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Saying adios to Farmland Partners as its dividend gets slashed

Saying adios to Farmland Partners as its dividend gets slashed

 

Key point inside this Alert:

  • We are issuing a Sell on shares of Farmland Partners (FPI) and removing them from the Tematica Investing Select List.

 

While I realize the selling out of Farmland Partners may come as a bit of a surprise to subscribers, I was shocked last night by the dramatic cut to the company’s quarterly dividend that was announced as a part of its disappointing June quarter results. Candidly, given the impact of trade and tariffs, I was inclined to give the June quarter a pass, but when a company slashes its dividend by 75% to $0.05 per share for 3Q 3018 from the expected $0.20 per share per quarter it’s a signal that something is likely amiss.

The fact that the Board “will evaluate the dividend in subsequent quarters” offers little solace, especially given the cut to its outlook. Farmland now expects its 2018 AFFO/share guidance to a range of $0.30-$0.34 from the prior range of $0.40-0.44.

Granted Farmland management tried to explain the dividend cut as a part of the decision by the Board to boost its buyback activity given what it sees as a very undervalued stock.

But… and it’s a big but… one has to wonder why the company opted to cut the 3Q 2018 dividend payment by $5.6 million ($0.15 per share times the 37.5 million shares of common stock outstanding on a fully diluted basis) when it exited the June quarter with $26.4 million in cash on the balance sheet. The math suggests that we’re not likely to see a pronounced rebound in the dividend especially since the company’s revised guidance is heavily weighted to the December quarter.

Am I frustrated?

You bet, but as I have learned over the years it’s far better to stick to the facts and data and to exit the position lest we become emotional and hope it sorts itself out at some point. In other words, remain cold-blooded. I also expect the shorts that have been circling the shares will use the dividend cut to reaffirm their argument, which means FPI shares are likely in for a tough time in the coming months especially with a very different dividend yield to be had compared to when we first acquired them.

Yes, it will be a painful exit given the position will likely be down some 30% from where we added them, but despite the pain, the goal here is to stem the loss of capital (worst case) and avoid a dead money stock (best case).  I suspect we will be better off to let this one go vs. the alternative to be had.

 

 

Costco’s July sales report keeps us bullish

Costco’s July sales report keeps us bullish

Key point inside this alert:

  • Our price target remains $230 for Costco Wholesale (COST) shares, however, we will once again assessing incremental upside to be had based on the context to be found in the July Retail Sales Report.

 

Last night, Costco Wholesale (COST) served up its July sales figures that once again confirmed it continues to take consumer wallet share and open new warehouse locations. We see the month’s data as the latest thesis affirming data point for the company’s business and our position in the shares.

Digging into the particulars of Costco’s July data, net sales hit $10.59 an increase of just over 10% year over year. That brings the trailing three-month year over year increase in net sales to $35.16 billion, up just shy of 12% year over year. Impressive for sure, and the soon to be upon us July Retail Sales Report that will be published next week (Aug. 15) will more than likely once again confirm Costco’s consumer wallet share gains.

One of the keys for these overall revenue gains has been the targeted expansion of the company’s warehouse footprint, which stood at 757 locations exiting July vs. 749 this past April and 736 at the close of July 2017. Excluding the impact of those new openings, which will no doubt drive favorable membership fee income figures, profits and EPS, on a same-store-sales basis, Costco was up 8.3% company-wide (6.4% excluding gas and foreign exchange) in July. This tells us that the core Costco business continues to resonate with consumers, and we see that continuing as we head into the seasonally strong shopping season with Back to School, Halloween, Thanksgiving and the year-end holidays. E-commerce sales climbed more than 20% year over year for the month, which signals the company continues to make inroads as it continues to expand its digital offerings.

Quickly back to the July data for those keeping tabs, each of the company’s reportable segments rose year over year with the strongest gains in the US (up 6.6% excluding gas and foreign exchange) followed by Other International (up 7.1%) and Canada (up 5.0%).

  • Our price target remains $230 for Costco Wholesale (COST) shares, however, we will once again assessing incremental upside to be had based on the context to be found in the July Retail Sales Report.
Digital Infrastructure: the underpinning of today’s digital super highway

Digital Infrastructure: the underpinning of today’s digital super highway

 

 

In our recently reconstituted Digital Lifestyle investment theme, we combined our former Connected Society, Content is King and Cashless Consumption themes to better reflect the increasingly connected and digital consumer. If you missed that post, click here to read the details.

Of course, much the way a car would be challenging to drive if there were no roads or a radio would only play static if there were no radio stations, there would be no Digital Lifestyle to live if the underlying high-speed data networks, increasing computing power, and falling storage costs that make it possible didn’t exist, which is where our new theme, Digital Infrastructure, comes into play.

We define Digital Infrastructure as the foundational services and technologies that enable continuous access to information, commerce, communication, and entertainment that have become a daily fact of life for billions. These include mobile, cable and satellite networks, the equipment that comprise those networks, the companies that build the networks; data centers and the servers, racks, routers and other equipment that enable them; payment processing networks and their point of sale devices; chipsets and modems that allow devices to connect to these networks. But more simply, while the Digital Lifestyle investing theme focuses on the consumer aspect of the connected world, the Digital Infrastructure theme is the highway that connects these devices and carries the data traffic they create.

 

 

The Digital Landscape

Today, there are billions of connected mobile devices, more than 3.5 billion mobile broadband subscriptions, more than 1 billion fixed broadband subscriptions and some 5 billion Internet of Things devices. All of them connect to 1 billion websites and each one is expected to work anytime, anywhere. That is just the beginning. As internet-based technologies are implements in areas such as healthcare, education, and government services both in the developed countries as well as in emerging ones, access to digital services will only become more crucial in the years to come for individuals, businesses and other institutions.

According to Cisco Systems’ most recent Visual Networking Index:

  • Globally, there will be 27.1 billion networked devices in 2021, up from 17.1 billion in 2016.
  • Globally, internet traffic will grow 3.2-fold from 2016 to 2021, a compound annual growth rate of 26%.
  • Globally, the average internet user will generate 57.0 Gigabytes of Internet traffic per month in 2021, up 139% from 23.9 Gigabytes per month in 2016, a CAGR of 19%.
  • In 2021, the gigabyte equivalent of all movies ever made will cross the Internet every 1 minutes.

 

That unquenchable thirst associated with our Digital Lifestyle investing theme periodically leads to network capacity constraints, which in turn leads to the building of new digital networks that expand capacity, improve data speeds and enable a host of new applications. That, in turn, leads to incremental network capacity additions over the ensuing years to alleviate bottlenecks and improve the user experience, and oftentimes creates an opportunity for players such as those in our Disruptive Technologies investment theme to step into the void.

Even as companies such as AT&T and Verizon are building out their next-generation 5G networks they continue to add incremental 4G network capacity to improve network coverage and performance. The same is true for Comcast as it builds out its Xfinity Gig-Speed internet offering that has come a long way from dial-up and DSL service.

For some historical perspective, let’s remember mobile telephony was originally voice-based. That was until the rollout of 2G technology, which brought networks that allowed basic messaging and data services at data speeds up to 250 kilobits per second (Kbps). With a minimum consistent Internet speeds of 144Kbps, 3G was the first move into what was called “mobile broadband”. Next up, of course, came 4G, which offered high speed, high quality and high capacity to users while improving security and lower the cost of voice and data services, multimedia, and internet over IP. The emergence of 4G, in turn, paved the way for mobile applications such as mobile web access, IP telephony, gaming services, high-definition mobile TV, video conferencing, and streaming services.

Moving beyond smartphones, as the cost of connectivity has fallen from both a chipset and service perspective, there has been an explosion in the types of connected devices in other aspects of our lives. Home appliances, door locks, security cameras, cars, wearables, vacuum cleaners, dog collars, and many other devices are getting connected. Gartner predicts that nearly 21 billion devices will be connected to the Internet by 2020.

With 5G technology, we are looking at another leapfrog in network capacity and data speeds that are expected to give rise to the Internet of Things, autonomous cars, virtual reality and other applications that will foster new network connections and demands as well. As 5G networks spread across the globe, we can expect the number of connected devices to explode even further, which of course will begin to bottleneck the 5G networks, necessitating further spending on infrastructure and technologies.  As you can see, the cycle goes on and on and on.

 

 

Making 5G a Reality

North America will likely be the first 5G market as AT&T, Verizon and T-Mobile US/Sprint look to launch those networks in 2019. The latest GSMA Intelligence report on 5G estimates that U.S. operators will spend about $100 billion (excluding spectrum acquisitions) between 2018 and 2020 upgrading their 4G LTE networks and investing in 5G. This should drive incremental revenue for mobile equipment companies Ericsson, Alcatel Lucent, Nokia and Cisco Systems, while also driving activity at those companies like, Dycom Industries, that build the physical networks. Over the longer-term 5G networks will launch in Western Europe and across the globe. Moor Insights & Strategy sees this driving massive IT hardware spending to the tune of $326 billion by 2025. This includes 5G data processing, storage and networking needs in the data center and edge computing, carrier network transformation projects, and 5G modems and IP.

Here’s the thing, the buildout of these next-generation networks takes time as carriers obtain the necessary spectrum and then build the physical network. SNS Research estimates that by 2020, 5G networks will account for nearly 5% of all spending on wireless network infrastructure rising to more than 40% by the end of 2025. What this means is that mobile carriers will continue to spend on soon-to-be legacy 3G and 4G technologies in the interim as they buildout existing network capacity to accommodate demand associated with our Digital Lifestyle investing theme.

Then there is the incremental spending on various backhaul aspects of the network that include wireless solutions as well as fiber, microwave, carrier Ethernet and satellite that moves data to the network backbone to distribution points around the network.  According to Deloitte, without deeper fiber deployment, carriers will be unable to support the projected four-fold in mobile data traffic increase between 2016 and 2021. While a majority of Internet traffic terminates on a wireless device, nearly all of that traffic relies on WiFi access points, homespots, and hotspots connected to wireline broadband infrastructure services such as fiber, coax, or twisted-pair copper. Wireless networks only carry 11% of traffic, implying wireline networks support nearly 90% of total Internet traffic.

And let’s not forget the chipsets needed to connect devices to these 5G networks – the 5G chipset market is expected to grow from $0.4 billion in 2016 to $2.03 billion in 2020 to $ 22.41 billion by 2026, a CAGR of 49% from 2020 to 2026. The primary driver of this will initially be smartphones, which are expected to reach 80-100 million units by 2021 up from 2 million in 2019.

As Hans Vestberg, CEO of Verizon, put it, “5G is an access technology” that will drive even greater data consumption as connected devices move past smartphones. This is expected to create demand for incremental data centers, cloud services, payment processing network capacity and the hardware that powers them. And that’s just inside the US, a more global view that focuses on the global population likely means more consumers adopting our Digital Lifestyle as these connected devices and networks reach their shores.

  • Long-term, IDC expects spending on off-premises cloud IT infrastructure will grow at a five-year compound annual growth rate (CAGR) of 10.8 percent, reaching $55.7 billion in 2022.
  • The global data center deployment spending market is expected to reach $83.7 billion by the end of 2022 up from $44.3 billion in 2017. This reflects the growing number of small and medium enterprises who need servers and other hardware, the emergence of the Internet of Things (IoT) and big data, and surge in the number of smart devices that can be interconnected.

The bottom line is that if there is no Digital Infrastructure to carry mobile payments, online and mobile searching and shopping, stream audio and video content, to carry Tweets and emails as well as Facebook posts, there can be no Digital Lifestyle. As 5G and other new technologies are deployed, the number of data-creating connective devices will expand, eventually pressuring networks and require incremental capacity additions and the deployment of next-generation technologies. Recently Motorola and Verizon launched the world’s first 5G capable smartphone, the Moto Z3, but it’s not what it claims to be as not only are there no 5G capable mobile networks there are no 5G modems available as yet. What the Moto Z3 boasts is a modular and upgradeable structure for when both are available. While clearly intended as marketing to attract attention, it’s a sobering reminder that the disruptive impact to be had with 5G cannot occur until the necessary infrastructure is in place.

 

Tematica’s Digital Infrastructure investing theme and Dycom shares

Tematica’s Digital Infrastructure investing theme focuses on those companies that will benefit from both the buildout of new and existing digital infrastructure from networks, base stations, data centers and related hardware to the chipsets and materials that power them and grant connectivity to a growing array of devices.   As we introduce this new theme, we are using specialty contractor and current Tematica Select List company Dycom Industries (DY) as a sample case study.

As a reminder, Dycom builds the physical networks for AT&T (T), Verizon (VZ), Comcast (CMCSA), CenturyLink, Charter Communications, Windstream Corp. and others. Those six named customers account for 82% of recent quarterly revenue with AT&T being the largest at just over 24%. Of note, while Verizon clocked in third place at just under 17%, that business grew substantially compared to 8.5% in the April 2017 quarter.

The combination of continued 4G mobile network spend, combined with the accelerating spending 5G and gigabit fiber networks across its customer base bodes well for Dycom in the coming quarters. While we acknowledge there have been some timing issues associated with the initial timing of 5G networks, as we’ve heard during the 2Q 2018 earnings season, network operators are shifting their capital spending to favor these new networks ahead of expected launches in the coming quarters.

Verizon expects to launch its fixed 5G service “by the end of ’18” and in May Samsung received FCC approval for the first 5G router. Along with its 5G launch, Verizon is reportedly looking to deliver bundled TV service in partnership with either Apple and Alphabet. AT&T plans to launch its 5G service in a dozen US markets before the end of 2018 alongside its construction of FirstNet, the country’s nationwide public safety broadband platform dedicated to first responders. Rounding out Dycom’s top three customers, Comcast continues to invest in line extensions to reach more business and residential customer addresses as well as other network investments including the buildout of its gigabit fiber offering.

That pick up in spending is expected to drive a 23% increase in revenue during the second half of 2018 compared to the first half with further growth in 2019 as 5G network building continues. As building activity for these new networks escalates, Dycom’s margins should benefit from greater absorption of labor and field costs as well as SG&A costs that drives favorable incremental operating margins and Eps generation.

Dissecting Dycom’s most recently quarterly earnings and revised outlook that calls for EPS of $1.78-$1.93 in the first half 2018, to hit its new full year 2018 target EPS of $4.26-$5.15, it means delivering EPS of $2.98-$3.22 in the back half of the year. In other words, a pronounced pick up in business activity that reflects network buildout activity from its customers. As that activity continues in 2019, consensus expectations have Dycom earnings nearly $6.50 per share, up from $3.88 per share in 2017. Our $125 price target equates to roughly 19x 2019 EPS expectations.

Dycom’s business tends to be seasonal in nature given the impact of weather, particularly winter weather on construction conditions. This can result in work disruptions and timing issues, which is one of the reasons that we prefer to look at Dycom on a multi-quarter basis.

  • As we introduce our Digital Infrastructure investing theme, we are reiterating our $125 price target on shares of Dycom Industries (DY) as we reclassify the company in this new theme.

 

Examples of other companies riding the Digital Infrastructure investment theme tailwind:

  • Adtran (ADTN)
  • Alcatel Lucent (ALU)
  • Alphabet/Google (GOOGL)
  • Amazon (AMZN)
  • Applied Optoelectronics (AAOI)
  • ARRIS International (ARRS)
  • AT&T (T)
  • Broadcom (AVGO)
  • CenturyLink (CTL)
  • Cisco Systems (CSCO)
  • CommScope (COMM)
  • Corning (GLW)
  • Digital Realty Trust (DLR)
  • Dycom Industries (DY)
  • Encore Wire (WIRE)
  • Equinix (EQIX)
  • Ericsson (ERIC)
  • Harmonic (HLIT)
  • Intel (INTC)
  • Lumentum Holdings (LTE)
  • MasterCard (MA)
  • Maxlinear (MXL)
  • Motorola Solutions (MSI)
  • Nokia (NOK)
  • Nvidia (NVDA)
  • Power Integration (POWI)
  • Qualcomm (QCOM)
  • Skyworks Solutions (SWKS)
  • STMicroelectronics (STM)

 

Eye on the long-term prize with Disney shares

Eye on the long-term prize with Disney shares

 

Key Point Inside this Alert:

  • We are boosting our price target on Walt Disney (DIS) shares to $130 from $120.

 

Last night Walt Disney (DIS) reported June quarter results that missed expectations modestly on the top and bottom line, taking some wind out of the shares in after-market trading. To be fair, Disney shares have ascended quickly quarter to date as it became clear that it would be the one to acquire the TV and movie assets at 21st Century Fox (FOXA). That melt up put DIS shares in the position to having to deliver upside relative to expectations to justify the share price move over the last five weeks, but those new catalysts won’t begin to fire for Disney for a few quarters.

I continue to see many positives associated with that transaction, which include adding the vast Fox content library to Disney’s existing one that spans its historical characters as well as Marvel, Star Wars, and Pixar. As the transaction closes, Disney will likely reveal its strategy to integrate the properties, but odds are it will focus on the existing Disney strategy to leverage tentpole franchises across its various businesses like we are seeing with Marvel, Star Wars and Pixar across its parks and consumer businesses. Believe me, there is no reason to complain about that strategy given its success; if anything, the Fox acquisition allows Disney to double down on that strategy.

The Fox assets will also give a positive shot in the arm to Disney’s international plans given Fox Networks Group International’s 350 channels that reach consumers in 170 countries, while Star reaches 720 million viewers a month across India and more than 100 other markets. That library also shores up Disney’s competitive position for the expected launch of its own streaming services in late 2019, which the financial media has come to call “Disflix”. My view remains that if Disney is successful in deploying its streaming service — a service that will tap into a vast content library and is expected to be priced below Netflix’s (NFLX) streaming service — investors will have to revisit how they value the company, especially if the streaming service becomes a meaningful part of Disney’s sales and profit stream.

So, if one is focused on the rear-view mirror that was the company’s 2Q 2018 quarterly results I can understand some disappointment with the top and bottom line misses, but to me, it is the coming quarters where the action is when it comes to Disney. No doubt, there will be challenges along the way, but over the coming 12-24 months, the scope and scale of Disney will be far greater with solidified competitive moats around its business. For that reason, I am nonplussed by the company’s June quarter results and while we recognize the need to be patient with Disney given the timing of these two key transformative events, we have a vibrant array of films hitting the box office in 2019 that include Captain Marvel, Dumbo, Avengers, Aladdin, Toy Story 4, The Lion King, Artemis Fowl, Jungle Cruise, Frozen 2 and Star Wars: Episode IX.

While I we will certainly be able to dig far more into the details as the Fox acquisition closes, Disney has shared that it expects to achieve $2 billion in cost-related synergies associated with the Fox transaction and that has us bumping our long-term price target on DIS shares to $130 from $125. As management shares potential revenue synergies and updates its cost savings prospects as well as simply runs the existing business leveraging its 2019 content pipeline, I’ll look to revisit our price target as needed.

  • We are boosting our price target on Walt Disney (DIS) shares to $130 from $120.

 

Weekly Issue: Booking a Tasty Gain in this Guilty Pleasure Stock

Weekly Issue: Booking a Tasty Gain in this Guilty Pleasure Stock

Key points inside this issue

  • Earnings continue to roll in as trade tensions remain and economic data is in conflict.
  • We are selling half the position in Habit Restaurant (HABT) shares on the Tematica Investing Select List, booking a hefty win in the process, and boosting our price target on the remaining shares to $16 from $12.
  • Our price target on Costco Wholesale (COST) shares remains $230
  • Our price target on United Parcel Service (UPS) shares remains $130.

 

We are now more than one-third of the way through the September quarter, and firmly into the month of August, a time that is traditionally one of the slowest times of the year. Corporate earnings for the June quarter continue to come in and the United States has reimposed sanctions on Iran with additional measures potentially later this year as the Trump administration looks to pressure the Tehran regime to negotiate or step aside.

In response to President Trump instructing U.S. Trade Representative Lighthizer to consider raising proposed tariffs on $200 billion in Chinese goods to 25% from 10%, the Chinese government on Friday shared a list of 5,207 U.S. products (meat, coffee, nuts, alcoholic drinks, minerals, chemicals, leather products, wood products, machinery, furniture and auto parts) on which it would impose tariffs between 5% to 25% if the U.S. followed through on proposed tariffs.

The stock market’s performance this week suggests it is shrugging off some of these geopolitical concerns, however, the longer they play out the more likely we are to see them have an impact to earnings expectations. The word “tariff” was mentioned 290 times in S&P 500 conference calls in the first quarter. So far this quarter that number is up to 609, and we have yet to finish the current season. We take this to mean that while many are hopeful when it comes to trade, companies are factoring potential pain into their planning. This could set the stage for a stronger finish to the year if the president is able to deliver on trade. We’ll continue to watch the developments and position the our holdings in the Tematica Select list accordingly.

As we move through the dog days of summer, I’ll continue to chew through the data and heed the messages from all the thematic signals that are around us each and every week.

 

Taking some profits in Habit after a smoking run

Even ahead of last week’s better than expected June quarter results, our shares of Habit Restaurant (HABT) have been rocking and rolling as they climbed just shy of 60% since we added them to the Tematica Investing Select List in early May.

Helping pop the shares over the last few days, Wall Street analysts boosted their forecasts for Habit following strong top and bottom line June quarter results that were driven by several pricing factors and better-than-expected volume, and an outlook that was ahead of expectations. On the pricing front, there were two items worth mentioning. First was the 3.9% increase taken in mid-May to offset California labor pressures, followed by the premium pricing associated with third-party delivery with the likes of DoorDash. As Habit rolls out third-party delivery in other locations and with other partners, such as Seamless with whom it is currently in testing, we are likely to see further pricing benefits that should drop to the bottom line.

Underlying this, our core thesis for the company, which centers on Habit’s geographic expansion outside of its core California market, remains intact. During the June quarter, it opened seven new company-operated restaurants, three of which were drive-thrus. While there were no new East Coast locations during the quarter, Habit remains committed to opening a total of 30 new locations in 2018 with 20% of them on the East Coast — one of which will be right near Tematica in Northern Virginia! Franchisees will add an additional seven to nine locations in 2018, with recently opened ones including Seattle and the second location in China.

In response, we are going to do two things. First, I am boosting our price target for HABT shares to $16, which offers modest upside from the current share price. As we do this, we will prudently book some of those hefty profits to be had given the move in the shares over the last three months, which has them in overbought territory. We will do this by selling half the HABT position on the Tematica Investing Select List, and keep the other half intact to capture the incremental upside. I’ll also continue to monitor the company to gauge its progress relative to revised expectations to determine if another beat is in the cards.

  • We are selling half the position in Habit Restaurant (HABT) shares on the Tematica Investing Select List, booking a hefty win in the process, and boosting our price target on the remaining shares to $16 from $12.

Costco shares get another boost

I recently boosted our price target on Costco Wholesale (COST) shares to $230 from $220. Over the last few weeks the shares have climbed, bringing their return on the Tematica Investing Select List to more than 40%. Yesterday a similar move was had at Telsey Advisory Group (TAG), which raised its COST price target to $230 from $220. The similarities don’t end there as TAG also sees Costco to be a share gainer that should see double-digit growth in earnings per share this year. I’ve said it before, and odds are I’ll say it again, I love it when the herd comes around to our way of thinking.

Later this week, we should receive Costco’s July same-store sales metrics, which should confirm continued wallet share gains but also update us as to the number of open warehouse locations. As a reminder, more open warehouses drive the high margin membership fee income that is a key driver of Costco’s EPS.

  • Our price target on Costco Wholesale (COST) shares remains $230

 

UPS keeps on trucking

Quarter to date, our shares of United Parcel Service (UPS) have soared 13%, bringing the return for us to more than 18%. In my view, the company is clearly benefiting from the improving economy and consumer spending, particularly that associated with our Digital LifeStyle investing theme. As we head into the thick of Back to School spending, let’s remember that UPS is well positioned to benefit not only from Amazon’s (AMZN) Prime Day 2018 but also march toward the year-end holiday spending bonanza that spans from Halloween through New Year’s. Over the last several years, we’ve seen digital shopping win a growing piece of consumer wallets and I see no reason why that won’t continue yet again this year.

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

 

WEEKLY ISSUE: Confirming Thematic Data Points Continue to Pour In

WEEKLY ISSUE: Confirming Thematic Data Points Continue to Pour In

Key points inside this issue:

  • Oh how the stock market has diverged over the last week
  • Ahead of Apple’s (AAPL) upcoming annual product refresh, we are boosting our price target to $225 from $210 for the shares.
  • Our price target on Amazon (AMZN) shares remains $2,250.00
  • Our price target on Costco Wholesale (COST) remains $230.00
  • Our price target on Nokia (NOK) shares remains $8.50
  • Our price target on AXT Inc. (AXTI) shares remains $11.50
  • Our price target on Dycom (DY) shares remains $125.00
  • Here come earnings from Habit Restaurant (HABT)

 

Oh how the stock market has diverged over the last week

Last week the divergence we saw in the major domestic stock market indices continued as both the Dow Jones Industrial Average and the S&P 500 powered higher while the Nasdaq Composite Index and the small-cap heavy Russell 2000 retreated. The technology-heavy Nasdaq moved lower following drops in Facebook (FB) and Twitter (TWTR) late last week, while the Russell’s move lower likely reflecting potential progress on trade following a positive meeting between the US and EU.

In recent weeks, we’ve shared our view that 2Q 2018 earnings season would likely lead to the resetting of earnings expectations, and it appears that is indeed happening. The stock market, however, didn’t expect that resetting to happen with Facebook, Twitter, Netflix (NFLX) and other high fliers. We also shared how that resetting could lead to some downward pressure in the overall market, so we’re not surprised by how it is digesting these realizations.

Also weighing on the market is the realization the 2Q 2018 GDP figure of 4.1%, which was propped up by government spending and some pull forward in demand ahead of tariff phase-ins, is not likely to repeat itself in the current quarter. As we noted above, there was some progress on trade between the US and EU last week — more of an agreement to work on an agreement — and there are still tariffs with Canada, Mexico, and China to face. And as much as we would like to see last week’s progress as hopeful, we’ve heard from a number of companies about how under the current environment higher input costs will weigh on margins and profits in the back half of the year. The response has companies boosting prices to pass along those increased costs, which could either sap demand or stoke inflation concerns.

We saw that rather clearly in the IHS Markit Flash US PMI for July last week. The headline flash PMI index clocked in at 55.9, a three-month low with the manufacturing component at a two month higher while services slipped month over month. One of the key takeaways was summed up by Chris Williamson, Chief Business Economist at IHS Markit who said, “…the July flash PMI is in line with the average for the second quarter and indicative of the economy growing at an annualized rate of approximately 3%.” The same flash report also showed a steep increase in prices with survey respondents citing the impact of tariffs, but also supply chain delays, which in our experience tends to be a harbinger of further price increases.

Because we’re still in the thick of earnings, we’ll continue to assess the situation as more company commentary becomes available and what it means for profits in the coming quarters. Odds are, however, the Fed, is seeing the above and will remain on a path to boost interest rates in the coming months. We’ll get more on that later today when the Fed exits its latest FOMC policy meeting. Barring a meaningful pick up in wage growth it could lead to more restrained consumer spending. We see that as positives for incremental consumer wallet share gains at Amazon (AMZN) and Costco Wholesale (COST) as we head into the seasonally strong shopping season.

  • Our price target on Amazon (AMZN) shares remains $2,250.00
  • Our price target on Costco Wholesale (COST) remains $230.00

 

Apple delivers and boosting our price target in response

We are boosting our price target on Apple (AAPL) shares to $225 from $210. This boost follows last night’s solid June quarter results and guidance, which topped expectations as investors and consumer prepare for the latest iteration of iPhone and other Apple products to hit shelves in the coming months. Here are some of the highlights from Apple’s June quarter:

  • Reported EPS of $2.34 vs. the consensus forecast of $2.18 on revenue of $53.265 billion vs. the expected $52.43 billion.
  • Year over year revenue grew 17% with led by double-digit increases at iPhone, Services and Other while Mac and iPad revenue declined vs. year-ago levels.

Moreover, the company forecasted September quarter revenue to grow double digits sequentially with prospects for an improving gross margin profile. That combination is leading Wall Street to take its EPS expectations higher, and I suspect we will see a number of price target increases this morning.

As exciting as this is — as well as proof positive the Apple model is not broken as some doomsayers would suggest — in several weeks Apple will take the wraps off its revitalized Fall 2018 new product lineup that is expected to have a number of new models across iPhones and iPads. Some products, like iPads, are expected to get new features such as FaceID, while the iPhone X lineup should expand to larger screen sizes as well as lower cost models utilizing an LCD screen instead of an organic light emitting diode (OLED) one. I see the Apple enthusiasm once again cresting higher as that date approaches.

Now let’s break down the quarter’s results:

iPhone revenue grew 20% year over year to $29.9 billion despite tepid smartphone industry dynamics. During the quarter Apple sold 41.3 million iPhones, which paired with the 19% year over year improvement in average selling price (ASP) to $724 vs. $606 in the year-ago quarter drove the revenue improvement. That surge in ASP reflects ongoing demand from the company’s premium iPhone products – iPhone X, iPhone 8 and iPhone 8+.

The Services business grew 30% year over year to $9.5 billion, roughly 18% of overall Apple revenue vs. 16% in the year-ago quarter. The total number of paid subscriptions rose 30 million sequentially to hit 300 million, up from 185 million exiting the June 2017 quarter. I see this as a positive given the subscription nature of iCloud, Apple Music, Apple Care, Texture and other offerings that drive not only cash flow but revenue predictability. During the earnings call, Apple tipped that it has over 50 million Apple Music listeners “when you add our paid subscribers and the folks in the trial…”

As the Services business continues to grow across the expanding Apple device install base, accounting for a greater portion of revenue and profits, odds are investors will begin to re-think how they value Apple shares, especially as the company’s dependence on iPhone sales is lessened at least somewhat. That will be especially true as Apple tips its original content plans, from both a programming perspective as well as pricing and subscription plan one.

Other products grew 37% vs. the year-ago quarter driven by wearables (Apple Watch, Air Pods, Beats) to account for 7% of overall revenue for the quarter.

For the September quarter, Apple guided revenue to $60-$62 billion with gross margin between 38.0-38.5% (vs. 38.3% in the June quarter). That double-digit sequential revenue improvement looks strong heading into the Fall unveiling of new devices, including multiple iPhone models, which as I mentioned earlier is expected to include a larger screen sized iPhone X model as well as a new iPhone X model and a lower priced one with an LCD screen. That implies a rebound in unit volume growth tied with favorable ASPs to drive iPhone revenue growth in the coming quarters. Of course, I continue to see the next major upgrade cycle tied to 5G, which increasingly looks to go live in North America during 2019 and outside the US thereafter.

Investor confidence in new products and Apple’s new product pipeline should be bolstered by the growth in R&D spending that has now outpaced revenue growth in 24 of the last 25 quarters. Historically speaking, when this has happened in the past, it was a forbearer of Apple unveiling a number of new products, including a new product category or two. While it would be easy to read into the possibilities of potential products as 5G goes mainstream, we’ll continue to focus on the near-term upgrades to be had in a few month’s time and what it means for Apple’s businesses.

Exiting the quarter, Apple’s balance sheet had a net cash position of $129 billion even after retiring some 112 million shares during the quarter. On a dollar basis that was $20.7 billion spent on share repurchases during the quarter, including the last part $10 billion of its prior authorization. That leaves roughly $90 billion under its current $100 billion authorization and we continue to see the company supporting the shares with that mechanism.

Finally, last night Apple’s board of directors has declared a cash dividend of $0.73 per share of the Company’s common stock. The dividend is payable on August 16, 2018, to shareholders of record as of the close of business on August 13, 2018.

In sum, it was a stronger than expected quarter that showed Apple’s various strategies bearing fruit with more to come as it updates existing products and introduces new ones as well as new services. If there was one disappointment in the earnings release and conference call it was the lack of discussion around 5G and original content efforts, but my thinking on that is good things come to those who wait.

  • Ahead of Apple’s (AAPL) upcoming annual product refresh, we are boosting our price target to $225 from $210 for the shares.

 

Nokia scores the biggest 5G contract win thus far

Earlier this week, T-Mobile (TMUS) named Nokia (NOK) as a supplier for $3.5 billion in 5G network gear, making this the largest 5G deal thus far. This is clear confirmation of the coming network upgrade cycle that bodes well for not only Nokia’s infrastructure business but will expand the addressable market for its licensing business as well.

Nokia’s deal with T-Mobile US is multi-year in nature, which means the $3.5 million will be spread out over eight-plus quarters. To put some perspective around the size of that one contract, over the last two quarters, Nokia’s infrastructure business has been averaging a little over $5 billion per quarter.  In our view, this speaks to the diverse nature of the customer base across not only the US but the EU, Africa, and Asia.

The thing is, 5G networks will be coming to each of those geographies over the coming years, and for those further out deployments, mobile carriers will be adding incremental 4G LTE capacity.  In other words, we are at the beginning of the 5G buildout, and it may seem like it has taken longer than expected to emerge, the data points from smartphone components to network builds suggest 2019 will be the beginning of a multiyear upcycle in mobile infrastructure demand.

And a quick reminder, we see the coming 5G buildout and the necessary smartphones and other devices driving demand for AXT Inc.’s (AXTI) compound semiconductor substrates. Those shares have been bouncing around like ping-pong balls of late, but we’ll continue to focus on the long-term drivers such as 5G and the eventual smartphone upgrade cycle.

And I would be remiss if I didn’t touch on Dycom Industries (DY) as well. To me, this T-Mobile US news says it is serious about building out its 5G network, and I strongly suspect both AT&T (T) as well as Verizon (VZ) will be sharing their own buildout plans in the coming days and weeks. These carriers are all about one-upping each other be it on data plan pricing or how good their networks are. As AT&T and Verizon fight back, it’s a solid reminder of the activity to be had for Dycom’s specialty contracting business.

  • Our price target on Nokia (NOK) shares remains $8.50
  • Our price target on AXT Inc. (AXTI) shares remains $11.50
  • Our price target on Dycom (DY) shares remains $125.00

 

Here come earnings from Habit

Quickly turning to Habit Restaurants (HABT), the company will report its quarterly earnings after today’s market close. Consensus expectations are looking for EPS of $0.03 on revenue of roughly $100 million for the June quarter. Ahead of that report, Wall Street is coming around to the Habit story. On Monday, investment firm Wedbush bumped up their price target to $15 from $12 and upped their rating to Outperform from Buy. Yes, I am wondering where they’ve been for the last 30% plus rally in HABT shares…

The gist of the upgrade reflects the positive impact to be had from recent price increases as well as premium pricing associated with delivery. Those are certainly positive drivers for revenue and margins, however, I continue to see the bigger thesis centering on the company’s geographic expansion. That expansion means more burgers and shakes being sold in more locations, drive-thru, and delivery. In other words, it’s the platform that allows for these other margin improving activities. This means I’ll be watching the company’s capital spending plans for the coming quarters.

As tends to be the case, I’ll be reassessing our $11.50 price target with tonight’s earnings report given the shares have sailed right through it over the last few days.

  • Heading into tonight’s earnings report, our price target on Habit Restaurant (HABT) shares remains $11.50.

 

What a difference between Facebook and Amazon June quarter results make

What a difference between Facebook and Amazon June quarter results make

 

Key points:

  • As we sail into the seasonally stronger second half of the year, I am boosting our price target on Amazon (AMZN) shares to $2,250 from $1,900, which keeps the shares on the Tematica Investing Select List.
  • After a disappointing outlook for the back half of 2018 due to slower revenue growth and mounting spending costs, we will remain on the sidelines with Facebook (FB) shares for now.

 

Over the last few days, we’ve had quarterly results from two companies that are riding tailwinds associated with our Digital Lifestyle investment theme – Facebook (FB) and Amazon (AMZN). The report from each company, however, and their reception from investors couldn’t have been more different.

Amazon’s earnings report reflected continuing strength as consumers across the globe embrace digital commerce and the company’s Amazon Prime service, while Amazon Web Services saw its business and profits surge as cloud adoption continues. Facebook on the other hand … is a very different story. A story that included rising costs and slowing revenue growth, which led the social media giant to not only miss revenue expectations but signal slower growth and earnings ahead.

No surprise then that Facebook shares were pummeled, while Amazon traded higher. Now let’s break both of those reports down, focusing on what matters with each.

 

Amazon – Operating Income Crushes Expectations

Last night, Amazon reported blowout June quarter earnings, which more than overshadowed a modest top-line miss as its operating income not only crushed expectations but shattered the company’s own guidance. On almost every front for each of its three business segments — North America, International and Amazon Web Services (AWS) — the company continued to make solid progress, delivering its third straight quarter with profits over $1 billion and continuing the string of a dozen profitable quarters. I doubt we’ll be hearing much from those “no profit at Amazon” naysayers anymore.

As I’ve said previously, one of the “secret weapons” that Amazon has under its hood is it’s the high margin and cash flow rich Amazon Web Services (AWS) division, and the June quarter clearly confirmed that. Revenue at AWS rose 49% year over year. That’s a figure that clearly shows Amazon is fending off the likes of Alphabet (GOOGL) and Microsoft in the cloud computing space. To me, the more important figure was the operating profit that AWS generated, $1.6 billion, which is up an impressive 80% year over year, and roughly 47% of the company’s overall operating profit. On the earnings call, management shared that machine learning, artificial intelligence and analytics have been key drivers of AWS’s revenue gains, which to me cements Amazon’s position in our Disruptive Innovators investing theme.

The balance of Amazon’s operating profit was generated by the company’s North American business as International continued to generate operating losses, albeit less than a year ago, as Amazon target future growth in those markets.

That profit generation and prospects for more led Wall Street to overlook the modest top-line miss for the quarter, but then again, it’s hard to complain at the 39% year over year revenue growth Amazon did deliver. Amazon also served up a September quarter revenue forecast in the range of $54-$57.5 billion, which was also below analysts’ consensus estimates. Here again, those same analysts will have to adjust their profit forecasts higher following AWS’s performance in the June quarter. My take is the combination of the recent Prime membership price increase ( a 20% increase to $119 per year) and Prime Day paired with what will likely be an aggressive attack on Back to School shopping could make for conservative 3Q 2018 revenue guidance.

One other potential upside driver for Amazon in the coming quarters is its digital-advertising business. In the segment breakdown, this is found in the often overlooked “Other” category, which generated $2.1 billion in revenue for the June quarter (wish I had an “other” revenue source like that!). While it accounted for less than 4% of overall quarterly revenue, these Other items grew nearly 130% year over year.  Amazon does not disclose Other’s profitability metrics, given that the digital advertising business is one of the larger ones in the category with billions in revenue and hundreds of thousands of customers, but odds are it has the potential to be wildly profitable if it isn’t already.

For those unfamiliar with Amazon’s digital advertising business, it is attracting spending that would have traditionally taken place in brick-and-mortar stores to ensure good “shelf placement” and other brand initiatives across Amazon.com. Small today, compared to advertising efforts at Google and Facebook, but Amazon is able to tell its advertising customers when a consumer actually bought a product, directly showing an ad’s effectiveness — something Google and Facebook can only accomplish through tracking cookies and other data mining techniques, which are not 100% accurate and are also coming under the scrutiny of privacy advocates more and more these days. Of course, all of this also allows Amazon to amass a sea of data that it can use to formulate its next move with its own private label products — forcing retailers into a dance with the devil of sorts.

If there was anything disappointing on Amazon’s earnings call it was the lack of comment on the company’s announced acquisition of online pharmacy PillPack. Not surprising given the company’s usual tight-lipped nature, but still disappointing.

  • As we sail into the seasonally stronger second half of the year, I am boosting our price target on Amazon (AMZN) shares to $2,250 from $1,900, which keeps the shares on the Tematica Investing Select List.

 

 

Facebook – the bloom is off the rose

Ouch! There is no other way to say it given the 19% drop in Facebook (FB) shares following what can only be described as unexpected results inside its June-quarter earnings report. While the market might have been caught flat-footed, it was the privacy and user data issues at Facebook that led us to remove the shares from the Tematica Select List back in March as we saw the risk-reward trade-off to be had as limited.

Despite those slipups, expectations have been running high for Facebook as advertisers look to reach increasingly connected consumers across Facebook, Instagram and the company’s other social media platforms. Indeed, those expectations and the potential impact to Facebook’s revenue and bottom line were what catapulted the stock from $160 in late April to Wednesday’s closing price of over $217.50. That’s a surge in excess of 35% in 14 weeks, compared to a 6.7% rise in the S&P 500 over the same time frame.

But that was before the June quarter earnings report and conference call…

While Facebook reported a bottom line beat and rising revenue per customer in the U.S. for the June quarter this week, the rest of the earnings press release and conference call took the bloom off the rose at the social media juggernaut. Revenue for the quarter missed expectations and management guided for declines in revenue growth in the back half of 2018 as spending on safety and content continue leading to a one-two punch to its operating margins. For those tracking monthly and daily active users, there was saw a sequential dip with the U.S. users flat but a 3 million drop in Europe due in part to General Data Protection Regulation (GDPR) that went into effect in late May.

You may recall that earlier this year management telegraphed a shift toward a focus on building community, which would likely hit revenue growth, but as management shared on the earnings call, it expects “revenue growth rates to decline by high-single-digit percentages from prior quarters sequentially in both Q3 and Q4.” Not exactly the vector or velocity that investors had been expecting at all.

Adding to the shock and awe of it all was the simple fact that this was the first time Facebook has missed expectations since the March 2015 quarter. However, continued investment and revenue pressure is expected to take its toll and we are seeing operating margin expectations reverse course — going to mid-30% vs. the mid-40% that was previously forecasted by Wall Street for 2018 and 2019.

The net result has Facebook shares crashing as analysts put pencil to paper to re-forecast top and bottom line expectations. While that happens, we’ve already seen several investment banks slash their price targets to the $180-$185 level and a number of them also cut their “Buy” ratings to “Hold.”

Of course, the main question is that since March we’ve been on the sidelines with Facebook shares as of late, we have to ask is now the time to jump in? The removal of Facebook from the Tematica Investing Select List stemmed from the potential fallout from Cambridge Analytica as well as implications from the phase in of GDPR. There was also the hefty amount of insider selling on behalf of CEO Mark Zuckerberg as well as COO Sheryl Sandberg. When management is selling that much stock that fast, it’s usually not a good sign. At a minimum, and no matter the actual reason for the sale, it raises a flag.

Getting back to the question raised, above, we believe it hinges on the value in the shares relative to revised EPS expectations and management gaining back some credibility.

Do I expect advertisers will continue to utilize all of Facebook’s platforms to reach consumers? Yes, but even Facebook has stated that corporate advertising using Instagram’s Stories is ramping slower than expected.

For me, Facebook shares will sit in “stocks to keep tabs on” group until we see user engagement metrics rebound and the share price reflects not only revised growth prospects but a favorable value to be had. I don’t expect that to happen in just a few days. That said, I’ll be watching how those revised EPS and revenue expectations shake out. Thus far, 2018 EPS expectations have dropped to $7.31 from $7.74, while those for 2019 have fallen to the $8.50 level from nearly $9.30. Hefty cuts, but odds are we won’t see the full impact on consensus revisions for at least a few more days.

 

Disruptive Innovators are more than just technology stocks

Disruptive Innovators are more than just technology stocks

 

KEY POINTS FROM THIS POST

  • As we continue to recast our investment themes here at Tematica, this week we launch a new theme  — Disruptive Innovators.
  • We are adding Universal Display (OLED) shares back to the Tematica Investing Select List as part of our Disruptive Innovators investing theme with a $150 price target.

 

Over the last few weeks, we’ve been reconstituting our collection of investment themes. Following the recent unveiling of our Digital Lifestyle theme, today we are recasting a theme we call Disruptive Innovators. If you thought disruption was only to be had from technology evolution, you’ll want to pay attention.

Every so often a new technology, business practice or other development comes along that upends the status quo: the personal computer; the internet; high speed networks; Google; Uber; the App store; Streaming; Cloud computing; Amazon Prime; mobile advertising, ordering and payments; Light Emitting Diodes (LEDs).

These are just some of the many disruptions that have changed how we think, interact, behave, conduct business, learn, shop and go about our day-to-day lives.

Harvard Business School professor and disruption guru Clayton Christensen says that a disruption displaces an existing market, industry, or technology and produces something new and more efficient and worthwhile. It is at once destructive and creative.

 

 

Established businesses tend to focus on improvements to their existing products and services, usually for their most demanding and most profitable customers. Their focus is on making iterative changes and adjustments along the way, which allows them to maintain their pole position in their particular category, without rocking the boat too much, safe and steady.

Disruptive solutions on the other hand not only look to rock the boat but often tip it over and completely change the lake.

Disruptors often begin by successfully targeting those overlooked customer segments — typically ones that complain about the complexity and cost of existing products and services. The goal of a disruptor is to gain a toehold in a category by removing friction. Oftentimes this could be a technological advance that makes the customer experience much better, which was the case with the introduction of the iPod into the MP3 player market. But disruption can also come in the form of removing friction from the actual process of purchasing a product or service or simply improving the customer experience.

As slow-moving incumbents focus on harvesting profits from mainstream products, disruptive entrants expand their reach and begin to move upmarket, delivering the performance that incumbents’ mainstream customers require, while preserving the advantages that drove their early success. When mainstream customers start adopting the entrants’ offerings in volume, disruption has occurred.

There are numerous examples of this disruptive process to be had, but none greater than mobile phone giant Nokia (NOK). Back in 2007, Nokia sat atop the market with its 41% global market share of the mobile phone category. The cellphone giant, however, completely misread the prospects for the smartphone, a device that reshaped not only a number of industries but one could easily argue it’s the single device that has reshaped all of our lives and is in the process of transforming frontier and emerging economies. At first, it was Blackberry and Palm that gained market share, but when Apple introduced the first iPhone — a device that featured a disruptive capacitive touchscreen and full internet browsing — the writing was on the wall for Nokia’s handset business.

Another example of the creative destruction that disruptors cause came in our media consumption habits. It really wasn’t too long ago that music, TV shows, movies, books, software and games were once sold only in physical formats. Today, in large part due to devices like the iPhone, iPad and Kindle, much of the media we engage with on a daily basis is downloaded or streamed through the internet directly to the device of choice. That change, destroyed established players such as Blockbuster Video, Borders Books and Tower Records, to name a few, and completely changed the product offering in stores like Best Buy, Target and Wal-Mart.

According to the Recording Industry Association of America, within the $8.72 billion spent in 2017 by U.S. consumers on music, streaming was the dominant growth vehicle, accounting for $5.66 billion in revenue (65%), up from 2016’s $3.96 billion. While digital downloads were hardest hit, falling 22% by volume year over year, physical album sales continued to fall vs. 2016. Underneath that disruptive shift, we find robust 4G LTE mobile networks and highspeed fiber networks as well as storage and increasing processing power.

Interface technologies have morphed from keyboard-mouse to touchpad and with the launch of Apple’s first iPhone 10-years ago capacitive touch. In 2011, Apple launched its digital voice assistant Siri that paved the way for Amazon’s Alexa and Google Home as well as a number of other virtual assistant offerings. While those digital assistants are racking up design wins in consumer appliances and cars, voice interface technology has expanded into other markets including financial services with Bank of America’s Erica, which has more than 1 million users.

At a consumer level, Amazon Prime’s two-day shipping has disrupted how the entire retail industry serves its customers. Online retailers, including Amazon, initially gained a foothold in the retail category because of their competitive advantage in two critical areas — choice and pricing. Amazon’s Prime service, however, removed the two remaining points of friction that came with online shopping — the time and cost of shipping your purchases to your doorstep and the hassle of returning items. Amazon Prime, and other online retailers that have followed Amazon’s lead, have completely removed the need to “just run to the mall” and we are now experiencing a “retailmageddon” that is disrupting the bricks and mortar landscape and transforming what a physical retailer looks like in the United States. Amazon is now looking to do the same with grocery and pharmacy given its acquisitions of Whole Foods and more recently PillPack.

 

 

Disruption Is More Than Just Technology

We now live in a time where technological disruptions are almost expected — one of the main criticisms of the latest round of iPhone’s was their lack of disruptors. But disruptions can come in all aspects of our lives.

Passersby used to hail a taxi, but now using an app they can do the same via their smartphone. Uber has transformed the task of summoning a ride into an easy, affordable proposition. Through its mobile app, users can request a ride and choose a vehicle based on luxury level and fare for their destination, a vast improvement on the old taxi model. As riders shifted from taxis to these on-demand ride services, the shares of Medallion Financial (MFIN), a finance company that focused on taxi medallion lending, saw its shares fall below $5.50 from a peak near $18 in November 2013.

Anyone who has booked a hotel knows it isn’t always an intuitive, cost-effective or pleasant experience. AirBnB has completely disrupted the industry by offering a completely different experience when visiting a new city or destination. Thanks to the company’s disruptive business model, travelers can now look beyond the hotel chains, inns or B&B’s, and rent local rooms in homes or apartments, often at a significant discount to traditional alternatives. AirBnb’s disruptive business model, of course, has the dual benefit of allowing anyone with an extra room, empty apartment, or house to earn a profit from their unused asset.

While those are more recent examples, there are numerous others to be had over the past decades and in each case, a new technology, service or capability has altered the competitive landscape.

 

 

The Disruptors Don’t Always Emerge as the Winner

Of course, not every would-be disruptor gains sufficient footing that its business model or technology becomes sustainable. For example, any number of internet-based retailers pursued disruptive paths in the late 1990s, but only a small number prospered. Pets.com, Webvan, eToys, Drkoop.com, and GeoCities are just a few examples of those that failed.

More recent examples of questionable disruptors include subscription-based movie ticketing service MoviePass and ingredient and recipe meal kit service Blue Apron (APRN). While both are attempting to alter their respective landscapes, MoviePass is contending with the accelerating adoption of streaming video services and fresh proprietary content as well as Hollywood studios continuing to push to offer movies in the home mere weeks after their theatrical review. With Blue Apron, numerous meal kitting companies have popped up as have similar services from the likes of Kroger (KR) and other grocery giants that have removed its early foothold.

Some technologies like 5G and organic light emitting diodes have a long runway in front of them, which necessitates tracking competitive developments and other signposts to determine when they will disrupt past disruptors 4G LTE, liquid crystal displays and LEDs. Other developments, such as augmented and virtual reality as well as drones are waiting for the spark that will stir widespread adoption across businesses and consumers alike.

 

 

Investing In Disruption

Today there are many disruptors spanning information technologies, biological sciences, material science, healthcare, energy, consumer and business services and other fields and are the basis for our Disruptive Innovators investment theme. Some of the technologies and business models we are tracking as part of this investment theme include but are not limited to:

  • 5G
  • Artificial intelligence
  • Autonomous vehicles
  • Blockchain
  • Business services
  • Cloud
  • Display technologies
  • Drones and unmanned vehicles
  • Internet of Things (IoT)
  • Organic light emitting diodes
  • Renewables and clean energy
  • Smart manufacturing (3-D printing)
  • Spatial Computing (augmented/virtual reality)
  • Voice control and digital/virtual assistants

As we examine these and other disruptors, we look for the key enablers of the disruption. In some cases, this could be the service providers themselves, device/technology companies, key component vendors or in some cases intellectual property holders. Using 5G as an example, the array of contenders would include:

  • AT&T (T) and Verizon Communications (VZ) as service providers;
  • Ericsson (ERIC) and Nokia (NOK) as 5G infrastructure players;
  • Chipset companies Qualcomm (QCOM) and Skyworks Solutions (SWKS);
  • And Qualcomm again as well as InterDigital (IDCC) given their respective 5G patent portfolios.

That food chain or ecosystem view enables us to identify key customer-supplier relationships that capture the companies with the widest reach, which tends to reduce customer specific risks. As an example, because Qualcomm and Skyworks sell their chips to the who’s who in smartphones, smartphone market share shifts have a modest impact on their revenue streams.

Could we go deeper into the food chain? We could, but the further down we go, the further removed we could be from the source of disruption. Putting it all together, this investment theme focuses the major disruptive evolutions and then identifies those companies whose bottom lines are best positioned to benefit.

 

Our Disruptive Innovator Leader

One of the companies that match the criteria of a Disruptive Innovator and also holds prime food chain position in its category is organic light emitting diode company Universal Display (OLED). We’ve danced with this company and its shares over the last two years, riding it to heights as Apple (AAPL) prepared to launch the iPhone X that featured an OLED display supplied by Samsung, only to exit the shares as forecasts for that smartphone’s shipments were dialed back. At the time we noted that we still liked Universal’s two-pronged business model comprised of key chemical sales as well as high margin IP licensing.

The good news is that business model remains intact at Universal Display, and we are seeing rising industry capacity for its OLED screens come on line in the marketplace. That was one of the issues that plagued Apple (AAPL) — tight capacity levels that made the OLED display one of, if not the, most expensive components of the iPhone X. With Apple slated to introduce two new OLED smartphone models in a few months, odds are it has tackled those supply issues. Commentary from display equipment maker Applied Materials (AMAT) suggests that to be the case. The notion that Apple isn’t the only driver of OLED demand also remains true given other smartphone manufacturers, including Samsung, Huawei, and Xiaomi, are introducing new models that feature OLED displays, while new TV models incorporating the technology are also hitting shelves later this year. Longer-term, I continue to see OLED technology following the roadmap laid our by light emitting diodes (LEDs) into automotive, specialty lighting and ultimately general illumination replacing traditional lighting and LEDs along the way.

What this means is an expanding array of applications that will grow Universal’s addressable market for the IP business while increasing demand for its chemical business. A very nice push-pull that drives revenue and profit growth over the coming 12-24 months.  As with any company, there are associated risks, and one of them for Universal Display is the risk of slower than expected adoption of OLED technology – we saw that unfold over the last nine months. Another risk is that this disruptive technology itself gets disrupted, which means keeping tabs on new display technology developments.

As we add OLED shares back to the Tematica Investing Select List, we are instilling a $150 price target. That target is based on EPS growth to $3.83 in 2019, up from $1.83 this year and $0.94 in 2015 equates to a compound annual growth rate of 37% over the 2015-2019E time frame. On a price to earnings growth basis, our $150 target equates to a multiple of 1.2x — hardly rich, but in my view one that reflects the protracted demand ramp we encountered during the first half of 2018.

That assessment doesn’t factor in the more than $9.50 per share in net cash on Universal’s balance sheet, which should grow in the coming quarters due to a combination of cash flow and licensing payments. I’d be remiss if I didn’t mention the company’s dividend, but with it clocking in around $0.06 per share per quarter, it’s not going to be a major factor in assessing the share price or for lining shareholder pockets.

  • We are adding Universal Display (OLED) shares back to the Tematica Investing Select List as part of our Disruptive Innovators investing theme with a $150 price target.

 

Examples of companies riding the Disruptive Innovators investment theme tailwinds include:

  • Amazon (AMZN)
  • Applied Materials (AMAT)
  • Cree (CREE)
  • Dropbox (DBX)
  • Grub Hub
  • Interdigital (IDCC)
  • Lyft
  • Nokia (NOK)
  • Nuance Communications (NUAN)
  • Qualcomm (QCOM)
  • Skyworks Solutions (SWKS)
  • Spotify (SPOT)
  • Stamps.com (STMP)
  • Synaptics (SYNA)
  • Uber
  • Universal Display (OLED)

 

 

 

Weekly Issue: Trade Meetings and Earnings Reshape Market Outlook

Weekly Issue: Trade Meetings and Earnings Reshape Market Outlook

Key points from this issue:

  • Earnings from Boeing (BA) and General Motors (GM) signal markets will trade day-to-day as trade meetings and earnings season heat up.
  • Our price target on Dycom Industries (DY) shares remains $125
  • Our AXTI price target remains $11.
  • Our price target on Nokia (NOK) shares remains $8.50
  • Our long-term price target for Farmland Partners (FPI) shares remains $12.
  • As we head into the seasonally strong second half of the year for United Parcel Service (UPS), our price target on the shares remains $130.

 

This week we’ve moved into the meaty part of 2Q 2018 earnings season, and so far, we’ve seen a number of companies beat top and bottom line expectations. Some market observers will point out that some 20%-25% of the S&P 500 group of companies are in that boat, and are declaring “victory” for the market. With today’s earnings from Boeing (BA) that and General Motors (GM), the market is trending lower as Boeing’s outlook falls short of Wall Street expectations while GM cut its outlook due to higher commodity prices. As you probably guessed, one of the culprits for GM is higher aluminum and steel prices.

My take on that is with 75%-80% of the S&P 500 yet to report, that claim while it could prove to right, it also could be a bit premature. As I shared with Oliver Renick, host at the TD Ameritrade Network a few days ago, we’ve only started to see the impact of initial trade tariffs and if the international dance continues we could see far more tariff jawboning put into action.

Consider a tweet from President Trump this morning that suggests a tariff follow through is possible.

 

 

But last night Trump tweeted a path forward to eliminating tariffs and other trade barriers between the Eurozone and the US ahead of his meeting today with the European Commission President Jean-Claude Juncker today to discuss trade, including tariffs on autos.

It would appear Trump is attempting to keep his negotiating opponents off balance in the hopes of improving trade relations from a US perspective. But it also seems that others have read Trump’s Art of the Deal by now as according to EU trade commissioner Cecilia Malmstrom, the Commission is also preparing to introduce tariffs on $20 billion of U.S. goods if Washington imposes trade levies on imported cars.

While I would love to see some forward progress coming out of these talks, but just like with China the probability is rather low in my opinion. Much like with the China trade talks, things have escalated so that both sides will be looking to claim some victory to report back to their countrymen and women.  This likely means that as we migrate over the next few weeks of earnings, we will have to continue to watch trade developments, especially if more recent and wider spread tariffs wind up being enacted.

With more on the earnings and trade to be had in the coming days, we should be ready for day-to-day moves in the market, which will make it challenging for traders and options players. As they struggle, we’ll continue to take a longer-term focus, heeding the signals to be had with our thematic investing lens. Now, let’s get to some updates and other items…

 

Checking in on 5G spending from Verizon and AT&T

With both Verizon Communications (VZ) and AT&T (T) reporting June quarter results yesterday, I sifted through their comments on several fronts but especially on 5G given our positions in mobile infrastructure and licensing company Nokia (NOK), specialty contractor Dycom (DY) as well as compound semiconductor company AXT Inc. (AXTI). The nutshell take is things remain on track as both carriers look to launch commercial 5G networks in the coming quarters.

Verizon delivered solid quarterly results, buoyed by its core wireless business that added 531,000 net retail postpaid subscribers, which included 398,000 postpaid smartphone net adds. We’ve talked about how sticky mobile service is with consumers as smartphones are increasingly a life link for their connected lives so it comes as little surprise that Verizon’s customer loyalty remains strong with the quarter marking the fifth consecutive period of retail postpaid phone churn at 0.80 percent or better.

In terms of capital spending, a figure we want to watch as Verizon gets ready to launch its commercial 5G network, the company shared its 2018 spend will be at the lower end of its previously guided range of $17.0-$17.8 billion. Now here’s the thing, the mix of spending will favor 5G, which confirms the bullish comment and tone we shared last week from Ericsson (ERIC) on the North American 5G market.

With AT&T, its net capital spending in the June quarter slipped to $5.1 million, down from roughly $6 million in the March quarter but the company shared it will spend roughly $25 billion in all of 2018. Doing some quick math, we find this spending is weighted to the back half of 2018, which likely reflects investments in its 5G network as well as the new first responder network, FirstNet, it is building. During the earnings call, management shared the company now has 5G Evolution in more than 140 markets, covering nearly 100 million people with a theoretical peak speed of at least 400 megabits per second with plans to cover 400 plus markets by the end of this year. In terms of true 5G, trials are progressing and AT&T is tracking to launch service in parts of 12 markets by the end of this year.

That network spend and 5G buildout bodes well for both our Dycom shares.

  • Our price target on Dycom Industries (DY) shares remains $125

 

In addition, a few days ago mobile chip company Qualcomm (QCOM) shared that its 5G antennas are ready from prime time. More specifically, Qualcomm is shipping 5G antennas to its device partners that include Samsung, LG, Sony (SNE), HTC and Xiaomi among others for testing. Moreover, Qualcomm said it stands ready for “large-scale commercialization” which likely means 5G devices are just quarters away instead of years away.

We’d note those device partners of Qualcomm’s mentioned above have all announced plans to bring initial 5G powered phones to market during the first half of 2019. That means the supply chain will be readying power amplifiers and switches that will enable these devices to communicate with the 5G networks, which bodes well for incremental compound semiconductor substrate demand at AXT. Because 5G is being viewed as an “access technology” that will move mobile broadband past smartphones and similar devices, I continue to see this as a positive for the higher margin licensing business at Nokia as well.

As a reminder, AXT will report its quarterly results after tonight’s market close, and expectations for its June quarter are clocking in at $0.08 per in earnings on $26.1 million in revenue, up 60% and roughly 11% year over year.

  • Our AXTI price target remains $11.
  • Our price target on Nokia (NOK) shares remains $8.50

 

Farmland Partners fights back

A few weeks ago, we shared not only our long-term conviction for Farmland Partners (FPI) shares but also prospects for continued drama in the coming months. Well, let’s say we’re not disappointed as this morning the company filed a lawsuit in District Court, Denver County, Colorado against “Rota Fortunae” (a pseudonym) and other entities who worked with or for Rota Fortunae in conducting a “short and distort” scheme to profit from the sharp decline in Farmland’s stock price resulting from false and misleading posting on Seeking Alpha. Farmland is seeking damages and injunctive relief for defamation, defamation by libel per se, disparagement, intentional interference with prospective business relations, unjust enrichment, deceptive trade practices, and civil conspiracy.

Are we surprised? No, especially since the Farmland management team signaled it would be moving down this path. While this will likely result in some incremental noise, we’ll continue to focus on the business and the long-term drivers of the agricultural commodities that drive it.

  • Our long-term price target for Farmland Partners (FPI) shares remains $12.

 

Paccar delivers on the earnings front, boosts its dividend

Tuesday morning, heavy and medium duty truck company Paccar (PCAR) delivered strong June quarter results, beating on both the top and bottom line. For the quarter, Paccar reported earnings of $1.59 per share, $0.16 better than the $1.43 consensus on revenues that rose more than 24% year over to year to $5.47 billion, edging out the $5.39 billion that was expected. The strength in the quarter reflects not only rising production and delivery levels that reflect the pick up in truck orders over the last 6-9 months, but also the ripple effect had on the company’s high margin financing business. Also too, as truck up time increases as does the number of Paccar trucks in service, we’ve seen a nice pick up in the company’s Parts business that carries premium margins relative to the new truck one.

During the quarter, Paccar repurchased 1.21 million of its common shares for $77.2 million, completing its previously authorized $300 million share repurchase program. The Board of Directors approved an additional $300 million repurchase of outstanding common stock earlier this month and given the current share price that is below that average repurchase price we suspect this new program will be put to use quickly. Also during the quarter, Paccar boosted its quarterly dividend to $0.28 per share from $0.25, and management reminded investors of the company’s track record of delivering quarterly and special dividends in the range of 45-55% of net income.

Given 111% year over year growth in the new heavy truck orders throughout the U.S. and Canada during the first half of 2018, we continue to be bullish on PCAR shares as we head into the second half of 2018. Even so, we’ll continue to analyze the monthly truck order data as well as freight indicators and other barometers of domestic economic activity to assess the continued strength in new truck demand. In the coming months, we expect long-time followers of Paccar will begin to focus on the potential year-end special dividend the company has issued more often than not.

  • Our price target on Paccar (PCAR) shares remains $80.

 

A quick note on United Parcel Service earnings

Early this morning, United Parcel Service (UPS) beat estimates by a penny a share, with an adjusted quarterly profit of $1.94 per share. Revenue beat forecasts, as well, boosted by strong growth in online shopping – no surprise to us given our Digital Lifestyle investing theme. UPS will host a conference call this morning during which it will update its outlook for the back half of the year, and that should help quantify the year over year growth in Amazon’s (AMZN) Prime Day 2018 ahead of its earnings report later this week.

  • As we head into the seasonally strong second half of the year for United Parcel Service (UPS), our price target on the shares remains $130.

 

 

Amazon shares some Prime Day results, Bullish 5G comments from Ericsson

Amazon shares some Prime Day results, Bullish 5G comments from Ericsson

Key points in this issue:

  • Our $1,900 price target for Amazon (AMZN) shares is under review with an upward bias.
  • Our price target on United Parcel Service (UPS) remains $130.
  • Our price target on Dycom (DY) shares remains $125.
  • Our price target on AXT Inc. (AXTI) shares is $11.
  • Our price target on Nokia (NOK) shares is $8.50.

 

Follow up on Prime Day 2018

As the dust settles on Amazon’s (AMZN) 2018 Prime Day, the company shared that not only did Prime members purchase more than 100 million products during the 36-hour event, but that it was also the “biggest in history.” While details were limited, this commentary like means the 2018 event handily eclipsed last year’s. Adding credence to that was the noted addition of Prime Day in Australia, Singapore, the Netherlands, and Luxembourg, which brought the total event country count to 17. It was also reported that Prime Day Sales on Amazon’s third-party marketplace were up some 90% during the first 12 hours of Prime Day this year.

All very positive, but still no clarity on the overall magnitude of the event relative to forecasts calling for it to deliver $3.4-3.6 billion in revenue. There was also no mention about the number of new Prime members that joined the Amazon flock, but historically Prime Day has led to a smattering of conversions and with it occurring in 17 countries this year, including four new ones, odds are Amazon continued to draw in new Prime users.

As we mentioned yesterday, our $1,900 price target for Amazon shares is under review with an upward bias. In looking at Prime Day from a food chain or ecosystem perspective, we see it benefitting the package volume for Tematica Investing Select List resident United Parcel Service (UPS). I’ll be looking for confirming data in comments from United Parcel Service when it reports its 2Q 2018 quarterly results on July 25 as well as any insight it offers on Back to School shopping and the soon to be upon us year-end holiday shopping season. Let’s also keep in mind that UPS will share those comments one day before Amazon reports its quarterly results on July 26.

  • Our $1,900 price target for Amazon (AMZN) shares is under review with an upward bias.
  • Our price target on United Parcel Service (UPS) remains $130.

 

Ericson’s 5G comments are positive for Dycom, AXT and Nokia shares

Also yesterday, leading mobile infrastructure company Ericsson (ERIC) reported its 2Q 2018 results, and while we are not involved in the shares, its comments on the 5G market bode very well for our the shares of specialty contractor Dycom Industries (DY) and compound substrate company AXT Inc. (AXTI) as well as mobile infrastructure and wireless technology licensing company Nokia (NOK).

More specifically, Ericsson called out that its sales in North America for the quarter increased year over year due to “5G readiness” investments across all of its major customers. This confirms the commentary of the last few weeks as AT&T (T) and Verizon (VZ) – both of which are core Dycom customers – move toward commercial 5G deployments in the coming quarters.

We’ve also heard similar comments from T-Mobile USA (TMUS) as well. But let’s remember that 5G is not a US-only mobile technology, and we are seeing similar signs of readiness and adoption for its deployment in other countries. For example, the top three mobile operators in South Korea are working to launch the technology in March 2019. Mobile operators in Spain are bidding on 5G spectrum, France has established a roadmap for its 5G efforts and recently the first end to end 5G call was made in Australia.

While the US will likely be the first market to commercially deploy 5G service, it won’t be the only one. This means similar to what we have seen with past mobile technology deployments such as 3G and 4G LTE, this global rollout will span several years. While Ericsson’s North American comments bode well for our DY shares, these other confirmation points keep us bullish on our shares of AXT and NOK as well.

  • Our price target on Dycom (DY) shares remains $125.
  • Our price target on AXT Inc. (AXTI) shares is $11.
  • Our price target on Nokia (NOK) shares is $8.50.