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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.

 

Nokia: 5G paves the way for higher earnings

Nokia: 5G paves the way for higher earnings

 

Shares of Disruptive Technology company Nokia (NOK) are gapping up nicely this Thursday afternoon, following better than expected December quarter results, and favorable long-term guidance that reflects the pending ramp in 5G mobile technology. For the December quarter Nokia delivered EPS of $0.13 vs. the expected $0.11 and $0.12 in the year ago quarter. Despite a modest dip in revenue for the quarter, Nokia’s revenue for the final three months of the year came in ahead of expectations.

Breaking down the results across the Nokia’s two core businesses – Networks and Nokia Technologies – our core investment thesis on the shares that hinges on the IP licensing business was confirmed as both revenue and profits at Nokia Technologies soared during the quarter. Year over year Nokia Technologies revenue rose 79% year over year and profits rose 145% due primarily to new licensing agreements as well as catch up payments from licensees. With a gross margin of more than 90%, incremental wins like those had during the quarter tend to flow through to the company’s bottom line. During the fourth quarter 2017, Nokia Technologies entered into a multi-year patent licensing agreement with Huawei and received an arbitration ruling related to a contract dispute with BlackBerry.

With approximately 20,000 patent families, we see 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. We see this high margin business delivering meaningful EPS expansion in the coming quarters as 5G deployments gain momentum similar to past 3G and 4G rollouts.

One of the leading indicators that we’ll be watching for that expansion will be Nokia’s own networks business as well as that of others. We’ll also be listening to comments from AT&T (T), Verizon (VZ) and T-Mobile USA (TMUS), all of which are expected to begin 5G deployments later this year.

Sticking with Nokia’s Networks business, for the December quarter, currency moved against it, leading revenue to fall 4%; however, on a constant currency basis, revenue was up 2% year over year. For the coming year, Nokia sees the transition to 5G network deployments from 4G/LTE ones weighing on margins in 2018, but as those deployments scale and mature the company sees a more favorable financial impact in 2019 and 2020. We see the above comments about AT&T, Verizon and T-Mobile USA as confirming Nokia’s expectations.

This expected uptick in 5G is reflected in Nokia issuing longer-term guidance and the boosting of its divided points to the confidence in the pending upturn related to 5G. For 2018, Nokia is forecasting EPS of €0.23-€0.27 vs. €0.33 in 2017 rising to markedly to €0.37-€0.42 in 2020. In terms of its dividend, the company has proposed dividend of €0.19 per share for 2017, which is up considerably from the $0.02 per share paid for 2016. In terms of 2018 and beyond, management continues to target a dividend payout of between 40%-70% of EPS. What this likely means is as the Networks business turns up as 5G ramps and Nokia Technologies expands its reach, we are apt to see further increases in the company’s annual dividend.

While this position has been frustrating, the key with any business tied to cyclical spending is to catch the shares as the winds of spending are poised to blow harder driving revenue and earnings higher in the process. That’s what we see in the coming quarters for 5G, and that means being a patient investor with NOK shares.

  • Our long-term price target on Nokia (NOK) shares remains $8.50
Trade Alert: Adding a Tooling & Re-tooling position to the Select List

Trade Alert: Adding a Tooling & Re-tooling position to the Select List

 

Key Points in This Alert:

  • We are adding 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.

 

We are adding 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.

As a result of tax reform, the new tax rules allow companies over the next five years to immediately deduct the entire cost of equipment purchases compared to writing off only a portion of the cost in a single year. 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, odds are this upgrade and expansion spending will span more than just 2018.

Rockwell Automation is a leader in industrial automation and information products that serve the automotive, textiles, food & beverage, infrastructure, personal care, oil & gas, life sciences, power generation, semiconductor and other industries. Roughly 55% of the company’s business is domestic in nature, with the balance spread across 79 other countries, which positions the company to take advantage of the improving global economy.

Over the last several months, ROK shares have been a strong performer, but over the last few weeks, they’ve drifted lower despite the upward revisions we are seeing in EPS expectations for both this year and next. Current Wall Street consensus expectations have the company delivering EPS of $7.78 per share this year, up 15% year over year, and climbing another 12% to $8.75 in 2019. Based on historic P/E multiples, I see upside in ROK shares to $235 vs. downside to $175. On a percentage that’s upside of 20% vs. downside of 11%. Factor in the company’s increasing dividend policy and the current dividend yield of 3.4%, and it tips the upside vs. downside into a more favorable position. With roughly $1.4 billion available under the company’s recently upsized share repurchase plan, the shares have a nice safety net as well, which means historic downside multiples may not be as applicable this time around.

In terms of catalyst to watch, I’ll be focusing on forecast updates from the Association for Manufacturing Technology, monthly industrial production and manufacturing capacity utilization data as well as aggregate capital spending forecasts for US companies.

 

  • We are adding shares of Rockwell Automation (ROK) to the Tematica Investing Select List with a Buy rating as part of our Tooling & Re-tooling investment theme with a $235 price target.

 

 

Forget ADAU with Facebook, it’s all about ARPU

Forget ADAU with Facebook, it’s all about ARPU

 

Last night Connected Society investment theme and social media platform company Facebook (FB) reported December quarter results that simply smashed expectations on a number of fronts. Of course, the market responded by trading the shares down roughly 5% in the aftermarket. Why? Well on the earnings call the management team talked changes that would impact time spent on Facebook — at least in the near term — as they focus more on “connecting people” and “healthy interaction” than the amount of time people spend on Facebook.

I see this announced strategy as part of the company’s response to criticism in the second half of 2017 over “fake news” and populist backlash, as well as part of its strategy to lure back users, particularly in the US and Canada where it reported a drop in daily active users for the first time. These changes led to a 5% reduction in average user time spent on Facebook in the December quarter and that revelation in the earnings press release sent FB shares lower in aftermarket trading last night.

Then came the earnings conference call, where the above pivot in strategy was reiterated, but Zuckerberg and crew also shared that ad impressions continue to grow and more importantly advertising pricing on the company’s platforms continues to climb. Also, on the call Facebook once again guided for a large uptick in spending, something we’ve heard several times before and yet it never seems to get in the way of Facebook meeting or beating bottom-line expectations.

As a reminder, the company is more than just the Facebook app and website and looking at the metrics across the company’s various social media platforms we are reminded of its growing presence in the advertising market. At Facebook proper, even though average daily active users (ADAU) dipping sequentially by 1 million to 184 million in the US and Canada in the December quarter, solid growth for that metric was had in Asia-Pacific and Rest of the World. Baked into the geographic figures are the 300 million daily average users at Facebook-owned Instagram vs. 178 million at Snap (SNAP) and 1.5 billion monthly active users at WhatsApp. As I look at those growth figures, I am rather nonplussed about the modest dip in Facebook average daily users.

Despite the dip in the US and Canada, revenue for the geography rose 27% quarter over quarter, which in our view solidifies the argument that growing advertising volume and pricing will more than offset short-term disruptions in average daily active users and usage. Outside of the US and Canada, Facebook continues to make solid progress in monetizing other geographies, with solid gains in Europe (31% quarter over quarter) as well as Asia-Pacific and Rest of World.

I see all of this reflected in Facebook’s overall average revenue per user (ARPU) that rose 22% sequentially (28% year over year) to $6.18. As Facebook looks to further monetize its various platforms, we continue to see further revenue and earnings growth ahead as advertisers look to be seen by buyers. As these platforms embrace video as part of our Content is King investing theme, we suspect Facebook will be a key beneficiary from the shift away from TV advertising and we are only in the early innings of that. In other words, the company remains well positioned as a Connected Society company.

  • Our price target on Facebook (FB) shares remains $225.
Weekly Issue: We Must Maintain Context and Perspective

Weekly Issue: We Must Maintain Context and Perspective

 

As we bring the first month of 2018 to a close, the market has gotten a little wobbly over the last few days as rising yields put stocks under pressure as some fretted that higher interest rates could snuff out the recent market rally. Given the economic data of late, odds are we will see higher interest rates this year as the Fed looks to tighten throughout the year. It’s a question of degree as the market is already starting to consider a potential fourth rate hike this year. We’ll get more on that along with the changing of the guard at the Fed later today when the Fed breaks from its latest FOMC policy meeting.

 

Maintaining Some Market Perspective

As I often say, context and perspective are key for investors. Let’s keep in mind the 500 point move lower in the Dow Jones Industrial Average early in the week is far from what it was 5, 10, or even 20-years ago. With the economy set to at worst continue to muddle along with GDP below 3%, we’re not heading for a bear market in the near-to-medium term.

The next few days will also bring the usual start of the month data, pulling back the curtain on how the economy faired in January. Based on the data received thus far, it paints a firmer picture compared to the initial 4Q 2017 GDP print we received last Friday. In this week’s Cocktail Investing podcast Tematica Chief Macro Strategist Lenore Hawkins and I break that GDP report down and share some observations from the recent Inside ETF 2018 conference as well as Bitcoin. It’s another great conversation and here’s a link to this week’s episode.

For my money, it will likely be a few months until we see the flow through from tax reform related benefits that have been announced in droves by companies. That doesn’t mean we won’t pay attention to the near-term data — of course we will. Rather, because the market tends to move on relative performance I’ll be looking to see if the actual acceleration to be had matches what’s increasingly expected. If it does, it likely means we’ll see the market pick back up and continue to grind higher as current rich valuations become less so. If not, given the market’s current “priced to perfection” status we could see more volatility like the last few days. Such volatility is not a bad thing in my opinion as it would allow us to take advantage of potential disconnects between businesses and stock prices. Case in point, is the opportunity we are seeing with Universal Display and Apple.

 

Market Overreacts to Apple News, Hitting OLED Too

There is little doubt we will see far more devices utilizing organic light emitting diode displays over the next few years. Evidence of that was abundant at CES 2018, yet our shares of Universal Display have fallen more than 20% over the last two weeks as the talking heads on TV are like a dog with a bone when it comes to Apple’s iPhone X volumes in the first half of this year. As I shared in last week’s issue, I see it as an overreaction, but we have seen this before as companies that directly or indirectly supply Apple bob and weave based on the latest iPhone chatter.

We’ll continue to be patient investors with Universal Display (OLED) shares and watch organic light emitting diode display adoption over the coming quarters. For newer subscribers or ones that missed the sharp move higher in recent months for OLED shares, the current price offers another opportunity to take a bit from the apple so to speak. My advice would be wait to make a move on OLED shares until AFTER Apple reports its quarterly results on Thursday, so any additional “bad” Apple news is reflected in OLED shares. Long-term, the opportunity for Universal Display remains very bright, especially given the favorable tax treatment to be had for intellectual property companies as part of tax reform. Those reforms reduce tax on foreign income from goods and services produced in the U.S. using patents and other intellectual property to 13.125% until the end of 2025, after which the rate rises to 16.4%. Previously, royalties paid to a unit in the U.S. would have been taxed similarly to other U.S. income, for which the top corporate tax rate was 35%. I expect Universal Display to talk more about these positive implications when it reports its December quarterly results in February.

With Apple, it remains thematically well positioned with our Connected Society and Cashless Consumption investment themes and is positioning itself to ride the Content is King tailwind as well. Later this week, Apple will report its quarterly results and if we see weakness in the shares as the herd digests the “news” I’m inclined to scale into the position as the shares settle out.

  • Our price target on Apple (AAPL) shares remains $200
  • Our price target on Universal Display (OLED) shares remains $225.

 

State of the Union and Infrastructure

Last night President Trump gave what is being described as a presidential State of the Union. As expected, it was part victory lap and part agenda setting as he shared a preliminary framework to “rebuild our crumbling infrastructure” and bolster the country’s security. Adding in the benefits from tax reform and it all rings similar to our Economic Acceleration/Deceleration, Tooling & Re-tooling and Safety & Security investing themes.

To me, the infrastructure discussion is something we’ve been waiting on for some time, as has the Association of American Civil Engineers and their infrastructure report card. Lest you might have forgotten, the grade has been a consistent D+ for some time. In the coming days and weeks, Washington will cobble together a bill to target in Trump’s words “at least $1.5 trillion for the new infrastructure investment we need.”

The key will be how this rebuilding is paid for given the national debt and tax reform implications on the deficit near-term. The solution is looking increasingly like Federal spending will be partnered with State and local spending as well as public-private partnerships. The bottom line is this – the details will be forthcoming and as those firm up we’ll have greater clarity on when we’re likely to see jobs being created, equipment roll, and shovels hit the ground.

Helping speed the process, Trump called for streamlining the permitting and approval process to get “it down to no more than two years, and perhaps even one.” Team Trump has been busy slashing unnecessary regulations that have hamstrung businesses, and hopefully we will see more of this with the pending infrastructure bill. Rather than jump the gun and risk a timing issue by moving companies from the Tematica Contender List to the Select List, I’ll be watching the infrastructure bill like a hawk over the coming weeks. To paraphrase Orsen Welles in his famous Paul Masson wine commercial, we will add no stock before it’s thematic time.

 

Select List Moves and a Stop Out

Along with the overall market, the Tematica Select List has seen its share of positions come under pressure. It’s going to happen from time to time — after all the market can’t climb higher and higher forever. Not fun to hear I know, but it’s the truth. Expect the best, prepare for the worst as they say. We did that with several positions on the Select List with select stop loss usage, and that led to our being stopped out of AXT Inc. (AXTI) yesterday. While I may not be thrilled given the prospects for 5G networks and devices as well as a growing optical communications market, AXT shares were another victim of the Apple chatter I talked about earlier. For now, I’m placing AXTI shares on the Contender List and I’ll look for the right time to put them back on to the Select List.

Earlier this week, I shared my take on Corning’s (GLW) quarterly results, and the shares continue to drift lower today. Despite the action of the last few days, we remain nicely profitable in the position, but I’m still assessing price points to double down in the shares.

The other company that reported earnings in the last few days was Starbucks (SBUX), and candidly they put up some figures that were less than expected, which led the shares to trace back to their early December levels. While China was a bright spot for the company with same-store sales up 6% year over year, the reality was its holiday 2017 offerings simply didn’t resonate with consumers. That is a rare thing for Starbucks, but when this has happened in the past the company has quickly responded. Odds are they will again as we enter the spring season, but for now, the shares will be a “show me” story until they can once again demonstrate they are setting the beverage trend. I have full faith that they will and see the recently introduced Blonde Espresso as a step in the right direction.

  • Even though we will be patient with Starbucks (SBUX) shares, I am trimming our price target to $68 from $74, which still offers roughly 20% upside from current levels before accounting for the current 2.1% dividend yield.

 

Buckle up as the Earnings Train is Here

As I shared a few days ago, we have a full plate of earnings coming later today and tomorrow. It will be a barn burner of a time, and while things could get a little bumpy the underlying thematic tailwinds remain intact. As such, we’ll use any meaningful pullback to better our cost basis should the opportunity arise. In case you missed it, here’s a link to which companies are reporting as well as their respective consensus expectations.

As you might imagine, I expect to have much to share with you in the coming days.

 

 

 

Corning beats, but smartphone comments will be the near-term guide for the shares

Corning beats, but smartphone comments will be the near-term guide for the shares

 

Amid a falling stock market open this Tuesday morning, which comes on the heels of a Monday that was the worst day thus far for stocks in 2018, Disruptive Technology company Corning (GLW) reported better than expected December quarter earnings, beating on both the top and bottom lines. The sparse release from the company showed positive results across the majority of its business and hinted at expectations for the company’s top line to rise 5% this year. All in all, a solid report ahead of the company’s 8:30 AM ET conference call, which should shed far more details on its quarterly results and outlook. It’s that more granular view, especially for the smartphone market, that will determine how GLW shares will trade later today as well as those for Apple (AAPL) and Universal Display (OLED).

Piecing some comments together from its earnings press release, it appears Corning’s Display Technologies business (31% of sales) will continue to benefit from larger screen sizes and better LCD glass pricing, while Optical Communications (34% of sales) is expected to grow 10% year over year due in part to a contract with Verizon (VZ) as well as ongoing backhaul demand. That year over year improvement at the Optical Communications segment is forecasted without any benefit to be had from the recently acquired 3M Communications Market Division. Two of the company’s other segments – Life Sciences and Environmental Technologies – are slated to deliver positive sales gains, but there is some rather cryptic wording for the company’s Specialty Materials business (14% of sales)

As I noted above, Corning is holding its December quarter earnings conference call this morning and we expect the dialog to be had to provide far more details on management’s expectations as well as the dynamics, such as smartphone shipment expectations for the first half of 2018, that will impact product mix and profits. Current consensus expectations have the company delivering EPS near $1.80. Because the company’s Display Technologies business accounted for 46% of earnings in the December quarter and 47% in all of 2017, we expect Wall Street to pepper the company with questions surrounding iPhone production levels in the coming quarters. Those answers will determine the likelihood of those 2018 EPS forecasts that fall between $1.64 – $1.98 per share. Quite a wide berth, and the answers will determine if there is upside to our $37 price target.

I have shared there is much speculation over iPhone X production levels to be had, but we would remind subscribers the iPhone X is just one of Apple’s smartphone models. That said, given the rapid rise in the overall stock market year-to-date, up 6.7%-8.2% across the major market indices after yesterdays’ performance, and the 7% increase in GLW shares over the same time frame, Corning’s smartphone commentary could weigh on the shares if it indicates an overall weaker than expected smartphone market. It will also help chart the near-term direction for the Apple and Universal Display shares on the Tematica Investing Select List.

From my perspective, we are hearing reports of larger format smartphones from Apple and others hitting shelves later this year. Paired with the growing adoption of larger format organic light emitting diode (OLED) displays on both smartphones and TVs, as well as burgeoning demand for backhaul technologies that should grow in the coming quarters as 5G networks are built, we’ll use any pullback to be had in GLW shares in the near-term to improve our long-term position.

 

 

This week’s earnings season game plan

This week’s earnings season game plan

 

We have quite the bonanza of corporate earnings for holdings on the Tematica Investing Select List. It all kicks off tomorrow with Corning (GLW) and picks up steam on Wednesday with Facebook (FB). The velocity goes into over drive on Thursday with United Parcel Service (UPS) in the morning followed by Amazon (AMZN), Alphabet/Google (GOOGL) and Apple (AAPL). Generally speaking, we expect solid results to be had as each of these companies issues and discuss their respective December quarter financials and operating performances.

Given the recent melt-up in the market that has been fueled in part by favorable fundamentals and 2018 tax rate adjustments, we expect to hear similar commentary from these Tematica Select List companies over the coming days. The is likely to be one of degree, and by that I mean is the degree of tax-related benefits matching what the Wall Street herd has been formulating over the last few weeks? Clearly, companies that skew their geographic presence to the domestic market should see a greater benefit. The more difficult ones to pin down will be Facebook, Apple, Amazon and Google, which makes these upcoming reports all the more crucial in determining the near-term direction of those stocks.

We are long-term investors that can be opportunistic, provided the underlying investment thesis and thematic tailwinds are still intact. Heading into these reports, the thematic signals that we collect here at Tematica tell me those respective thematic tailwinds continue to blow.

As we await those results, we continue to hear more stories over Apple slashing iPhone X production levels as well as bringing a number of new iPhone models to market in 2018. These reports cite comments from key suppliers, and we’ll begin to hear from some of them tomorrow when Corning reports its quarterly results. We’ll get more clarity following Apple’s unusual tight-lipped commentary on Thursday, and even if production levels are indeed moving lower for the iPhone X we have to remember that Apple’s older models have been delivering for the company in the emerging markets. Moreover, the company could unveil a dividend hike or upsized repurchase program or perhaps even both as it shares the impact to be had from tax reform. As I shared last week, there are other reasons that keep us bullish on Apple over the long-term and our strategy will be to use any post-earnings pullback in the shares to improve our cost basis.

In digesting Apple’s guidance as well as that offered by other suppliers this week and next we’ll be keeping tabs on Universal Display (OLED), which is once again trading lower amid iPhone X production rumors. As I pointed out last week, Apple is but one customer amid the growing number of devices that are adopting organic light emitting diode displays. We remain long-term bullish on that adoption and on OLED shares.

We’ve received and shared a number of data points for the accelerating shift toward digital shopping in 2017 and in particular the 2017 holiday shopping season. We see that setting the stage for favorable December quarter results from United Parcel Service and Amazon later this week. We expect both companies to raise expectations due to a combination of upbeat fundamentals as well as tax reform benefits. With Amazon, some key metrics to watch will be margins at Amazon Web Services (AWS) as well as investment spending at the overall company in the coming quarters. As we have shared previously, Amazon can surprise Wall Street with its investment spending, and while we see this as a positive in the long-term there are those that are less than enamored with the company’s lumpy spending.

In Alphabet/Google’s results, we’ll be looking at the desktop/mobile metrics, but also at advertising for both the core Search business as well as YouTube. Sticking with YouTube, we’ll be looking for an update on YouTube TV as well as its own proprietary content initiatives as it goes head to head with Netflix (NFLX), Amazon, Hulu and Apple as well as traditional broadcast content generators.

In terms of consensus expectations for the December quarter, here’s what we’re looking at for these six holdings:

 

Tuesday, JANUARY 30, 2018

Corning (GLW)

  • Consensus EPS: $0.47
  • Consensus Revenue: $2.65 billion

 

Wednesday, January 31, 2018

Facebook (FB)

  • Consensus EPS: $1.95
  • Consensus Revenue: $12.54 billion

 

Thursday, FEBRUARY 1, 2018

United Parcel Service (UPS)

  • Consensus EPS: $1.66
  • Consensus Revenue: $18.19 billion

 

Alphabet/Google (GOOGL)

  • Consensus EPS: $10.00
  • Consensus Revenue: $31.86 billion

 

Amazon (AMZN)

  • Consensus EPS: $1.84
  • Consensus Revenue: $59.83 billion

 

Apple (AAPL)

  • Consensus EPS: $3.81
  • Consensus Revenue: $86.75 billion

 

 

OLED: This technology will be a marathon, not a sprint

OLED: This technology will be a marathon, not a sprint

Shares of organic light-emitting diodes display chemical and intellectual property company Universal Display (OLED) have been hard hit this past week, falling more than 17% through last night’s market close from a high of $208 per share back on January 18, 2018. While a drop such as this can be hard to swallow, maintaining context and perspective is always important and the reality is the shares have simply retraced back to their mid-December level. Clearly, OLED shares were a strong performer closing out 2017 and the first few weeks of 2018 as data showed robust iPhone X sales in the December quarter.

The recent drop in OLED shares, however, reflects growing chatter across Wall Street over lower iPhone X shipments to be had in the coming quarters. While we are less than thrilled with the pullback in OLED shares, we also recognize that suppliers, direct or indirect, that live by the Apple, can be hit by the Apple. It’s also quite true that the late December-early January move pushed OLED shares into over bought territory.

Here’s the thing, while many are focusing on Apple as the main thesis behind the push in Universal Display share price, the reality is we are still in the early innings of organic light emitting diode display adoption. Other devices and applications — TVs, smartphones other connected devices interior automotive lighting, and eventually general illumination — are still just beginning to incorporate this Disruptive Technology. Rather than focus on quarter to quarter moves by a well-known adopter, we will continue to play the long-game when it comes to organic light emitting diode display adoption and in turn, OLED shares.

For subscribers that have missed the run in OLED shares thus far, I suggest holding off adding the shares until Apple reports its December quarter results on Feb. 1 so any and all bad news to be had is priced into the shares. If the group think on iPhone X shipments is right, it will offer a great long-term entry point for OLED shares.

  • Our long-term price target ahead of any tax reform benefit to be had remains $225.
Boosting our price target on LSI Industries

Boosting our price target on LSI Industries

 

Our shares of LSI Industries (LYTS) on the Tematica Investing Select List are popping today following a solid earnings beat for the companies December quarter and raised bottom line expectations for the coming year due in part to the benefits of tax reform. With that benefit, which is based on a consolidated tax rate of 29% vs. 34% for 2017, we are boosting our price target on LYTS shares to $11 from $10, which keeps the shares a Buy rating despite this morning’s 15% move higher. We’re more than happy to take that 15% move as it brings the return thus far on LYTS shares to just under 14%.

As I mentioned above, the earnings beat was partly due to tax reform. The other part was the stronger than expected operating performance as revenue for the quarter rose 7.7% year over year to $92.3 million, well ahead of the $88.5 million “consensus” expectation formulated by all two of the Wall Street analysts that follow the shares. More impressive was the sharp improvement in operating profit that rose significantly higher year over year as its operating margins climbed to roughly 4.9%, up from 3.3% in the year-ago quarter. This continues the trend of year over year margin improvement, which bodes well for incremental EPS growth in the coming quarters, even before we factor in the company’s new tax rate.

Once again, we are seeing that stocks under covered by Wall Street analysts offer opportunity, provided the fundamentals and other data points support the investment thesis. As a reminder, LSI remains well-positioned with its lighting solutions as non-residential construction activity continues to rise in the coming quarters. Comments from construction equipment heavy weight Caterpillar (CAT) are certainly comforting in this regard as it “expects improvement in North American residential, non-residential and infrastructure. The outlook does not include any impact from a potential U.S. infrastructure bill.”

I continue to see the rebuilding of US infrastructure as pouring gasoline on non-residential contraction and LSI’s business. I continue to wait for more formal details to emerge out of Washington on this, but between now and then, I’ll continue to look for additional confirming data points as the December quarter earnings season heats up.

  • We are boosting our price target on LSI Industries (LYTS) to $11 from $10