WEEKLY ISSUE: Some Underperformers Set to Come out from the Shadows
Monday was one of those sort-of holidays that saw banks, the post office and schools closed, but domestic stock markets and a number of other businesses open. The result was once again a more subdued start to the week that leads into what is poised to be a focal point for the stock market as 3Q 2017 earnings kickoff. Over the last several days, we saw through earnings from restaurant company Darden (DRI) and Cal-Maine Foods (CALM) and this week the negative 2017 reset from coatings company Axalta Coating Systems (AXTA). This tells me that not only has Wall Street underestimated the impact of September’s hurricane trifecta — a fact we saw in last Friday’s September Employment Report — but it has likely overestimated the current speed of the economy as well.
The next few days will give way to several economic reports that will more fully shine a light on the true speed of the economy, and they will help set the table for what is to come over the next few weeks as literally thousands of companies report. As subscribers, you know through our weekly Thematic Signals and our Cocktail Investing Podcast that I co-host with our Chief Macro Strategist Lenore Hawkins, we are constantly scrutinizing data points with our thematic lens and assessing the market.
Now let’s take a look at our overall market view, which is one of the key backdrops when it comes to investing – thematic or otherwise. As we shared on last week’s podcast, the domestic stock market continues to grind its way higher ahead of 3Q 2017 earnings. This march higher is being fueled in part by the return of investor greed as measured by CNNMoney’s Fear & Greed Index. The question we are increasingly pondering is what are those late to the party seeing that allows them to get comfortable with enough upside to now jump into a market that is trading at more than 19x expected 2017 earnings?
With the market priced to perfection and expectations running high, odds are we are bound to see some disappointment. The fact that margin debt is running at record levels is not lost on us here at Tematica, and it has the potential to exacerbate any near-term bump or pullback in the market.
This has us holding steady with the Tematica Select List, but it doesn’t mean we are being idle. Rather, we are scrutinizing contenders and revisiting price points at which we would scale into existing positions. Not quite our 2017 holiday shopping list, but one that as we approach Halloween could be ripe for harvesting.
Checking in on some of our outperformers
We’ve benefitted from this push higher as the Select List’s positions in LSI Industries (LYTS), Amplify Snacks (BETR), USA Technologies (USAT), Amazon (AMZN), Alphabet (GOOGL) and International Flavors & Fragrances (IFF) have outperformed the month to date move in the S&P 500. With USAT shares, this has them closing in on our $6.50 price target, while the others have ample upside to our respective price targets.
We continue to rate these stocks as follows:
- Our price target on LSI Industries (LYTS) remains $10.00
- Our price target on Amplify Snacks (BETR) remains $10.50
- Our price target on Amazon (AMZN) remains $1,150
- Our price target on Alphabet (GOOGL) remains $1,050
With USA Technologies (USAT) shares, we will continue to keep them on the Select List and as we reassess our Thematic Signals and other data points for additional upside to be had relative to our $6.50 price target.
The same is true with International Flavors & Fragrances (IFF), given the accelerating shift away from sugar toward food that is good for you vs. the modest upside to our current $150 price target.
It’s not all bad news for the underperformers however
While we like to focus on the outperformers, we tend to spend as much, if not more time, on the ones that are underperforming. Currently, that means shares of Costco Wholesale (COST), Nokia (NOK), MGM Resorts (MGM) and recently added United Parcel Service (UPS).
In reverse order, shares of Connected Society derivative company UPS shares came under pressure following comments that Amazon is once again flirting with expanding its own logistics business. While this may happen, it will take years to replicate the hub and spoke to home delivery service currently offered by UPS that is poised to benefit from the accelerating shift to digital commerce this holiday shopping season. We remain bullish on this position and expect the shares to rebound as we move into the 2017 holiday shopping season. We will look to scale into UPS shares closer to $110 should such a pullback in the shares emerges this earnings season.
Shares of Guilty Pleasure company MGM Resorts continue to languish following the recent Las Vegas shooting. In our view, it will take some time for the perception of the business to recover. As that time elapses, we’ll look to improve our cost basis following the better than expected August Nevada gaming data. Below $30 is where we are inclined to make our move, and our price target stands at $37.
We continue to see favorable data on 5G testing and deployments that bode very well for Nokia’s intellectual property business as well as its communications infrastructure business. Much like MGM shares we will be patient and look to opportunistically improve the cost basis on this Disruptive Technologies Select List position.
We have a more detailed look at Cash-Strapped Consumer company Costco down below, but as you’ll soon read we continue to favor the shares despite some concerning developments.
So, what’s up with Costco Wholesale?
As we mentioned above Costco is one of the recent underperformers and it comes following last week’s better than expected quarterly earnings results. The issue is that its the earnings call Costco shared that it is seeing a slowdown in membership rates, which Wall Street took to mean “Here comes Amazon!” While we agree that Amazon is set to continue disrupting traditional retail as it leverages Whole Foods into grocery and meal kits, and continues to focus on apparel, Costco’s issue is it opened 16 new warehouses during the first 9 months of its recently completed fiscal year, so odds are it would see some slowing in membership growth.
For those not convinced that Costco’s business is thriving we would point out the following:
- September 2017: Net sales up 12%
- August 2017: Net sales up 10.0% year over year with comparable stores sales up 7.3% (up 5.9% excluding gasoline prices and foreign exchange)
- July 2017: Net sales up 8.8 percent year over year with comparable store sales up 6.2% (up 5.3% excluding gasoline prices and foreign exchange)
- June 2017: Net sales up 7.0% year over year with comparable store sales up 6.0% (up 6.5% excluding gasoline prices and foreign exchange)
Looking at that data, we see Costco not only as a company that has continued to improve net sales month over month, but one that is hardly suffering the same fate as traditional brick & mortar retailers. Moreover, we would point out the company had 741 warehouses in operation during the August 2017 quarter, up from 715 a year ago. This led to a 13% increase in its high margin Membership Fee revenue, which accounted for nearly all of its net income during the quarter.
As we have said before, the power in Costco’s business model is the warehouses and membership fee income, and we see this continuing to be the case. As part of our Connected Society theme, we will continue to monitor consumer acceptance of delivered grocery. This includes Costco’s new two-day delivery services for both dry groceries and fresh foods that will be free for online orders exceeding $75 from 376 U.S. Costco stores. Unlike many brick & mortar retailers, Costco is not standing around and watching its competitors outflank it, rather it is responding. To us, this suggests the recent pullback is overdone.
- We continue to have a Buy on Costco Wholesale (COST) shares, and our price target remains $190.
