Category Archives: New Middle Class

Tyson Foods eyes China and our New Global Middle-class investing theme

Tyson Foods eyes China and our New Global Middle-class investing theme

Noel White, the new CEO of beef, chicken and pork company Tyson Foods, is looking to capitalize on our New Global Middle-class investing theme as it considers overhauling its strategy in China. One of the key tenants in our Rise of the New Middle-class theme is the trade up in products, services, and other purchases, including food, that consumers will make as their disposable incomes rise. From Tyson’s perspective, tapping into this tailwind should drive revenue and profits on the back of rising protein demand in China and other emerging economies.

Tyson Foods Inc. is looking to expand internationally to help stabilize its business and reduce exposure to U.S. agricultural-market swings, its chief executive said.

The Arkansas-based company is considering acquisitions in new markets and revamping its strategy in China, where earlier investments in company-run poultry-farming complexes have struggled, said Noel White, who took over as Tyson’s chief executive officer at the end of September.

Tyson’s effort to rebuild its overseas presence is a way for the top U.S. meat company by sales to harness growing protein demand in developing countries as well as in established markets for meat, Mr. White said in his first interview since taking over.

A broader international presence would make Tyson less reliant on the ups and downs of the U.S. meat sector, where processors like Tyson, Pilgrim’s Pride Corp. and Hormel FoodsCorp. are grappling with low prices and growing meat supplies.

Source: Tyson Foods CEO Looks to Make International Acquisitions – WSJ

The new middle-class boom in the coming decade

The new middle-class boom in the coming decade

Amid the concerns of rising interest rates and what it may do in the near to medium term for Middle-class Squeeze consumers, new research from the Brookings Institute remind us of the positive economic force to be had with our Rise of the New Middle-class investing theme over the coming decade-plus. No wonder Apple CEO Tim Cook has been sharing upbeat thoughts about the coming demographic wave in India. He’s not alone, as other consumer product companies from Starbucks to Mondelez International and Proctor & Gamble are all focused on the sales and profits to be had from meeting this expected demand surge.

According to research from the Brookings Institution, more than half of the planet can now be considered “middle class” or “rich.” It is estimated that some 48 percent of the world’s population earns between $11 and $110 per day in PPP-adjusted dollars—a standard definition of the middle class using absolute (rather than relative) cut-offs—while another 2 percent earns more than $110 per day. According to projections and measures, the middle class will reach 4 billion people worldwide by the end of 2020 and 5.3 billion by 2030. This expansion has been driven by two phenomena: a steep decline in poverty around the world since the 1980s and rising household incomes in Asia.

There should be reasons to cheer this global “tipping” point. For the first time in recorded history, the majority of the world’s population will not consist of impoverished peasants or workers but of wage-earners who can afford to buy cellphones, washing machines and televisions, to go out to restaurants and theaters, and to take vacations with their families.

A growing middle class is supposed to be good for society. Their consumerism is supposed to boost global production of durable goods and make businesses more efficient and innovative in targeting these new customers. The global middle class is also committed to the education of their children. The middle class is more entrepreneurial than either the rich or the poor, and it demands more transparency from policymakers and tolerates less corruption. Because the middle class does not owe its wealth to privileges granted by the state, its members are more likely to support protections for property rights, as well as greater access and representation in decision-making.

Source: Fear and Loathing in the Global Middle Class – Lawfare

October Buy-the-Dip Trick or Treat?

October Buy-the-Dip Trick or Treat?

 

So much for the typical October strength in equities – a month in which the major US indices historically have gained ground 75% of the time. We’ve seen major index support levels broken while earnings beats have been smaller than we’ve seen over the past year with revenue and forward guidance giving investors jitters.

Over the summer and through September we warned that this earnings season would likely be a very bumpy ride as earnings would probably be decent, but guidance would not support the market’s multiples. Our concerns have proven warranted. Overall this earnings season the average company that has reported saw its shares fall 2% on its earnings reaction day – if this keeps up it will be the worst stock performance reaction on record since 2001.

How bad has it been?

  • On Wednesday, October 24, the Nasdaq had its worst daily drop since 2011, closing the day down over 10% from its recent highs and by the close of the trading day, the Dow Jones Industrial Average and the S&P 500 had lost all their gains for the year. If the market’s close in the red again Friday, the S&P 500 will have closed down 15 days during the month thus far, the most since 2012.
  • The FAANGM stocks entered a bear market this week, losing 4.4% on Wednesday – the worst decline since August 2011.
  • The Global MSCI All World Index hit a 14-month low, in bear market territory with a more than 20% decline since the January highs, losing 11% in October alone – the biggest decline since the financial crisis. This week only 4 of the 47 countries in the MSCI all country world index were above their 200-day moving average.
  • Homebuilder stocks have fallen more than 40% from their January highs – the canary in the consumer coal mine. New home sales plunged 5.5% in September versus expectations for a -0.6% decline as the supply of homes for sale rose +2.8% (the sixth consecutive increase) to the highest level since 2008 while demand has fallen to a 2-year low. Tell me again how great that consumer is doing and how they might contend with 5% mortgages? As those homes become more expensive to purchase, fewer Middle-Class Squeeze consumers will be filling out a mortgage application.
  • The only two S&P 500 sectors in the green this month are defensive – Consumer Staples (+1%) in the midst of its longest winning streak since November 2009 and Utilities (+3%). Even one of the must-have lifelines for our Digital Lifestyle investing theme mobile service wasn’t a safe haven as AT&T (T) shares fell some 9% this week hitting a new 52-week low in the process.
  • This week the Russell 2000 small cap index fell over 15% from its highs, closing Wednesday just 5 points away from a new 52-week low.
  • After spending 262 consecutive days above its 200-day moving average, oil closed this week below that marker. Streaks of such magnitude have only happened two other times over the past 30 years – April 10, 2000, which ended a 272-day streak and September 2, 2008, which ended a 330-day streak. Those dates are worth noting.
  • The first 18 trading days in October have seen a daily open to close loss 83.3% of the time, besting the previous 75% record in September of 2000. If the market rallies from open to close on the next 4 trading days, October’s closed in the red versus open will be 65.2% of days – the worst for any single month since October 2008 which was at the height of the financial crisis – and that is the very BEST we could hope for.

Investors are taking note with the weekly sentiment survey from AAII reporting that bullish sentiment fell to 27.9% from 34%, the fourth weakest reading for bullish sentiment this year. Bearish sentiment rose from 35% to 41%, the highest reading since the last week of June. Other indicators, such as the CNN Fear & Greed Index which fell to Extreme Fear (6) this week from Greed (64) a month ago, also point to increasing investor unease.

 

What is driving all this is the market starting to sync up with the reality of geopolitics and economics.

  • The era of central bank continual infusions of liquidity is over. The flow has not only stopped, but in the case of the US, reversed course.
  • We are facing trade wars and tariffs. The recent Federal Reserve Beige book was packed full of executives complaining about the impact of such on their businesses.
  • A decent portion of the domestic economic acceleration has been thanks to unsustainable fiscal deficits. The market is just starting to figure that out as the headlines move from cheerleaders to more rationale skeptics. Our Safety & Security investing theme is making headlines as a solid portion of growth has been driven by increases in defense spending which shifted from an average annual -2.1% rate of decline from June 2009 to March 2017 to a +2.9% average annual rate of increase since April 2017.
  • The Italian problem is not going away. It is too big to save and to say its current leadership is incompetent is putting it mildly, (as someone who lives a good portion of my time in Genoa of the collapsed bridge fame) and the clock is ticking on its sovereign debt bomb. As an example of the breathtaking level of incompetence, after two months basically no progress has been made on replacing that bridge despite its vital importance to not only Italy’s economy but to the greater Eurozone given its link to a major port.
  • China is in a full bear market, its economy is saddled with a staggering level of debt, and the Chinese yuan has dropped to its lowest level versus the dollar in a decade. We are watching these and other data points with an eye toward our Rise of the Global Middle-Class investing theme.
  • Geopolitical tensions are mounting around the world and the current Saudi situation highlights just how much the balance of global power is shifting.

 

The big question is where do we go from here?

Just 13% of stocks in the S&P 500 are above their 200-day moving average – these are mostly in the aforementioned Consumer Staples and Utilities sectors. This level has only occurred a few times in the past, marking just how oversold near-term the market has become. There is not one Energy or Industrial sector stock above its 50-day moving average. Rebounds are to be expected with such near-term oversold conditions.

Looking at the economics, the Citigroup Global Economic Surprise Index has been in negative territory, (meaning more data coming in below expectations than above) since April – the longest stretch in 4 years. The October Eurozone PMI fell to a 25-month low. Back in the US, the Richmond Federal Reserve local business conditions index for services hit a 7-year low, similar to what we’ve seen on the manufacturing side.

The employment situation is increasingly worrisome. The Richmond Fed’s wage expectations index for 6 months out recently jumped dramatically up to a level not seen since March 2000 as the available pool of labor has dropped to an 11-year low. Looking at who has been getting jobs recently, 70% of job gains over the past 6 months and 100% over the past 4 months have gone to folks with just a high-school degree or less. While we love to see more people getting jobs, from the corporate side of things, that means that companies are having to hire those with the weakest skill set. Great for the person getting a job as they can now develop more skills, but brutal for the employer who is facing weaker productivity as a result – that hurts earnings which are already facing rising costs from tariffs and trade wars as well as rising interest rates.

The bottom line is we are likely to see some interim rebounds, but it doesn’t look like the market is yet in sync with global realities. We have been pointing out for months that US stocks indices have been outperforming the rest of the world to a degree that was simply not sustainable.

The market is starting to appreciate the magnitude of the fiscal stimulus economic sugar high, that trade wars aren’t so easily won, that geopolitical risks are material, that the change in central bank liquidity flows matters and that future earnings growth is likely slower. We haven’t even gotten started when it comes to the fireworks I’m expecting from the Italian situation. We are likely to see the occasional rebound, but my money is that more pain is yet to come. That is great news for those that are focused on solid, long-term investing themes like the ones we have developed at Tematica Research, and have a shopping list of stocks ready for the bargains that will be coming our way.

 

 

Auto companies spur Africa’s new middle class

Auto companies spur Africa’s new middle class

When most people talk about rising disposable incomes, the knee-jerk reaction tends to be one that involves China or India. While those are natural reactions and are key drivers for our Rise of the New Middle-class investing theme, we are seeing the same begin to unfold in Africa as auto companies invest for what they see as a vibrant market in the coming years. That compares to an auto market in the mature markets that is primarily driven by replacement demand and faces an uncertain volume future longer-term due to prospects associated with autonomous vehicles.

On the flipside, the investments in making North Africa a car manufacturing hub and the better-paying jobs that follow are helping speed the rise of the new middle-class in the region. That bodes well for companies ranging from Colgate Palmolive, Proctor & Gamble, Clorox and the other rising tailwinds associated with our Rise of the New Middle-class investing theme.

Auto manufacturers are betting on Africa as the next growth frontier, and they’re building a new production hub to power it.

In a rare industrialization success story for the continent, some of the largest car makers have been transforming North Africa into the world’s newest car-manufacturing cluster. Volkswagen AG , Renault SA, Peugeot SA, Hyundai Motor Co. and Toyota Motor Corp. have invested billions in Africa in recent years, drawn by growth prospects that maturer auto markets no longer offer. New-car sales in the U.S., China and Europe are ebbing after a bumper decade.

While still a small market, the Middle East and Africa are expected to have 90 million vehicles on the road by 2040, up from 59 million today, according to OPEC forecasts.

Foreign direct investment in North Africa rose from just under $5 billion in 2011 to $12 billion in 2016, largely driven by auto makers’ investment, according to Frost & Sullivan, an industry research group.

Source: Car Makers Turning North Africa Into Auto Hub – WSJ

Travel industry to record 2.4 billion international trips by 2030

Travel industry to record 2.4 billion international trips by 2030

A new report from Euro Monitor provides confirmation for prior forecasts calling from continued growth in international travel that is riding the tailwinds of our Rise of the New Middle Class investing theme. Beneficiaries span not just the airlines but also hotels and consumer goods companies as well. We can also see the influence of our Digital Lifestyle investing theme at work as digital sales become a greater part of the travel mix.

New research shows the travel industry is set to record strong growth with international arrivals reaching 2.4 billion by 2030, corresponding to USD 2.6 billion in incoming receipts. China, France and the US will be the main beneficiaries of international arrivals.

Global arrivals will grow by 5 percent between 2017 and 2018 to reach 1.4 billion trips, thanks to an upgraded economic outlook for major economies such as the US, Japan and the Eurozone. Low-cost carriers are expected to show a passenger growth rate of 6 percent in 2018-2023, thus outperforming the scheduled operators. By 2023, travel intermediaries are forecast to exceed USD 2 trillion stimulated by digital advances and the shift to mobile sales representing 70 percent of travel agents’ sales in 2017.

Source: Travel Industry Will Record 2.4 Billion International Trips by 2030

Energy Pain Points in Puerto Rico Force Disruptive Innovation Acceleration

Energy Pain Points in Puerto Rico Force Disruptive Innovation Acceleration

Looking for pain points in the economy is often one of the best investment strategies — finding those places where extreme friction exists, just waiting for an innovator to step in with a solution that solves the problem and reaping the financial rewards along the way.

Here in the Washington, DC area, we saw this playout with the adoption of hybrid vehicles in the early 2000’s. The combination of fast-rising gas prices, traffic that is among the worst in the country and HOV lanes being made available to single-occupancy energy-efficient vehicles resulted in a quick adoption of the cars. Pretty quickly, the Toyota Prius seemingly became among the most popular cars on the road during rush hour heading in and out of the nation’s capital — or at least it seemed that way for those of us stuck sitting in traffic watching them zip by.

In Puerto Rico, we are seeing such a phenomenon occur in the area of renewable energy as they struggle to get back on their feet following the Hurricane Maria. Bloomberg recently reported that:

10,000 new [solar power] systems have been installed in the year since Hurricane Maria hit the island, and some battery suppliers such as Tesla Inc. are having trouble keeping up.The 10,000 residential solar plus battery storage systems were installed between September 2017 and September 2018, P.J. Wilson, president of the Solar and Energy Storage Association of Puerto Rico, which represents the territory’s solar and battery industries, told Bloomberg Environment. This number rivals the 12,000 existing residential solar systems on the island before the storm hit, but virtually none of the systems were paired with batteries.

Now, all of the major Puerto Rican installers are selling combined solar and battery systems, not just solar. Why? Energy security and resiliency. The Category 4 hurricane, which made landfall Sept. 20, 2017, wiped out the island’s fragile electricity system, taking nearly 11 months for the Puerto Rico Electric Power Authority (PREPA) to return power to all of its residential customers.

“Before the storm, it was basically a savings play,” Alejandro Uriarte, CEO of New Energy, a solar and battery installer, told Bloomberg Environment, explaining residents’ previous rationale for buying rooftop solar. “People looking to save on their bills were the ones buying solar, but now saving is not as important as resiliency and being able to have power.”

Source: Rooftop Solar Nearly Doubles in Puerto Rico One Year After Maria | Bloomberg Environment

Is Puerto Rico going to change the entire marketplace for solar and renewable power?  Probably not. But as greater levels of the population live in the wake of extreme weather, it’s becoming part of our Safety & Security theme as residents look to at least have solar power if not as their primary source of power, but as a backup for when the next storm inevitably knocks out the lines again. Contributing to the health of the environment — part of our Clean Living investment theme — is a bonus for consumer flocking to install solar panels on their homes in Puerto Rico. And of course, the evolving nature of solar power, battery technology and other renewable energy components are all part of our Disruptive Innovators theme.

India’s rising middle-class to drive energy alternatives in the long run

India’s rising middle-class to drive energy alternatives in the long run

We have another confirming data point that India is poised to become one of the key economies when it comes to driving global growth. The underlying reason ties with the other data points that point to this – India’s expanding middle-class, which will spur demand for a variety of goods and service. And yes, India and its evolving demographics is one of the geographies associated with our  Rise of the New Middle Class investing theme.

Longer-term, it also appears it could be a meaningful driver when it comes to the adoption of alternative energies that are a part of our Clean Living investing theme at the expense of oil. Something to watch in terms of the adoption curve for electricity, solar, wind and other alternatives as they continue to move down the cost curve. We’ll also be watching for the adoption of other aspects of our Clean Living investing theme – food, snacks, beverages, and other products – as that middle-class continues to swell and the accompanying increase in disposable income opens numerous doors for consumers in India.

 

India is set to overtake China as the biggest source of growth for oil demand by 2024, according to a forecast announced Monday by research and consultancy group Wood Mackenzie.The country’s oil demand is set to increase by 3.5 billion barrels per day from 2017 to 2035, which will account for a third of global oil demand growth. India’s expanding middle class will be a key factor, as well as its growing need for mobility, according to Wood Mackenzie.

On the other hand, China — currently the second-largest oil consumer in the world — may soon need less oil. In 2017, it overtook the U.S. as the biggest importer of crude oil, but it’s set to see a decline in oil demand growth from 2024 to 2035, Wood Mackenzie Research Director Sushant Gupta told CNBC.That’s due to two trends: Alternative energy sources such as electricity and natural gas are displacing the need for gasoline and diesel. And, a more efficient freight system and truck fleet will also result in sluggish road diesel demand, Gupta said.

Source: India set to overtake China as top driver of global oil demand growth

Amazon targets Medplus and two of our investing themes

Amazon targets Medplus and two of our investing themes

As we saw this past Prime Day 2018, Amazon is targeting international expansion of its Prime services. It’s also doing the same with its acquisition of online pharmacy as PillPack it looks to disrupt the pharmacy market, an event that we here at Tematica are anxiously awaiting. As Amazon builds on PillPack that acquisition should pave the way for Amazon feeling the benefits of our Aging of the Population tailwind to a much greater degree. Now with Amazon reportedly looking to acquire MedPlus, an Indian pharmacy chain, it looks to leverage both of these strategies — targeting international markets and disrupting the pharmacy market — which would serve to expand its footing inside our New Middle Class investing theme as well as our Aging of the Population one.

 

Amazon is reportedly engaged in deal talks about acquiring MedPlus, the Indian pharmacy chain.According to Reuters, citing FactorDaily, the Indian news website, sources said the talks are in the early stages. MedPlus Health Services operates more than 1,500 pharmacies in India, and also operates lab testing centers and has a surgical equipment distribution unit. “We do not comment on what we may do or may not do in the future,” an Amazon spokesperson told Reuters.In late June, Amazon announced it had inked a deal to acquire PillPack, the pharmacy focused on people in the U.S. who take multiple daily prescriptions.

Source: Amazon In Talks To Acquire India’s MedPlus | PYMNTS.com

Tematica’s Recast New Middle Class Investing Theme

Tematica’s Recast New Middle Class Investing Theme

 

Key Points from this Alert:

  • We are completing the recasting of the Rise & Fall of the Middle Class investment theme with an introduction to the New Middle Class theme. 
  • We are adding International Flavors & Fragrances (IFF) shares back to the Tematica Investing Select List as part of the New Middle Class investment theme with a Buy rating and a $165 price target.

 

As part of constantly revisiting and testing our investing themes, from time to time we will make changes and enhancement to them. As part of that ongoing effort, we recently re-cast part of our Rise & Fall of the Middle Class investing theme. You can read about the change in detail by clicking here, but in summary, what we did was combine the aspect of the theme that deals with the struggling middle-class in the United States (the “Fall” part of the investment theme) and combined it with our Cash-Strapped Consumer theme to form the Middle Class Squeeze. That move left Rise of the New Middle Class, which we’ve shortened to the New Middle Class. This investing theme focuses on areas around the world, notably China and India, but other emerging markets as well where rising disposable incomes are driving demand for a host of products and services.

Why this focus on the middle class?

The middle-class is one of the primary engines behind consumption and domestic demand, in other words, a key part of the domestic economic engine. And while the middle class is under pressure in the U.S. and other mature markets, according to data published by the Brookings Institute, the middle class is set to grow worldwide by 160 million people per year on average through 2030. Let’s put some perspective around that — the size of the “global middle class” was 1.8 billion in 2009 and is expected to reach 3.2 billion by 2020 and then reach 4.9 billion by 2030.

Where is the vast majority of that middle-class growth slated to come from? Almost 90% of the next billion entrants into the global middle class will be in Asia: 380 million Indians, 350 million Chinese, and 210 million other Asians. In comparison, on a combined basis North America and Europe are expected to account for only a fifth of the world’s middle-class population, down from more than half in 2010.

And as the size of the middle class goes, so too does its influence on consumption. By 2030, North America and Europe are expected to account for 30% of the world’s middle-class consumption vs. 64% in 2010. Taking over the pole position and representing nearly 60% of middle-class consumption, as one might expect, is Asia with India and China slated to account for more than two-thirds of that consumption. In 2010, Asia represented just 23% of global middle-class consumption.

By 2020 in China, mainstream consumers are expected to for 51% of the urban population compared to 6% in 2010 and 1% in 2000 per McKinsey. While their absolute level of wealth will remain quite low compared with that of consumers in developed countries, this group of167 million households (close to 400 million people), will set the standard for consumption, capable of affording family cars and small luxury items. The result is a surge in discretionary spending that in part reflects aspirational drivers, such as consumers looking to improve themselves, the way they live, and their perceived social standing.

As these dynamics unfold in China, over time they will be replicated in India and other emerging markets. According to NCAER, India’s middle-class population would be 267 million in 2016. Further ahead, by 2025-26 the number of middle-class households in India is likely to more than double from the 2015-16 levels to 113.8 million households or 547 million individuals.

What is expected to unfold over the coming years is a significant shift in consumption dynamics that will favor the emerging economies like China, India, and larger Asia as well as Africa and several South American countries in the coming years.

According to research firm McKinsey & Company, these consumers tend to become more selective about where they spend their money, shifting from products to services and from mass to premium segments, seeking a more balanced life where health, family, and experiences take priority. Those findings also revealed the growth of premium segments is outpacing that of the mass and value segments, and foreign brands still hold a leadership position in the premium market.

Is it any wonder that Apple (AAPL) CEO Tim Cook has talked about the long-term, favorable demand dynamics in India and what it could mean for Apple’s businesses? If we look at forecasts for refrigerator, washing machines and other kitchen appliances, India is often cited as one of the key growth markets. But it’s not alone, sales of refrigerators, television sets, mobile phones, motors and automobiles have surged in virtually every African country in recent years as has car and motorcycle purchases.

Like any snowball that rolls downhill, it’s a slow start at first, but as time moves forward so too does the size and momentum of that snowball. The same is poised to happen with this new middle class and it’s increasing buying power. The ensuing ripple effects, however, will put pressure on global resources as they become wealthier and aspire to Western living standards. Their appetite for products, food, energy, housing and transport stimulates consumption, driving their economies, but that incremental demand will drive prices for products and services, and especially for scarce resources higher.

 

New Middle Class bodes well for International Flavors & Fragrances

The growth in discretionary spending as well as the growing importance of premium and branded products across a variety of categories. In keeping with our “buy the bullets, not the guns” investing strategy, we find International Flavors & Fragrances (IFF), whose scent and flavor solutions are found in a variety of consumer products, ranging from fine fragrances and beauty, detergents and household goods, and food and beverages. Moreover, the management team is focused on the emerging markets by leveraging its customer appetite to grow their businesses in emerging markets. Key customers include Procter & Gamble (PG), Unilever (UN), Colgate- Palmolive (CL), Estée Lauder (EL) and PepsiCo (PEP), and the top 25 account for a little more than 50% of IFF’s revenue. IFF derives roughly half of its revenue from the emerging markets.

In its latest report, “Global Markets for Flavors and Fragrances,” Research and Markets forecasts the global market to grow from $26 billion in 2015 to $37 billion by 2021 — an overall increase of more than 40%. We see fairly steady demand for the company’s flavors and fragrances in more mature markets given the participation in inelastic product categories such as personal care products (toothpaste, deodorant, shampoo, body and others) as well as household ones like detergents, softeners, cleaners and air fresheners. On top of that demand base, international demand in the emerging economies should continue to benefit from rising incomes and the continued adoption of the Western lifestyle when it comes to the personal care, household, food and beverage products that contain the company’s flavors and fragrance solutions. We see faster growth dynamics in those markets as consumers trade up in lifestyle.

What we find most fascinating about IFF’s business is, whether in flavors or fragrances, its products account for 1% to 5% of total product cost but influence the product’s scent or flavor that is responsible for repeat purchases. When was the last time something tasted or smelled awful and you opted to get more?

IFF’s business is also benefitting from the ongoing shift in consumer preference to natural and organic products. With its line of 100% pure and natural line of ingredients and extracts, IFF is well positioned to capitalize on this shift as its existing and prospective customers look to reformulate their products to exclude sugar and other “bad for you” ingredients without sacrificing taste or flavor. Helping accelerate its exposure to that additional tailwinds, in May IFF acquired Frutarom, a flavors, savory solutions and natural ingredients company that sells over 70,000 products to more than 30,000 customers in over 150 countries. With 43% of its 2017 revenue derived from the emerging markets up from 27% in 2010, and more than 75% of its sales comprised of natural products, Frutarom bolsters IFF’s exposure to both the New Middle Class and the global shift to natural, organic products.

The combination of inelastic demand in the mature markets, the rising demand for in the emerging markets and synergies to be had with the integration of Frutarom solidifies the company’s earnings growth prospects over the coming years. Current consensus expectations have IFF serving up EPS of $6.31 this year and $6.80 per share next year, up from $5.89 last year. That earnings growth bodes well for continued dividend increases in the coming quarters, continuing the company’s increasing dividend track record. Its current quarterly dividend sits at $0.69, up from $0.31 in the first half of 2012.

Owing to the escalating trade and tariff talk of the last few months that have also spared a move higher in the dollar, IFF share have fallen more than 20% thus far in 2018, which leaves them trading at a dividend yield near 2.25%. This is in line with trough dividend yield levels at which IFF shares have traded over the last decade-plus. This suggests that the worst has been priced into the shares, which for patient investors offers a favorable risk to reward to get into the shares and take advantage of the longer-term drivers laid out above. Historically, IFF shares have peaked near a dividend year of 1.7%, which, assuming no other dividend increase, yields upside in the shares to $165.

As we recast our New Middle Class investing theme, we are calling out shares of International Flavors & Fragrances (IFF) as a top New Middle Class pick:

  • We are adding International Flavors & Fragrances (IFF) shares back to the Tematica Investing Select List with a Buy rating and a $165 price target.

 

Examples of companies riding the New Middle-Class Tailwind

  • Alibaba (BABA)
  • MakeMyTrip (MMYT)
  • Nu Skin Enterprises (NUS)
  • Colgate Palmolive (CL) – 30% of oral care is to Asia
  • Proctor & Gamble (PG) – 32% of sales is Asia-Pac, China, Latin America, IMEA
  • McCormick & Co. (MKC)
  • McDonalds (MCD) — International Foundation Markets account for 43% of sales
  • Nike (NKE) – 30% of Nike branded sales are from Central & Eastern Europe, China, and the Emerging Markets

 

WEEKLY ISSUE: Trade and Tariffs, the Words of the Week

WEEKLY ISSUE: Trade and Tariffs, the Words of the Week

 

KEY POINTS FROM THIS WEEK’S ISSUE:

  • We are issuing a Sell on the shares of MGM Resorts (MGM) and removing them from the Tematica Investing Select List.
  • While the markets are reacting mainly in a “shoot first and ask questions later” nature, given the widening nature of the recent tariffs there are several safe havens that patient investors must consider.
  • We are recasting several of our Investment Themes to better reflect the changing winds.

 

Investor Reaction to All the Tariff Talk

Over the last two days, the domestic stock market has sold off some 16.7 points for the S&P 500, roughly 0.6%. That’s far less than the talking heads would suggest as they focus on the Dow Jones Industrial Average that has fallen more than 390 points since Friday’s close, roughly 1.6%. Those moves pushed the Dow into negative territory for 2018 and dragged the returns for the other major market indices lower. Those retreats in the major market indices are due to escalating tariff announcements, which are raising uncertainty in the markets and prompting investors to shoot first and ask questions later. We’ve seen this before, but we grant you the causing agent behind it this time is rather different.

What makes the current environment more challenging is not only the escalating and widening nature of the tariffs on more countries than just China, but also the impact they will have on supply chain part of the equation. So, the “pain” will be felt not just on the end product, but rather where a company sources its parts and components. That means the implications are wider spread than “just” steel and aluminum. One example is NXP Semiconductor (NXPI), whose chips are used in a variety of smartphone and other applications – the shares are down some 3.7% over the last two days.

With trade and tariffs being the words of the day, if not the week, we have seen investors bid up small-cap stocks, especially ones that are domestically focused. While the other major domestic stock market indices have fallen over the last few days, as we noted above, the small-cap, domestic-heavy Russell 2000 is actually up since last Friday’s close, rising roughly 8.5 points or 0.5% as of last night’s market close. Tracing that index back, as trade and tariff talk has grown over the last several weeks, it’s quietly become the best performing market index.

 

A Run-Down of the Select List Amid These Changing Trade Winds

On the Tematica Investing Select List, we have more than a few companies whose business models are heavily focused on the domestic market and should see some benefit from the added tailwinds the international trade and tariff talk is providing. These include:

  • Costco Wholesale (COST)
  • Dycom Industries (DY)
  • Habit Restaurants (HABT)
  • Farmland Partners (FPI)
  • LSI Industries (LYTS)
  • Paccar (PCAR)
  • United Parcel Services (UPS)

We’ve also seen our shares of McCormick & Co. (MKC) rise as the tariff back-and-forth has picked up. We attribute this to the inelastic nature of the McCormick’s products — people need to eat no matter what — and the company’s rising dividend policy, which helps make it a safe-haven port in a storm.

Based on the latest global economic data, it once again appears that the US is becoming the best market in the market. Based on the findings of the May NFIB Small Business Optimism Index, that looks to continue. Per the NFIB, that index increased in May to the second highest level in the NFIB survey’s 45-year history. Inside the report, the percentage of business owners reporting capital outlays rose to 62%, with 47% spending on new equipment, 24% acquiring vehicles, and 16% improving expanded facilities. Moreover, 30% plan capital outlays in the next few months, which also bodes well for our Rockwell Automation (ROK) shares.

Last night’s May reading for the American Trucking Association’s Truck Tonnage Index also supports this view. That May reading increased slightly from the previous month, but on a year over year basis, it was up 7.8%. A more robust figure for North American freight volumes was had with the May data for the Cass Freight Index, which reported an 11.9% year over year increase in shipments for the month. Given the report’s comment that “demand is exceeding capacity in most modes of transportation,” I’ll continue to keep shares of heavy and medium duty truck manufacturer Paccar (PCAR) on the select list.

The ones to watch

With all of that said, we do have several positions that we are closely monitoring amid the escalating trade and tariff landscape, including

  • Apple (AAPL),
  • Applied Materials (AMAT)
  • AXT Inc. (AXTI)
  • MGM Resorts (MGM)
  • Nokia (NOK)
  • Universal Display (OLED)

With Apple we have the growing services business and the eventual 5G upgrade cycle as well as the company’s capital return program that will help buoy the shares in the near-term. Reports that it will be spared from the tariffs are also helping. With Applied, China is looking to grow its in-country semi-cap capacity, which means semi- cap companies could see their businesses as a bargaining chip in the short-term. Longer- term, if China wants to grow that capacity it means an eventual pick up in business is likely in the cards. Other drivers such as 5G, Internet of Things, AR, VR, and more will spur incremental demand for chips as well. It’s pretty much a timing issue in our minds, and Applied’s increased dividend and buyback program will help shield the shares from the worst of it.

Both AXT and Nokia serve US-based companies, but also foreign ones, including ones in China given the global nature of smartphone component building blocks as well as mobile infrastructure equipment. Over the last few weeks, the case for 5G continues to strengthen, but if these tariffs go into effect and last, they could lead to a short-term disruption in their business models. Last week, Nokia announced a multi-year business services deal with Wipro (WIT) and alongside Nokia, Verizon (VZ) announced several 5G milestones with Verizon remaining committed to launching residential 5G in four markets during the back half of 2018. That follows the prior week’s news of a successful 5G test for Nokia with T-Mobile USA (TMUS) that paves the way for the commercial deployment of that network.

In those cases, I’ll continue to monitor the trade and tariff developments, and take action when are where necessary.

 

Pulling the plug on MGM shares

With MGM, however, I’m concerned about the potential impact to be had not only in Macau but also on China tourism to the US, which could hamper activity on the Las Vegas strip. While we’re down modestly in this Guilty Pleasure company, as the saying goes, better safe than sorry and that has us cutting MGM shares from the Select List.

  • We are issuing a Sell on the shares of MGM Resorts (MGM) and removing them from the Tematica Investing Select List

 

Sticking with the thematic program

On a somewhat positive note, as the market pulls back we will likely see well-positioned companies at better prices. Yes, we’ll have to navigate the tariffs and understand if and how a company may be impacted, but to us, it’s all part of identifying the right companies, with the right drivers at the right prices for the medium to long-term. That’s served us well thus far, and we’ll continue to follow the guiding light, our North Star, that is our thematic lens. It’s that lens that has led to returns like the following in the active Tematica Investing Select List.

  • Alphabet (GOOGL): 60%
  • Amazon (AMZN): 133%
  • Costco Wholesale (COST) : 30%
  • ETFMG Prime Cyber Security ETF (HACK): 34%
  • USA Technologies (USAT): 62%

Over the last several weeks, we’ve added several new positions – Farmland Partners (FPI), Dycom Industries (DY), Habit Restaurant (HABT) and AXT Inc. (AXTI) to the active select list as well as Universal Display (OLED) shares. As of last night’s, market close the first three are up nicely, but our OLED shares are once again under pressure amid rumor and speculation over the mix of upcoming iPhone models that will use organic light emitting diode displays. When I added the shares back to the Select List, it hinged not on the 2018 models but the ones for 2019. Let’s be patient and prepare to use incremental weakness to our long-term advantage.

 

Recasting Several of our investment themes

Inside Tematica, not only are we constantly examining data points as they relate to our investment themes we are also reviewing the investing themes that we have in place to make sure they are still relevant and relatable. As part of that exercise and when appropriate, we’ll also rename a theme.

Over the next several weeks, I’ll be sharing these repositions and renamings with you, and then providing a cheat sheet that will sum up all the changes. As I run through these I’ll also be calling out the best-positioned company as well as supplying some examples of the ones benefitting from the theme’s tailwinds and ones marching headlong into the headwinds.

First up, will be a recasting of our Rise & Fall of the Middle-Class theme.  As the current name suggests, there are two aspects of this theme — the “Rise” and the “Fall” part. It can be confusing to some, so we’re splitting it into two themes.  The “Rise” portion will be “The New Global Middle Class” and will reflect the rapidly expanding middle class markets particularly in Asia and South America. On the other hand, the “Fall” portion will be recast as “The Middle Class Squeeze” to reflect the shrinking middle class in the United States and the realities that poses to our consumer-driven economy.

We’ll have a detailed report to you in the coming days on the recasting of these two themes, how it impacts the current Select List as well as other companies we see as well-positioned given the tailwinds of each theme.