hit earlier in the year given renewed concerns that Amazon would expand its own logistics offering. At the time, my view was this was an overblown concern, and it still is. This week, we saw Stifel Nicolaus warm up to the shares, upping them to a Buy rating with a $121 price target given what it sees as a “strong underlying package and freight businesses.”

Each month in the Retail Sales report we see the share gains had at non-store retailers, and we know companies ranging from Costco and Walmart (WMT) to Nike (NKE) and many others are embracing the Direct to Consumer (D2C) business model. All of this bodes well for UPS shares over the coming year.

The one potential hiccup to watch will be negotiations with the Teamsters Union this summer. If that brings the shares near or below our Select List entry point, I’ll look to scale into this position ahead of the seasonally strong second half of the year.

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

 

 

Heavy truck orders surge in February

Heavy truck orders surge in February

Despite the recent sell-off in Paccar (PCAR) shares, I remain bullish on the shares of this heavy and medium duty truck company given the February industry order data. Early today it was reported that North American orders for Class 8 semi-trucks jumped more than 76% in February as trucking companies are looking to address tight industry capacity that is leading to escalating freight costs. In the December quarter earnings season, we’ve heard many a company report rising freight costs would take a bite out of profits and bottom line earnings. It was that pain point that prompted me to add PCAR shares to the Tematica Investing Select List, and the February data points to higher production levels and better financial results ahead for Paccar.

Preliminary orders in the United States, Canada, and Mexico for the heavy-duty trucks, better known in the industry as Class 8 trucks, hit 40,200 trucks, up from 22,886 in February 2017 according to FTR. The quick perspective is this is the second consecutive month in some time that orders exceeded 40,000 units. As I noted when we added PCAR shares to the Select List, heavy truck orders had been on the rise in 4Q 2017. That led full-year 2017 orders for Class 8 trucks to come in at 290,000 units compared with 164,000 in 2016. I suspect some attributed the sharp rise primarily to pull forward ahead of the federal mandate for the electronic logs (ELDs) from paper logs, which went into effect in December, rather than the truck shortage.

With truck orders continuing to surge in 2018, investors have a clearer view of underlying truck demand and it continues to look bright.

  • We continue to have a Buy rating on Paccar (PCAR) shares and our price target for this Economic Acceleration/Deceleration position on the Select List remains $85.

 

WEEKLY ISSUE: The Change in Investor Sentiment and Its Impact on the Select List

WEEKLY ISSUE: The Change in Investor Sentiment and Its Impact on the Select List

 

Later today we will close the books on February 2018 and thus the first two months of the year as well. As we here at Tematica have recounted across our various writings here at Tematica Investing, the Weekly Wrap and the Monday Morning Kickoff as well as our Cocktail Investing Podcast, we’ve seen quite a change in sentiment over the last several weeks as the conversation over the speed of the economy, the tone of inflation and what the Fed may do has taken center stage.

Over the weekend, legendary investor Warren Buffett once again offered some sage advice in his annual letter to Berkshire Hathaway (BRK.A) shareholders. Among the annual learnings offered up from the “Oracle of Omaha”, Buffett talked about the outperformance to be had by being an investor as opposed to a trader and thinking of investments as “interests in businesses, not as ticker symbols.” I could not agree more, but then again that speaks to how I use Tematica’s investment themes to identify well-positioned companies. When it comes to Buffett, he’s not exactly bad company to be lumped into.

In the same shareholder letter, we see how this investing style has led Buffett to outperform the S&P 500 over the long-term. While I would not be so bold to say we are in that same camp, I think we can all agree that we’ve seen the outsized returns that are possible when investing from a thematic perspective. In the coming review of the Tematica Investing Select List, I’ll highlight some of those returns as well as share some of my current thoughts on its holdings.

Rather than inundate you with pages and pages of updates here today, I’m splitting the overall update into two parts. Those companies that don’t appear in today’s issue, such as Amazon (AMZN), Apple (AAPL) and a few others, will be covered in the next weekly edition of Tematica Investing… here we go

 

Applied Materials (AMAT) Disruptive Technologies

Since being added to the Select List, just about a year ago, AMAT shares have risen 60% in that time — one of the strongest performers on the Select List. Both its business and share price have benefitted from the rising demand for chips, which has led to the current upcycle in spending on semiconductor capital equipment. 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 and virtual reality, are all 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.

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 has led 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.

All the while Applied’s Display business continues to benefit from larger format TVs as well as the ramp in organic light emitting diode display capacity. These drivers have led Applied to forecast more than 30% growth at its Display business in 2018, which follows nearly 60% growth in 2017.  As if that wasn’t enough, Applied recently upsized its quarterly dividend to $0.20 per share from $0.10, and increased its stock buyback programs by adding another $6 billion on top of the remaining $2.8 billion under its existing authorization. All in all, this makes for a compelling case when it comes to owning AMAT shares.

  • Our price target on AMAT remains $70.

 

Costco Wholesale (COST) Cash-Strapped Consumer

The decision to first add and then scale into COST share between last June and September has certainly paid off as the shares are up more than 19% on a consolidated basis. With each monthly same-store sales report, Costco shows it continues to thwart not only Amazon, but its business continues to garner consumer wallet share, outperforming grocery and other retailers in the process. The long and short of it is I see Costco thriving as consumers look to stretch their increasingly under-pressure disposable income, while other bricks-and-mortar retailers struggle.

We will look to assess the impact of tax reform on the Costco’s business and what that means for EPS estimates and our price target when Costco next reports its quarterly results on Mar. 7. I also expect the company to share offer a rich update on its e-commerce initiatives as well as its roadmap for new warehouse openings in 2018. As a reminder, the membership fee revenue stream is extremely profitable for Costco.

  • Our Price target on COST remains $200.

 

ETFMG Prime Cyber Security ETF (HACK) Safety & Security

It’s been almost a year since we added shares in this cybersecurity-focused ETF to the Select List and they are up just shy of 20%. With cyber-attacks becoming the next theater of warfare in the 21stcentury, I continue to favor the diverse approach to be had with holding HACK shares over owning just one or two cyber security companies. If you missed the overview on our Safety & Security investment theme published in a recent cyber security special report published by The Washington Times, you can find it here.

  • With cyber threats poised to continue in 2018 and beyond, and the Internet of Things offering a target rich environment, I am boosting my HACK price target to $40 from $35.

 

LSI Industries (LYTS) Economic Acceleration/Deceleration

Since adding shares of this non-residential construction-related company to the Select List this past September, the shares have climbed more than 21%, even after yesterday’s post Powell market sell off. While we wait for more on President Trump’s rebuilding U.S. infrastructure framework to trickle out, the next known catalyst for LYTS shares will be the January Construction Spending report from the Census Bureau that will be published later this week. Looking at the Architectural Billings Index (ABI), Architecture firms started 2018 on a positive note as AIA’s index rose to 54.7, its highest January score since 2007. I see the ABI as a leading indicator of building activity and view the uptick as very positive for LYTS.

  • My price target on LYTS remains $11.

 

On a side note, for those wondering why we’ve held off bringing DY shares back onto the Select List, you have no further to look than the December and January New Home Sales figures that fell roughly 7.5% each due to the impact of winter weather. As we put the impact of that weather behind us, including having it factored into Dycom’s quarterly results and its share price, we’ll revisit this soft circled stock.

 

McCormick & Co. (MKC) Rise & Fall of the Middle Class

I remain upbeat on MKC shares, despite no new developments in recent weeks following the favorable data found in the January Retail Sales Report. That data showed food-and-beverage retail sales at grocery stores climbing 4.5% year over year vs. falling same-store sales and traffic in January reported by the National Restaurant Association. While McCormick is heading into its seasonally slow time of year, I remain bullish as consumers look for healthier eating alternatives without sacrificing flavor. This week I’ll be looking to incorporate comments from food and restaurants from Dean Foods (DF), B&G Foods (BGS), Papa John’s (PAPA), Habit Restaurants (HABT) and others as well as the coming economic data into my McCormick tapestry.

  • Thus far in 2018, MKC shares are up some 5%, and as we soon enter the spring eating season I’ll look to review my current $110 price target.

 

MGM Resorts (MGM) Guilty Pleasure

Following a good quarterly report, an upbeat outlook offered by the management team and a 9% hike in the quarterly dividend, shares of this gaming-and- hospitality have moved modestly higher during what is a seasonally slow time of year for the gaming industry. On the earnings call, management shared that it is expects a “strong year” based on the trends it is seeing in both Las Vegas and Macau quarter to date due partly to the recent opening of MGM Macau Cotai as well as the separation this year between the Super Bowl and Chinese New Year. Bolstering that outlook, MGM has a rich line-up of entertainment over the coming months that should draw people to its hotels, restaurants and of course its casinos. For us, we’ll look for confirmation in the monthly gaming data to be had.

  • My price target for MGM shares sits at $39.

 

Nokia (NOK)  Asset-Lite

As the conversation surrounding 5G mobile network deployments has heated up, our shares of Nokia have climbed more than 25% thus far in 2018. That move has brought our overall position in Nokia shares well into the black. This week in particular, 5G is a focal point of the Mobile World Congress 2018 conference and we’ve already learned that T-Mobile USA (TMUS) will build out 5G coverage in 30 cities this year while Spring (S) shared the first five cities for its 5G network that will arrive in 2019.

I see the higher margin Nokia Technologies being well positioned to expand its licensing customer base as 5G networks move mobile connectivity beyond today’s smartphone-centric market into the connected home, connected car, wearables, and the industrial internet — in other words, the Internet of Things. In addition to Mobile World Congress this week, we’ll also be listening to specialty contractor Dycom’s (DY) earnings call for incremental details on the 5G network buildout from its customer base that includes AT&T (T) and Verizon Wireless (VZ).

  • My NOK price target remains $8.50.

 

Paccar (PCAR)   Economic Acceleration/Deceleration

We recently added shares of this heavy-duty and medium-duty truck manufacturer to capitalize on the growing pain point of rising freight costs due to a national truck shortage at a time when the domestic economy is on firmer footing. I’d also note this truck shortage comes amid that secular shift toward digital shopping, which in my view is not going to slow down and will likely exacerbate the shortage in the near-term.

My thesis on PCAR was recently supported by favorable commentary on the heavy-duty truck market from Daimler AG, a competitor to Paccar. ACT Research currently forecasts U.S. Class 8 (heavy-duty truck) retail sales to be 247,000 units in 2018, up from just under 200,000 in 2017, and solid growth in medium-duty trucks as well. Our $85 price target equates to just under 16x estimated 2018 EPS. In terms of signposts for this Buy-rated position, I’ll be watching monthly heavy-duty truck data as well as tonnage stats and manufacturing industrial production numbers.

  • My price target on PCAR shares remains $85.

 

Rockwell Automation (ROK)    Tooling & Re-Tooling

Early this month we added shares of Rockwell Automation (ROK) to the Tematica Investing Select List as part of our Tooling & Re-tooling investment theme with a $235 price target. Rockwell is a leader in industrial automation and information products that serve a wide variety of industries ranging from automotive, textiles, food & beverage, infrastructure, personal care, oil & gas, and life sciences to power generation, semiconductor and other industries.

This earnings season we’ve started to hear from companies, like Boeing (BA) that are boosting capital spending plans and investing in product development as well as its factories. Based on these prospects as well as statistics for private fixed assets that reveal the average age of US factory stock is near 60 years old, the Association For Manufacturing Technology forecast U.S. orders of manufacturing equipment to rise 12% in 2018 up from an annual rate of 9% it forecasted this past November. Given the tax code changes that for the next five years allow companies to immediately deduct the entire cost of equipment purchases compared to writing off only a portion of the cost in a single year, odds are this upgrade and expansion spending will span more than just 2018.

  • My price target remains $235.

 

United Parcel Service (UPS)  Connected Society

When we added UPS shares to the Select List just over a year ago, my view was they were a “second derivative” play on the accelerating of digital shopping. Over the last year, we have seen continued gains in that shift due in part to Amazon branching out into new categories (apparel, lingerie, furniture, and X to name a few), but also as other retailers, like Walmart (WMT), have looked to position themselves where customers.

We see no slowdown in that shift, and while we continue to hear chatter over Amazon developing its own truck fleet, given the size and scope of its network, it will be a long time and quite a capital expense to scratch the surface of that network. If they do, it will be a positive for our PCAR shares. On the housekeeping front with UPS, we sold half the position in early January netting a 22% return.

  • My long-term price target for UPS shares remains $130.

 

Universal Display (OLED)   Disruptive Technologies

Yesterday, we used the sharp pullback in OLED shares to add to our position given our view that we are still in the very early innings of this technology being adopted across a growing number of applications.

  • Our price target remains $225, which keeps OLED shares a Buy.

 

Of course, there were some exits . . .

Also, during the first two months of the year, we were stopped out of both AXT Inc. (AXTI) and USA Technologies (USAT) shares which generated returns of roughly 27% and 66%, respectively. Not too shabby, but all the more impressive when we consider both were added last April, so bear in mind those returns were generated over the span of 9-10 months and handily beat the return had by the major market indices over the respective time frames. Another proof point that thematic investing trumps sector investing… as if we needed yet another reminder.

 

 

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.

 

 

 

WEEKLY ISSUE: Volatility is back and will be with us for at least the next several weeks

WEEKLY ISSUE: Volatility is back and will be with us for at least the next several weeks

 

Even though it was a holiday, on Monday, I shared my view on what will be moving and shaking the stock market this week as well as what earnings we have on tap this week from the Tematica Investing Select List. We’re also just over half way through the current quarter and by this time next week, we’ll be getting ready to shut the books of February. That means we’ll have two of the three months in 1Q 2018 behind us. It also means the coming weeks will bring us a smattering of February data that will help us get a better measure on the vector and velocity of the domestic as well as global economy. That data will set the stage as well as expectations for the Fed’s next FOMC meeting to be held on Mar. 20-21.

As I’ve said on recent episodes of our Cocktail Investing Podcast, while the stock market is watching inflation data ahead of the next FOMC meeting in the hopes of gauging the Fed’s upcoming economic and potential policy update. In my view, the event the stock market is really looking forward to is the updated outlooks to be had on Mar. 21. Not only will this include the Fed’s latest thinking on the speed of the economy and inflation outlook, but it will also be the first commentary offered by new Fed Chairman Jerome Powell. Many have cited Powell’s tendency to vote alongside now former Fed chair Janet Yellen, but now Powell is in the Fed hot seat, and many, including us here at Tematica, are anxious to see if he remains as dovish as many suspect.

The bottom line is over the next four weeks or so all eyes will be puzzling out the data to be had. That likely means the stock market will pivot and roll based on the latest data point similar to what we saw between the January Employment Report and the January CPI Report. Said another way, volatility is back and will be with us at least for the next several weeks. As I’ve said before, volatility is not a bad thing – it can offer us an opportunity if we’re prepared, and given our Contender List, I would argue that we are just that.

In next week’s Tematica Investing, I’ll have a short update on each of the current Tematica Investing Select List positions. Ahead of those myriad updates, here is one for MGM Resorts (MGM), which reported quarterly earnings yesterday, as well as some thoughts on Walmart (WMT) as we add it to the Contender List. Speaking of the Contender List, I review the news on Rite Aid (RAD) shares as well. In the next few days, I’ll be providing a deep dive on engine company Cummins Inc. (CMI). Will it make the Select List or just be a Contender? My take later this week.

 

December quarter results for MGM Resorts (MGM)

Yesterday, Guilty Pleasurecompany MGM Resorts (MGM)reported December quarter results that beat on the top line but missed on the bottom line after adjusting for a non-recurring, non-cash income tax benefit of $2.52 due to the enactment of U.S. Tax Reform at the end of 2017. Excluding that benefit, the company’s bottom line fell well short of the expected $0.08 per share in earnings for the December quarter and the $0.04 achieved in the year-ago quarter. To help take the sting out of that miss, MGM’s Board approved a 9% increase in the quarterly dividend to $0.12 per share from $0.11. In addition to that good news, the company’s earnings press release had a less than subtle reminder that it has $672.5 million remaining under its current stock repurchase authorization. At the current share price, that would equate to more than 19 million MGM shares or 3%-3.5% of the company’s total outstanding shares.

In parsing the earnings release, we can see lower year over year vacancy rates in Las Vegas, which we attribute to recent shooting, as well as higher expenses, which reflect the opening and refurbishment activities during the quarter. While these were expected, the magnitude appears to be more than Wall Street was thinking even though on the earnings conference call MGM management shared the December quarter came in better than was internally expected back in October following the shooting.

That was the all contained in the earnings press release, but what was had on the follow-up earnings conference call, well that was something different. On that call, management shared that based on what it is seeing quarter to date both in Macau and Las Vegas it is expecting a “strong year” due in part to the recent opening of MGM Macau Cotai as well as the separation this year between the Super Bowl and Chinese New Year. Moving past the current quarter, MGM has a solid line up of entertainment and sporting events that should continue to be a draw to the company’s hotels, restaurants and casinos. Some of the headline entertainment in the coming months include Cher, Ricky Martin, Kevin Hart, Paul Simon, Justin Timberlake and Bon Jovi among others. In my view, this paints the picture of moving past the seasonally slow part of the year, but I’ll be looking for confirmation of the monthly gaming data for Nevada and Macau.

Shifting gears, based on the commentary surrounding the Tax Act, I suspect we will see EPS estimates rising, some for 2018 but more for 2019 and beyond given the changes to the company’s estimated effective tax rate. On the earnings call, MGM shared it sees the effective tax rate for 2018 landing in the low to mid 20%s and falling to the mid-to-high teens for 2019 and beyond. That upward move in EPS, combined with the 9% increase in the company’s quarterly dividend, supports our increasing our price target on MGM shares to $39 from $37.

As we’ve discussed previously, one potential new market for gaming is Japan and per MGM that topic should come to a boil mid-year when the Japanese government is expected to tackle the gaming bill. Given its presence in Macau, we see MGM as well positioned to capture wallet share if and when Japan opens its borders to the gaming industry. I’ll continue to monitor this development and what it means for this Guilty Pleasure company on the Tematic Investing Select List.

  • We are boosting our price target on the shares of MGM Resorts to $39 from $37. Our recommendation is subscribers be more active buyers below $33.50.

 

Adding Walmart to the Tematica Investing Contender List

Also, yesterday, increasingly omnichannel retailer Walmart (WMT) reported December quarter earnings that missed expectations, with the company clearly signaling that it will continue to invest in its ongoing transformation. Those investments along with higher freight costs, which I see as a resounding positive for the recently added PACCAR (PCAR) shares to the Tematica Investing Select List, hit Walmart’s margins in the December quarter and are expected to do so in the coming months as well.

Adding insult to injury, Wall Street didn’t like that Walmart’s digital sales rose just 23% year over year in the December quarter. The criticism is it was a sharp slowdown from the 50% growth rates in the prior quarter, but let’s remember the December 2017 quarter saw the anniversary of Walmart’s JET.com acquisition. We also know that other companies, like United Parcel Service (UPS)were overwhelmed by the shift to digital commerce from brick & mortar sales this past holiday shopping season. I suspect the same was true from Walmart.

Also catching investors off guard, Walmart is now shifting to annual guidance and shared it see the current year coming in at $4.75-$5.00, well below the consensus of $5.08 per share that Wall Street was modeling. That miss, which was somewhat softened by the 45thhike to Walmart’s annual dividend to $2.08 per share from the prior $2.04 per share, led WMT shares to have one of their worst days since January 1988 as they fell more than 10%.

Several times before, I’ve shared my view that Walmart alongside current Tematica Investing Select List residents Amazon (AMZN)and Costco (COST)is likely to be one of the three major retailers to be had amid the current brick & mortar shake-up. While Walmart’s margins are being hit today, I see the company following a similar path taken by Amazon in 2015-2016 as it invested for the Connected Society tailwind it, and we, saw coming. Over the coming weeks, I’ll be digging more into Walmart’s business as well as determining the potential upside to be had in the shares over the coming 12-24 months as it realizes the benefits of investments made in the near-to-medium term. As such we are placing WMT shares on the Tematica Investing Contender List.

  • We are adding Walmart (WMT) shares to the Tematica Investing Contender List.
  • Our price target on Amazon (AMZN) shares remains $1,750.

 

Contender List Rite-Aid catches a bid from Albertsons

Yesterday, The Wall StreetJournal is reporting that privately held grocery chain Albertson’s “plans to buy the rest of Rite Aid Corp. (RAD) that isn’t being sold to Walgreens Boots Alliance (WBA).” When I added RAD shares to the Contender List in January, I labeled the company a turnaround story, and while that likely remains the case – how much progress could even a stellar management team make in five weeks? – the reality is we are seeing both grocery as well as pharmacy companies scramble in the wake of Amazon.

While details on the proposed transaction are scant, per the Journal, the cited transaction would lead to Albertsons, which already owns Safeway and 19 other supermarket chains, holding “roughly 71% of the combined company, while Rite Aid investors would own the rest.” Now, this is where things get interesting, following completion of the merger, Albertsons Companies shares are expected to trade on the New York Stock Exchange.

The combined company will operate approximately 4,900 locations across under 20 well-known banners including Albertsons, Safeway, Vons, Jewel-Osco, Shaw’s, Acme, Tom Thumb, Randalls, United Supermarkets, Pavilions, Star Market, Haggen and Carrs, as well as meal kit company Plated. In addition, the new Albertsons will have, 4,350 pharmacy counters, and 320 clinics across 38 states and Washington, D.C., with its full complement of locations serving 40+ million customers per week.

On a pro forma basis, during its first year, the combined company is expected to generate revenue of approximately $83 billion and adjusted EBITDA of approximately $3.7 billion, which bakes in run-rate cost synergies to be had. As one might expect, the transaction has been approved unanimously by the boards of directors of both companies, and the merger is expected to close early in the second half of the calendar year 2018.

From my perspective, this combination is a response to the impact Amazon is having on the grocery industry as well as over the counter health products with companies such as Albertson’s looking to tap into the tailwind of our Aging of the Population theme. Much like with Costco Wholesale (COST)and McCormick & Co. (MKC), we see Albertson’s line of grocery stores as well positioned for the increasingly debt-laden Cash-strapped Consumers that are shifting to eating at home and embrace our Food with Integrity theme when and where possible. We saw proof of this shift in the January Retail Sales Report that showed food-and-beverage retail sales at grocery stores climbing 4.5% year over year vs. falling same-store sales and traffic in January reported by the National Restaurant Association.

As we approach the closing of the merger between these two companies and more details become available, I’ll look to be the new company through its paces to see if it deserves an update to Select List… or not.

  • Our price target on Costco Wholesale (COST) remains $200.
  • Our price target on McCormick & Co (MKC) remains $110.

 

A reminder on Universal Display’s earnings report

After tomorrow’s market close, Disruptive Technologies investment theme company Universal Display (OLED) will report its December quarterly results. I 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 I’ve heard from Applied Materials (AMAT)as well as developments over organic light emitting diode TVs and other devices at CES 2018, I also expect Universal will offer a positive outlook for the current as well as coming quarters.

  • Our price target on OLED shares remains $225.

 

 

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.

 

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

TRADE ALERT: Freight pain leads to this Economic Acceleration/Deceleration addition

TRADE ALERT: Freight pain leads to this Economic Acceleration/Deceleration addition

 

KEY POINTS FROM THIS ALERT:

  • We are issuing a Buy on truck company Paccar (PCAR) with an $85 price target as part of our Economic Acceleration/Deceleration investment theme.

With the market’s volatility over the last several days, a number of stocks are revisiting levels that are 5%, 10%, 15% lower than they stood at end of January. And while investors have been thunderstruck by the market gyrations, the day to day data from the December quarter earnings season as well as recent economic data, has continued to confirm certain opportunities. One of the recurring drum beats this earnings season has been companies ranging from Tyson Foods (TSN, Hershey (HSY), Packaging Corp. of America (PKG), Sysco (SYY) and J.M. Smucker (SJM) to Tractor Supply (TSCO) and Prestige Brands (PBH) talking about rising freight costs and the impact on earnings.

One of the culprits is the national shortage in available trucks, which has sent shipping costs soaring, with retailers and manufacturers in some cases paying over 30% above typical rates to book last-minute transportation for cargo. This, of course, goes hand in hand with the accelerating shift toward digital commerce that we talk about, a shift that led Amazon to correctly assess back in 2013 that as more shoppers bought products online, “parcel volume was growing too rapidly for existing carriers to handle.” As that shift to digital commerce has happened, we’ve seen that forward-looking view come to play out, and odds are it’s only going to get worse. According to Statista, e-commerce sales accounted for 9.1% of total U.S. retail sales in 3Q 2017, but we see that only growing further. In South Korea, e-commerce represented 18% of all retail sales in 2016 with forecasts calling for that percentage to reach 31% by 2021. We may not reach such a level for years to come, but each percentage point that e-commerce gains, means more product that needs to be shipped from a warehouse to the buyer.

Historically, the trucking industry has been associated with the economic cycle. When the economy is growing, more goods (parts, subassemblies, products) need to be shipped to customers at factories, distribution sites, warehouses and so on. According to the American Trucking Association, the trucking industry accounts for 70.6% of tonnage carried by all modes of domestic freight transportation, including manufactured and retail goods. This has made freight traffic a good barometer of the economy, and the December year over year increase of 7.2% in the Cass Shipments Index capped off a year in which the ATA’s truck tonnage index rose 3.7%, the strongest annual gain since 2013.

 


As truck tonnage climbed in late 2016 and 2017, industry capacity has been tightening after tepid tonnage in most of 2015 and the first half of 2016 leading to the robust jump in freight costs we described above. This data point from DAT Solutions puts in all into perspective – “there were about 10 loads waiting to be moved for every available truck in the week ending Jan. 20, compared with three in the same week last year…”

 

As freight costs climbed in the back half of 2017, so too did heavy truck orders, which have continued to climb into 2018. According to ACT Research, December 2017, which saw a 76% increase in truck order volume was the best month for orders since December 2014. In full, due to the year-end surge, 2017 saw truck orders hit 290,000 units, up 60% year over year. That strength continued into January with monthly truck orders hitting some 47,000 units, the highest level since 2006.

 

 

This data is not surprising, given that for the first three weeks of January, national average spot truckload rates were higher than during the peak season in 2017, according to DAT. January was also the fourth consecutive month in which truck orders were above the 30,000 mark. Initial heavy truck forecasts put orders near 300,000 for 2018, however tight industry capacity combined with companies that are benefitting from tax reform and looking to replace older, less fuel-efficient trucks, we could see that some lift to that forecast in the coming months.

But that’s heavy truck orders, and while four months above 30,000 paves the way for a pick-up in business, the real question to focus on is heavy truck retail sales. Heavy truck, otherwise known in the industry as class 8 trucks, industry retail sales were 218,000 units in 2017, compared to 216,000 vehicles sold in 2016, with forecasts calling for 235,000-265,000 trucks to be sold in the U.S. and Canada during 2018.

Looking outside the U.S. and Canada, the data shows an improving European economy and that should give way to a favorable truck market there as well. European truck industry sales above 16-tonnes were a robust 306,000 trucks in 2017, and It is estimated that European truck industry sales in that category will be in the range of 290,000 to 320,000 trucks in 2018.

 

Paccar – more than a leading heavy truck company

And that brings us to Paccar (PCAR), whose shares have fallen some 15% as the domestic stock market moved sharply lower over the last two weeks. The company is an assembler of heavy-duty trucks, with an estimated market share near 31% in the U.S. and Canada, as well as medium duty trucks (think the kind you see being driven locally by United Parcel Services (UPS) and FedEx (FDX)). That business drove 53% of its truck deliveries in 2017, with the balance coming from Europe (36%) and other markets (11%). As truck retail sales improve in the U.S., Canada and Europe, even absent additional share gains, Paccar’s truck business in terms of revenues and profits should see a nice lift.

The improving truck market also bodes well for Paccar’s high margin truck financing business – while it generated just 6.5% of total revenue in 2017 with operating margins that are more than double the truck business, it accounted for 12% of overall operating profits.

The third leg to the Paccar stool is its Parts business (20% of 2017 revenue, 28% of 2017 operating profit), which stands to benefit from the time lag between truck orders and sales in a capacity constrained industry, where up-time for existing equipment will be crucial.

Given the industry dynamics and Paccar’s position, we are seeing revenue and earnings expectations move higher in recent weeks, with the current consensus calling for EPS of $5.34 this year up from $4.26 in 2017 on a 13% revenue increase to $20.6 billion. With the company only recently sharing its 2018 tax rate will be 23%-25% vs. 31% in 2017, we could see the 2018 consensus move higher in the coming weeks.

As mentioned above, Paccar’s share price has fallen some 15% in the last two weeks, which in our view makes the shares rather compelling given our $85 price target. That target equates to just under 16x 2018 EPS. Over the prior seven years, PCAR shares have bottomed at an average P/E of 12.2x, which derives a downside target of $67.65 based on current 2018 EPS expectations. On the upside, the average peak multiple over those same years of just over 17x hints at a potential price target near $95. Looking at a dividend yield valuation, we see upside vs. downside of $82 vs. $60.

As we add the shares, we’ll split the difference with an $85 price target, and we’ll look to aggressively scale into the shares should the market come under further pressure and drag PCAR shares closer to $60. In terms of sign posts to watch for the shares in the coming days and weeks, monthly heavy truck data as well as tonnage stats and manufacturing industrial production data is what we’ll be watching. As the current earnings season winds on, we’ll be focusing on the results and outlook from Rush Enterprises (RUSHA), which owns the largest network of commercial dealerships in the U.S., with more than 100 dealerships in 21 states.

 

The bottom line for this alert today:

  • On Monday morning we are adding Paccar (PCAR) shares to the Tematica Investing Select List.
  • Our price target for PCAR shares is $85, nearly 26% above where the shares closed on Friday February 9.
  • At this time we are not setting a protective stop loss, but instead will look to scale further into the shares should further pressure drag them closer to $60 per share.