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Hope and enthusiasm can only carry the market so high for so long

Hope and enthusiasm can only carry the market so high for so long

Waiting for the Fed’s Economic Forecast Update

What a week it’s been! We’ve received a solid February jobs report, endured a March snow storm and late last night even saw another round of would-be news on President Trump’s 2005 tax return. Those two later stories were far less newsworthy than was widely anticipated as Trump paid a 25 percent tax rate and winter storm Stella’s impact wasn’t as extreme as expected, although it did leave trading volumes rather light yesterday. They would have been so regardless, as the market is still in wait-and-see mode as it eyes today’s afternoon announcement from the Federal Reserve on interest rates.

What was once thought of as a long shot, has reversed course and picked up steam with the market now widely anticipating the Fed to modestly boost interest rates. The rate increase is expected even though, as we pointed out in this week’s Monday Morning Kickoff, the Atlanta Fed has done nothing but trim its GDP expectations for 1Q 2017 over the last few weeks. Odds are, today’s latest iteration of that GDPNow report will see a boost up from the dismal 1.2 percent reading owing to the February Employment Report, but it will be hard pressed to break past the 1.9 percent GDP print for 4Q 2016.

Keeping in mind the Fed has a knack for boosting interest rates at the wrong time, and it looks increasingly like Trump’s fiscal policies will take longer than many have expected to take hold and boost the economy, we here at Tematica will continue to tread prudently and cautiously in the near-term.

 

Hope and enthusiasm can only carry the market so high for so long.

Yes, each week we continue to see confirming data points for our 17 investment themes, which you can see in our Friday missive that is Thematic Signals, but we remain concerned over the market’s stretched valuation and the simple fact that expectations have to catch up with the current economic reality.

Now when many hear talk like that, the first reaction is to get nervous. It’s understandable, but we’re not suggesting a market correction is coming. Even though there are signs the economy has slowed, it is still growing as evidenced by the recent reports from Markit Economics and ISM. Our thinking is that a market pullback — something we define to be in the 3-6 percent range — may not be popular to all the recently returned investors, but it would take, to quote former Fed Chief Alan Greenspan, some of the “irrational exuberance” out of the market. Not a bad thing as it would allow us to revisit some thematic contenders that have moved higher and faster than they probably should over the last four and a half months.

Like Warren Buffett is often quoted saying, “Price is what you pay, value is what you get.”

We couldn’t agree more.

Aside from the now largely expected interest rate increase itself, let’s remember the Fed tends to be very vague in its language and the market has a habit of not really listening to what the Fed is trying to communicate. As the Fed boosts interest rates, we’re likely to get an update on its economic and inflation forecasts in its policy statements and its that language that will either soothe the market or give it some indigestion.

 

You’ve probably come to the conclusion that it’s best to stand pat for now, and we certainly agree. 

We’ve got a number of positions on the Tematica Select List that are benefitting from pronounced multi-year tailwinds, like Connected Society company Dycom Industries (DY) and the 5G deployment; Disruptive Technology plays Universal Display (OLED) and Applied Materials (AMAT); Aging of the Population and AMN Healthcare (AMN) and the PureFunds ISE Cyber Security ETF (HACK) that is part of our Safety & Security investing theme to name just a few.

Two stocks we will be watching closely are Food with Integrity United Natural Foods (UNFI), which reported good quarterly earnings last week and recently stopped out Costco Wholesale (COST) shares. Both stocks drifted lower last week, with UNFI a tad below the average cost basis of $42.95 on the Tematica Select List and Costco shares breaking through their 50-day moving average at $167.34. When we’ve seen such moves in COST shares previously, it tends to take more than a few weeks for the shares to settle out. Given our Cash-strapped Consumer investing theme and the Costco’s continued expansion, as well as announced membership price hike, that should drive membership-related profits higher.

  • We’ll continue to keep our eyes on COST for an opportunity to jump back in.

 

Ways to Get Prepared for Future Moves

Be sure to listen to the latest edition of Cocktail Investing, in which Tematica Chief Macro Strategist Lenore Hawkins and I talk with Steve Fredette of Toast, a restaurant technology company at the intersection of the Connected Societyand Asset-lite investment themes. We’ll have another episode out tomorrow that will wrap up all the key market and economic data with a special guest Jack Mohr, who up until recently worked with Jim Cramer — yes that Jim Cramer — managing his Action Alerts Portfolio.

Also be sure to come back to Tematica Investing during the week to see our latest thoughts and comments on the economy, the market and stocks, both in and out of the Tematica Select List.

United Natural Foods Reports In-line Quarterly Results, Still Riding the Fresh & Natural Wave

United Natural Foods Reports In-line Quarterly Results, Still Riding the Fresh & Natural Wave

Last night Food with Integrity company United Natural Foods (UNFI) reported in-line quarterly earnings of $0.50 per share on revenue that rose 11.7% year over year to hit $2.29 billion. Despite that double-digit revenue growth, revenue for the quarter fell short of expectations by $50 million — not a big deal in our view, but we suspect some will look past the double-digit growth and focus on this being the second consecutive quarter where revenue fell just shy of expectations. To us that shortfall is overshadowed by the more than 16% increase in earnings before interest tax & depreciation (EBITDA) and the 12% increase in net income — we always like to see profits growing faster than revenue as it denotes margin expansion.

Given the continued deflationary environment the food and grocery industry is contending with, all in all, we were rather pleased with United Natural’s quarterly results as it continues to benefit from shifting consumers preferences and reap the benefits from cost savings initiatives and synergies with companies acquired in the last year. With those deflationary pressures poised to continue, the company is undertaking another initiative that will shed roughly 265 jobs in the current quarter, with benefits to be had in following ones. This latest effort is expected to result in pre-tax charges of $3.5-$4 million.

Even after this new initiative the company guided 2017 in line with expectations:

  • fiscal 2017 revenue between $9.38-$9.46 billion, an increase of approximately 10.7%-11.7% over fiscal 2016, and consensus expectations of $9.4 billion;
  • adjusted EPS in the range of $2.53 to $2.58 vs. the current consensus forecast of $2.54 per share.

Stepping back, we continue to see consumer shifting preferences to fresh, organic and natural products. Last week, grocery chain Kroger (KR) commented that it continues to “focus on the areas of highest growth like natural and organic products” and we’ve seen companies like Costco Wholesale (COST) continue to expand their fresh and natural offering to boost basket size and shrink time between visits. Against that backdrop that is not occurring at just Kroger and Costco, we continue to like United Natural’s strategy to expand its footprint, including its UNFI Next program that looks for new products and emerging brands and its e-commerce platform.

  • Our price target on UNFI shares remains $60, which offers more than 30% upside from current levels. As such we are keeping our Buy rating intact.

 

 

The data tells us that things aren’t exactly headed in the direction of an expanding economy

The data tells us that things aren’t exactly headed in the direction of an expanding economy

The start of March — the last month in the current quarter — started off on a much softer note than January and February, with far more modest gains in the stock market. Call it the calm before the Fed storm, given the next Federal Open Market Committee meeting next week. As we’ve moved closer to the FOMC meeting, the market’s expectations for the Fed to boost rates have climbed, but at the same time, we’ve gotten a number of conflicting data points.

Earlier this week in the Monday Morning Kickoff, we pointed out the weaker than expected January core capital goods orders and shipments, as well as disappointing January personal spending relative to expectations previously. Added to the mix are light vehicle sales data from last week and then the Atlanta Fed cutting its GDPNow forecast for the current quarter to 1.3 percent, down from 1.8 percent on March 1.

Not the direction of an expanding economy, but rather a slowing one, given the latest view that GDP in 4Q 2016 clocked in at 1.9 percent. As we outlined in this week’s Monday Morning Kickoff, there are a growing number of reasons to be cautious and the downward move in GDP expectations is another one, especially given the market’s current valuation.

Another reason for our cautiousness was published by WalletHub this week in a report based on Federal Reserve data that reminds us the Cash-strapped Consumer is alive and well. Per the report, U.S. consumers racked up $89.2 billion in credit card debt during 2016, pushing outstanding balances to $978.9 billion, which is roughly $3 billion below the all-time record set in 2007. Let’s put that into perspective — it equates to the average indebted household owing $8,377 to creditors. Yikes!

WalletHub projects that in 2017 we will surpass the current record by at least $100 billion. Not so good for an economy that has become reliant upon the consumer. This also helps explain why Automotive News reported incentive spending by automakers averaged $3,443 per vehicle in February, up 14 percent from a year ago. Another warning sign.

We’d also add in the growing brouhaha over the efforts to replace the Affordable Care Act, which given the response to the House bill put forth this week, looks to be on a course that is going to be less than smooth sailing. Following the issues surround the Executive Order on immigration, our concern is the market could wake up to the fact that it is going to take more time than expected for President Trump’s fiscal policies, especially tax reform, to ignite the domestic economy.

Given all these issues, it should be obvious why we recently raised a number of our stop loss positions, and we’ll continue to review them on an ongoing basis. Odds are we could see the market pullback in the coming weeks, and our strategy will be to scale into several positions on the Tematica Select List at better prices.

 

Checking in on Applied Materials and It Looks Good

A few weeks ago we added shares of semiconductor and display capital equipment company Applied Materials (AMAT) to the Tematica Select List as a Disruptive Technology play. As a quick reminder, Applied’s business is benefitting from next generation chip and display technologies that are forcing a ramp in new equipment demand. We’ve talked much about the adoption of organic light emitting diode display that has powered our Universal Display (OLED) shares higher (up nearly 57 percent as of last night’s close), but Applied is also seeing favorable demand signals for its chip equipment business.

Earlier this week, the Semiconductor Industry Association (SIA) reported worldwide sales of semiconductors rose 13.9 percent year over year to $30.6 billion for the month of January 2017. We’d note that January marked the global market’s largest year-to-year growth since November 2010, which to us confirms that chips, not cotton, are the new fabric of our increasingly digital lives.

Strong chip sales mean industry capacity should get tighter and foster additional demand for new industry capacity, and thus orders for Applied’s chip equipment business. We’re seeing tight capacity especially in the global NAND flash storage market, which led to sharp average selling prices in during 4Q 2016 per data from DRAMeXchange. Tight NAND flash supply is expected to persist through 2017 as the industry migrates to 3D NAND technology, which is spurring equipment demand at Applied as Samsung and Toshiba look to increase their output of 3D NAND flash throughout 2017.

  • We continue to rate AMAT shares a Buy with a $47 price target.
  • We continue to rate OLED shares a Buy with a $100 price target.

 

 

On Deck – Disney’s Annual Shareholder Meeting

The Walt Disney Company Chairman and CEO Robert Iger. (Photo by Chip Somodevilla/Getty Images)

Later today Content is King company Walt Disney will hold its annual shareholder meeting, and while we don’t expect anything material to emerge, CEO Bob Iger usually offers a pretty good rundown of the upcoming movie slate. As we have seen in the past and again more recently with Frozen, Star Wars and Marvel movies, the films lead to new park attractions and drive its merchandise business. So yes, we will be tuning in to hear what’s said later today.

  • As the company continues to focus on tentpole films that will ripple through its other businesses, we continue to rate Disney a Buy.
  • Our price target remains $125.
A quick reminder on being stopped out on Costco.

Last Friday afternoon we were stopped out of Costco Wholesale (COST) shares on the Tematica Select List when they briefly dipped below our $170 stop loss. Even though it was for the briefest of moments, the $169.90 low for the day means that the protective measure was triggered following quarterly earnings that missed expectations Thursday night.

Recall we sold half the position for a gain of more than 14 percent before dividends, and when paired with the stopping out of the remainder of the position, the blended return before dividends on the Tematica Select was 14 percent vs. a 9.8 percent move in the S&P 500 over the same time frame.

Given the business model dynamics and Costco continuing to benefit from the Cash-strapped Consumer tailwind, we’re inclined to revisit the shares in the coming weeks. The shares have continued to trade-off throughout this week in the $166 to $167 range, but we’re keeping an eye toward getting them back on the Tematica Select List at even better prices.

What Now After Being Stopped Out of Costco Shares?

What Now After Being Stopped Out of Costco Shares?

On Friday afternoon we were stopped out of Costco Wholesale (COST) shares on the Tematica Select List when they briefly dipped below our $170 stop loss. Even though it was for the briefest of moments, the $169.90 low for the day means that protective measure was triggered following quarterly earnings that missed expectations Thursday night. Recall we sold half the position for a gain of more than 14 percent before dividends, and when paired with the stopping out of the remainder of the position, the blended return before dividends on the Tematica Select was 14 percent vs. a 9.8 percent move in the S&P 500 over the same time frame.

 

The Catalyst Behind the Dip in the Share Price

While Costco’s revenue for the quarter was a whisper below expectation, earnings for the quarter were impacted by gross margin pressure primarily due to lower gas profitability vs. a year ago. You’ve probably noticed that gas prices have undergone a large double-digit increase since last year, and even Costco is not immune. In our view, this highlights the company’s thin retail margin structure, which can create earnings volatility from time to time.

While many focused on the earnings miss, we have been far more focused on Costco’s announced membership price increase that will bring its primary membership to $60 from $55 and its Executive Memberships in the US and Canada to $120 from $110. We see those $5 and $10 increases as not egregious, especially when compared to the $100 increase in the annual fee for American Express’s (AXP) Platinum Card that kicks in later this year, and suspect the vast majority of Costco members won’t blink at the price hike.

From an investor perspective, we like the announced price hikes because it translates into higher membership fees, which account for roughly 75 percent of overall operating income and help stabilize quarterly retail margin swings. Paired with more warehouse locations as Costco continues to grow its footprint and as Cash-strapped Consumer turn increasingly to Costco for fresh foods as well as bulk items, we continue to see solid revenue and earnings growth ahead. Exiting its most recent quarter, Costco had 728 warehouses, up from 698 in the year-ago quarter, with plans to add another 29 locations during 2017.

Again, we were stopped out of the position on Friday, but given the business model dynamics and Costco continuing to benefit from the Cash-strapped Consumer tailwind, we’re inclined to revisit the shares in the coming weeks with an eye toward getting them back on the Tematica Select List at better prices.

Trump’s strong performance pushes the market up even further

Trump’s strong performance pushes the market up even further

Last night President Trump addressed a joint session of Congress, and while it sounded somewhat like a campaign speech, the overall tone was far tamer and optimistic than we saw on the campaign trail and lacked his signature attacks. Even though there were no major policy shifts and as we expected few details, Trump called for both political parties to work together to get the country back on track after the last 8 years. That call for unity was far from surprising, given that in order to move tax reform ahead and replace the Affordable Care Act, Trumps needs a united GOP and support from at least some Senate Democrats. Given the quick exit of Democrats following Trump’s concluding remarks, odds are the President will have much work to do to get his agenda flowing.

There were a few surprises last night, including Trump’s softening stance on immigration as well as his calling on Congress to pass legislation to pave the way for a $1 trillion public-private infrastructure project. Trump has been rather vocal about the need to fix the country’s aging highways and byways, so the call itself isn’t surprising even though the price tag is larger than many expected. Again, the devil will be in the details for this public-private proposal given concerns for increasing the national debt even further than it has over the last several years.

All in all, it was a good speech and one that in our view signals a more presidential Trump, but for those looking for harder details there was little to be had and it looks like the policy timetable has probably been extended. While the stock market is gapping higher yet again today, it looks to us like it’s increasingly further out along its skis.

 

Recapping the Week’s Economic Data Thus Far

 

 

This morning we received the January reading on Personal Income & Spending, which showed income ticking up modestly month over month to 0.4 percent, but spending in January tumbled vs. that in December. Yes, there tends to be a seasonal dip following the holiday filled December, but even so, the January spending figure of 0.2 percent came in below the expected 0.3 percent reading. After dipping to 5.4 percent in December, the Personal Saving rate inched higher in January to 5.5 percent.

Now, that is a modest miss on the personal spending side of the equation, but when we pair it with January’s weaker than expected core capital goods orders and shipments, it’s another sign the domestic economy as a whole likely remains stuck in low gear this quarter. We talked about this earlier this week, as well as the current mismatch between GDP forecasts for the first half of 2017. Later this morning, we’ll get both the ISM Manufacturing Index and Markit Economics Final February Manufacturing PMI reports and we’ll be going over them to see what’s what when it comes to the current quarter’s GDP.

This morning also brought the final February Manufacturing PMI figures for the Japan and the Eurozone as well as the first viewing of the same for China. The final data for both the Eurozone and Japan are very much in line with the Flash reports we received last week, pointing toward a firming global economy from a  production and order perspective. The data also showed that their weaker currencies relative to the dollar is generating stronger export business; in the Eurozone, February saw the fastest growth of new export business in almost six years. While the February Manufacturing PMI figures of 53.3 and 51.7 in Japan and China clocked in lower than the 55.4 recorded for the Eurozone, the underlying economies continued to improved compared to several months ago. One of the key signs that we watch as an indicator of future business, orders, trended higher leading to the first expansion in work backlog levels in Japan since the end of 2015.

One other key element from these Final PMI reports was the pick-up in input costs due primarily to higher commodity and raw material costs. We’ll look for confirmation in both the Final Manufacturing PMI for the US as well as ISM’s February Manufacturing Index. Per data published by ISM, over the last few months prices have been expanding at a stronger pace and if this continues, we expect Federal Reserve representatives to talk more about inflationary prospects ahead of the March Federal Open Market Committee meeting.

On the back of President Trump sharing a $1 trillion infrastructure spending plan last night, should the February ISM and Markit data show continued manufacturing strength, we are likely to see share prices for companies like US Concrete (USCR), Ingersoll-Rand (IR), Home Depot (HD), and Granite Construction (GVA) that fit our Economic Acceleration/Deceleration investment theme benefit. The same can likely be said for shares of The Industrial Select Sector SPDR Fund (XLI) as well as Financial Select Sector SPDR Fund (XLF) should the market mentality shift to one that thinks a March rate hike for the Fed looks increasingly likely. Given the run several of these have had, we’re taking a hard look at what entry points offer subscribers a favorable risk vs. reward profile.

 

Dycom Trounces Expectations and Lifts Its Outlook

Early this morning Connected Society holding Dycom Industries (DY) a specialty contractor that serves the wireless and wireline industries, reported stronger than expected quarterly revenue and guided the current quarter ahead of expectations. For the January quarter, Dycom delivered EPS of $0.82, well ahead of the expected $0.69 and $0.54 in the year-ago quarter, on revenue that rose 25 percent year over year to $701.1 million, also well ahead of the $659.4 million that was expected.

Breaking down the quarterly revenues, organic contract revenue rose just under 23 percent and acquired businesses during the year added another $13.4 million. Year over year, adjusted EBITDA rose more than 29%, which in our view reflects solid cost control at its installations and projects, but we also recognize the 4 percent decline in the share count helped improve year over year EPS comparisons. Even so, it was a solid beat all the way around.

Details tend to be scant in the earnings press release, but the company does provide some additional details ahead of the earnings call. Peering over that material, we saw that Dycom’s customer composition that has had AT&T (T), Comcast (CMCSA), CenturyLink (CTL) and Verizon (VZ) among its top customers remained largely unchanged during the quarter. On a combined basis those four companies accounted for just over 70 percent of Dycom’s revenue in the quarter vs. just over 69 percent in the prior quarter and just under 63 percent in the year-ago quarter. We attribute that improvement to Dycom’s position with the wireless and wireline players that are building out network capacity and prepping to bring next generation networks to market in order to deploy more advanced service offerings.

We’ve noted previously the combined 2017 capital spending plans for AT&T, Verizon, CenturyLink and Comcast for broadband and wireless will be up modestly year over year with a greater portion of spending on network capacity and new technologies (5G, Gigabit fiber). We continue to see Dycom as a prime beneficiary of that wireless and wireline capital spending. In the earning press release, Dycom guided revenue for the current quarter, which is benefitting from mild winter temperatures, in the range of $715-$745 million vs. the consensus of $715.75 million with EPS in the range of $1.11-$1.24 compared to the consensus of $1.13. We expect far more details to emerge on the company’s earnings call that will be held this morning at 9 AM ET.

On the housekeeping front, this morning Dycom’s Board authorized an additional $75 million share repurchase.

  • Ahead of the earnings call this morning, we continue to rate Dycom Industries (DY) a Buy with a $110 price target.

 

Yet again, we’re boosting the Price Target for this Disruptive Technology company

Yet again, we’re boosting the Price Target for this Disruptive Technology company

Our shares of Universal Display (OLED) continued on a tear yesterday as they climbed more than 7 percent, bringing the year to date return to a staggering 55 percent. Last week the company reported robust quarterly revenue and earnings, which as we commented had a bullish outlook. In recent weeks, we’ve seen a positive piling on with regard to the shares and the robust outlook for organic light emitting diode displays, which includes adoption in Apple’s (AAPL) next iPhone iteration, but a number of other applications as well. We’ve used the last few days to revisit our 12-24 month price target on the shares, and we are boosting that one again to $100 from $85. At the current share price that new price target offers roughly 18 percent upside.

Given the sharp rise over the last few days, we aren’t surprised by the shares giving back some of the gains today. As we commented yesterday, President Trump’s speech to Congress tonight could present a bump in the road for the stock market, which has been on a steady move higher over the previous 12 days. We interpret that march higher as the market expecting some degree of details from Trump in his speech tonight. If the speech does underwhelm with scant details, we could see the market interpret that as a push out in the timing for Trump’s fiscal stimulus agenda and tax overhaul. Again, as we shared this morning, our view has been that we are not likely to see any impact from Trump’s initiatives until late in the second half of 2017 and the stock market needs to recognize that.

That’s a long way of saying we could see OLED shares pullback further tomorrow should the market get a case of digestion mixed with expectation resetting. Subscribers that are underweight OLED shares should view that as an opportunity given the ramping demand and industry capacity for organic light emitting diode displays.

  • Our new price target on OLED shares is $100, which has us keeping our Buy rating intact.
  • We continue to have a protective stop loss at $70 for the shares.
Prepping for Dycom’s Earnings This Week

Prepping for Dycom’s Earnings This Week

While we are finally starting to see the pace of corporate earnings reports subside, there are still a number of stragglers on the Tematica Select List. One of those is Dycom Industries (DY), which will report its quarterly results on Wednesday (Mar. 1) before the market open. Consensus expectations call for this communications heavy specialty contractor and Connected Society company to deliver EPS of $0.69 on revenue of $661.8 million and guide the current quarter to EPS of $1.09-$1.18 on revenue of $708-$725 million.

We’ve noted that as Dycom customers have been reporting and sharing their 2017 capital spending plans over the last few weeks, the combined 2017 capital spending plans for Dycom’s core customers — AT&T (T), Verizon (VZ), CenturyLink (CTL) and Comcast (CMCSA) — for broadband and wireless will be up modestly year over year with a greater portion of spending on network capacity and new technologies (5G, Gigabit fiber). We continue to see Dycom as a prime beneficiary of that wireless and wireline capital spending.

As we noted earlier today, this week the 2017 iteration of Mobile World Congress is being held and its one of the major wireless trade shows of the year. We expect a number of announcements to be had, some of which should shed light on expected 5G deployments. We see those items as filling in between the lines for Dycom’s core customers, many of which continue to build out existing 4G LTE networks as they begin to test their 5G offerings.

As we get ready for Dycom’s earnings and follow on management comments during the follow-up conference call, we are inclined to sit tight and be patient with the position given our view that, worst case, it’s only a matter of time for next-generation network technologies to be deployed. Keep in mind, in order for them to be deployed, they first have to be constructed.

  • We continue to rate DY shares a Buy with a $110 price target.
Putting Some Defensive Measures in Place Ahead of Tuesday’s Trump Speech

Putting Some Defensive Measures in Place Ahead of Tuesday’s Trump Speech

If you’ve missed our weekly Monday missive that is the Monday Morning Kickoff, we’d encourage you to pursue it later today as it offers both context and perspective on last week, including much talk about the Fed, and sets the stage for this week.

This week, we’ve got a lot of data coming at us, more corporate earnings that prominently feature our Cash-strapped Consumer and Fattening of the Population investing themes. There are a number of events and conferences as well, and before too long we’ll have some thoughts on this week’s Mobile World Congress, an event that meshes very well with our Connected Society, Disruptive Technology and Cashless Consumption investing themes.

We expect to see a number of announcements ranging from new smartphone models, connected as well as autonomous vehicle developments, voice digital assistant initiatives, drones, and payment systems to name a few. We’ll be watching these with regard to a number of positions on the Tematica Select List, including Universal Display (OLED), Nuance Communications (NUAN), AT&T (T), Dycom Industries (DY), CalAmp (CAMP) and Alphabet (GOOGL) as well as Amazon (AMZN). Already Amazon has announced it will bring its Alexa VDA to Motorola’s smartphones, and we see that as the tip of the proverbial iceberg his week.

As the Mobile World Congress gets underway, however, we have another event that should capture investor attention. After presenting today what’s called a “skinny budget”, (which we view as the “opening bid budget”) tomorrow night President Trump will be speaking to a joint session of Congress. Typically this is referred to as the State of the Union Address, but it’s not called that for a newly elected president. Trump has already shared that he will be talking about health care reform — “We’re going to be speaking very specifically about a very complicated subject…I think we have something that is really going to be excellent.”

As we’ve said before, we’re optimistic and hopeful, but thus far it seems Republicans have yet to find common ground on how to move forward on this. In addition to healthcare reform, investors, including us, will be listening for more details on Trump’s fiscal policies. The issue is speeches such as this tend to be lacking in specifics, and we would be rather surprised to see Trump deviate from that tradition. Moreover, we’ve already seen the Treasury Secretary push out the timetable for a tax report to late summer, and Trump himself suggested that we are not likely to see his tax reform proposal until after the healthcare reform has been addressed.

As we shared in this morning’s Monday Morning Kickoff, with the S&P 500 trading at 18x expected earnings, it looks like the stock market is out over its ski tips. Two drivers of the market rally over the coming months have been:

  • The improving, but not stellar economic data
  • The hope that President Trump’s policies will jumpstart the economy.

We’ve been saying for some time that the soonest we’d likely get any meaningful impact from Trump’s policies would be the back half of 2017. That’s been our perspective, but as we know from time to time, the stock market can get ahead of itself, and we see this as one of those times. The stock market’s move reflects expectations for an accelerating economy – it’s the only way to get the “E” that is earnings growing enough to make the market’s current valuation more palatable.

 

Need to Keep Our Eyes on Both Sides of the Equation

One of the common mistakes we see with investors is they almost always only focus on the upside to be had, without keeping an eye on the downside risks. If Trump is successful when it comes to the domestic economy, and we’d love nothing more than to see acceleration here, earnings will likely grow materially.

One of the potential risks we see this week is the market being disappointed by the lack of details that Trump will share tomorrow night, which might be read as a push out in timing relative to what the stock market expects. As we said on last week’s Cocktail Investing podcast, resetting expectations is a lot like children that open presents on Christmas morning to find something other than what they expected — it’s far from a harmonious event and more like one that is met with mental daggers, confusion, and second guessing. In short, not a fun time at all.

For that reason, we’re going to make some defensive adjustments to the Tematica Select List, which has enjoyed the market rally over the last few months and led to strong moves in our Universal Display (OLED), AMN Healthcare (AMN), Costco Wholesale (COST) shares as well as several others.

 

With an eye toward preserving profits, we are going to introduce the following stop losses:
  • Alphabet (GOOGL) at $800
  • Universal Display at $70
  • AMN Healthcare at $37
  • PowerShares NASDAQ Internet Portfolio ETF (PNQI) at $90

 

Alongside these new stop losses, we’re also going to raise several existing ones:
  • Boost our stop loss on AT&T (T) to $36 from $31
  • Raise our stop loss on International Flavors & Fragrances (IFF) to $115 from $105
  • Boost our stop loss on Costco Wholesale to $170 from $165
  • Increase our stop loss on Disney (DIS) shares to $100 from $87

 

Again, our thought is better to be safe than sorry given where the market currently sits. We’ll continue to review other positions on the Tematica Select List with similar actions where and when it makes sense.

 

Boosting Our Price Target on this Disruptive Technology Company Again

Boosting Our Price Target on this Disruptive Technology Company Again

Last night shares of Disruptive Technology company Universal Display (OLED) popped more than 10% in after-market trading as the company delivered substantially better than expected December quarter results and instituted a new dividend program. Granted the quarterly dividend of $0.03 per share equates to an extremely low dividend yield, but the program, which is expected to include regular quarterly dividend payments, is a signal that Universal sees enough cash generation to invest in the business and return capital to shareholders as the organic light emitting diode market expands.

 

Details Behind Universal Display’s Performance

For the quarter, Universal reported EPS of $0.55 per share, $0.14 ahead of consensus expectations on revenue that rose 20% year over year to $74.6 million, besting expectations of $69 million for the quarter. Breaking down the company’s revenue, licensing fees grew 27% year over year to $43.6 million (58% of revenue), material sales rose 5% to $29.2 million (39%) with the remainder generated by Universal’s contract research business (2%). Simply put, we see licensing business and materials business responding to the rising industry demand for organic light emitting diode displays, a phenomenon of which we are still in the early innings.

As expected, on the earnings call, Universal’s management team trotted out a number of examples of new products and market opportunities that are increasing demand for organic light emitting diode displays, which in turn drive demand for the company’s materials and licensing businesses. We see those examples, which included smartphones from ASUS and Huawei, TVs from Panasonic, LG, automotive lighting applications (tail lights, interior lighting, indicator lights and displays), augmented reality, virtual reality,  as solid reminders that organic light emitting diode display adoption spans far more than just Apple (AAPL) and the next generation iPhone.

If we were to be nit-picky, the only issue to be had with Universal’s earnings report was that management guided 2017 revenue in line with expectations. Coming into last night’s earnings report, consensus revenue for 2017 stood at $242.7 million across just over a handful of analysts and Universal’s guidance put revenue at $230-$250 million. Baked into that company guidance are two $45 million royalty payments from Samsung that land in the second and fourth quarter. In our view that guidance seems conservative, but we also recognize the biggest swing factor in the company’s revenue is not so much new capacity additions, but when that capacity moves past installation and testing, and into active production.

Given expanding capacity from a number of companies including Samsung, LG Display, AUO Optronics, Japan Display, Sharp and China BOE Technology, which is reflected in the order book at capital equipment company Applied Materials (AMAT) and its competitors, there is ample confirmation of expanding capacity over the next few years. Where it gets tricky is predicting the quarterly timing of productive capacity coming on stream. Given our long-term investment horizon, we’re inclined to sit back and be patient as the continued step up in capacity likely means an expanding business at Universal Display and boosting our price target on the shares along the way.

Earlier this week, shares of Applied Materials joined Universal Display shares on the Tematica Select List, and we continue to rate AMAT shares a Buy with a $47 price target.

 

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

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

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

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

 

A Look Ahead to 2018-19 for UPS

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

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

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

 

Embracing Technology of the Future

 

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

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

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

 

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