Slowing growth and rising debt hit China luxury brand sales

Slowing growth and rising debt hit China luxury brand sales

Over the last several months, we’ve received several pieces of data that not only point to a slowing global economy, particularly at Europe and China but also to growing worries over the consumer’s ability to spend. We’ve covered the US data points rather thoroughly on this episode of the Cocktail Investing Podcast as part of our Middle-class Squeeze investing theme. When it comes to China, from the CEIC shows why luxury goods companies associated with our Living the Life investing theme are seeing falling sales. Per the CEIC, China’s household debt as a percentage of GDP surged to 53.2% in December, from 36% five years earlier. While that remains below the global average of 62%, it’s the pace of growth that has caused concern likely leading to either a re-think or retrenchment in Chinses consumer spending.

Factor in the recent problems associated with Boeing’s 737 Max aircraft that are likely to crimp international air travel, and the outlook for luxury goods companies and others associated with our Living the Life investing theme, at least in the near-term, look for less vibrant than they have in several years. Casting a shadow as well is the latest pushout in US-China trade talks that appear to have slipped to June from March/April.

Prada SpA shares fell to the lowest close since 2016 as slower Chinese spending contributed to an unexpected drop in the Italian fashion house’s annual profit.

The Hong Kong-listed luxury group attributed a slump in Asia mostly to Chinese tourists reining in spending in Hong Kong and Macau because of the weakness in the yuan. Other luxury brands, including Kering SA’s Gucci, have seen the impact of softer buying by Chinese tourists offset by increased spending on the mainland, but Prada failed to get a similar boost from Chinese spending at home, said Citigroup analysts led by Thomas Chauvet.

Prada’s China sales were flat for the year, a “significant swing” after a first-half gain of 17 percent, Citigroup said. Monday’s stock plunge after the disappointing earnings shaved $864 million off the company’s market value.

Chinese consumers have turned more cautious amid the slowest economic expansion in almost three decades and a trade war with the U.S. While cars and iPhones have seen bigger slumps so far, Prada’s results could spark worry that China’s newly wealthy middle class is scaling back on high-end purchases. For an industry that relies on Chinese demand for 30 percent of $1 trillion in global luxury spending, that’s a chilling prospect.

Source: Prada Loses $864 Million in Value as China Slump Hits Profit – Bloomberg

Boeing’s 737-Max issues highlight index construction issues

Boeing’s 737-Max issues highlight index construction issues

The latest flight tragedy involving Boeing’s (BA) 737-8 Max plane has reignited air travel safety concerns that could pressure Boeing’s business in the near-term. Demand for its aircraft has been and is expected to continue to be powered by international air travel, particularly out of Asia, which fits very well with our Rise of the New Middle-class investing theme. This means the recent drop in BA shares could present an opportunity for investors but depending on what we learn in the coming days we could see the shares trend lower. The issue plaguing the company and its shares is the crash of two 737-8 MAX planes in a relatively short time causing several countries and regions to ground those planes as the causes of the most recent crash are sought.

This has raised several questions for Boeing – How long will those planes be grounded? What does it mean for future 737 family orders and production levels that drive revenue, profits and earnings? The 737 family is an important one for Boeing, as it accounted for 80% of its aircraft backlog entering 2019 and 58% of its January order book. In the past Boeing has quickly dealt with situations such as these, and it has already announced an extensive change to the flight-control system in the 737 MAX aircraft.

Still, we are in a period of uncertainty for the shares, and uncertainty has never been a friend for the stock market or individual stocks. Now to see what comes next.

On a different note, the Boeing issue highlights a key difference in how the major market indices are constructed. These tend to be bench marks by which we and others judge their performance, but there are several differences and intricacies between them. For example, we know the Dow Jones Industrial Average is limited to just 30 stocks, while the S&P 500 is roughly 500 stocks spread across 11 sectors, yielding a more broad based view of the market. For that reason, the S&P 500 tends to be the benchmark of choice for most investors even though the media still tends to focus on the Down.

No matter how many constituents an index has, who the constituents are, and their weightings make all the difference. As we know, the Nasdaq Composite Index tends to be weighted toward technology stocks, while the Russell 2000 is focused on stocks with smaller market capitalizations. Inside the Dow, the weighting of BA shares is just under 10%, which makes it the largest holding inside the index. The next closest constituent is UnitedHealth Group (UNH) at 6.52%. This means moves higher or lower in Boeing shares can have a pronounced impact on the overall index. We’ve clearly seen that over the last few days as Boeing’s shares have fallen more than 10%  the Dow’s performance has been markedly different than the rest of the market indices as the Dow has less than 1% while the S&P 500 has risen nearly 2.5%

In examining the S&P 500, we see the reason for that different performance. While nearly 10% of the Dow is represented by Boeing shares, exposure inside the S&P 500 is far more limited at 0.9%. Even though that is more than 1/500thof the S&P it is far, far lower than the weighting contained inside the Dow. The point of this is that to truly understand the movements in the major market indices one needs to understand how these market indices are constructed.

One of the key parts of that understanding is knowing what the holdings and their weightings. This same understanding should also be applied to ETFs as well, especially ones that are based on passive indices. While two ETFs may appear to have a similar strategy and practically the same constituents, the weighting mechanisms between an equal weighted, market cap weighted or a capped market weight approach can produce different returns as well as generate different risk parameters.

As far as the constituents themselves, it goes without saying an investor should be more familiar with the constituents. In the case of Boeing, there are a number of ETFs that hold the shares, but one with sizable exposure is the ETFMG Drone Economy Strategy ETF (IFLY). That ETF, which looks to invest in drones, holds 4.96% of its assets in BA shares, it’s second largest holding. That ETF, which looks to invest in drones, holds 4.96% of its assets in BA shares, even though its revenues from drones and other autonomous systems are so small they aren’t even broken out by the company in SEC filings. We can debate the rationale behind Boeing being the second largest holding, but until the current situation at Boeing is resolved, odds are those shares will have a meaningful impact on both the Dow and IFLY shares.

HTC’s AI, VR and blockchain applications only start in the healthcare sector

HTC’s AI, VR and blockchain applications only start in the healthcare sector

Long known as a smartphone company, as that market has become more competitive and as its market share has fallen, HTC has turned inwards to reposition itself as many companies have in the past and many very well could if not should in the future. Apple is focused on growing its subscription and services businesses, while Disney is entering the direct to consumer streaming market for its content. HTC has embraced several aspects of our Disruptive Innovation investing theme, including artificial intelligence, virtual and augmented reality and blockchain, to pivot more towards the education and training markets.

HTC’s first inroads have been in the healthcare sector, which is already changing to not only meet the needs of our Aging of the Population investing theme, but it is also contending with the intersection of our Digital Lifestyle and Digital Infrastructure ones as well in the form of telemedicine. That’s just one example that showcases how healthcare is on the cusp of dramatic change, and there are other Signals to confirm this.

As these and other innovations are embraced by the healthcare industry, odds are we will see a dramatic shift in how our healthcare is administered just like the ones we’ve seen in how we shop, communicate and consume content. As that takes hold, and the costs benefits begin to be realized, the potential to spread across other education and training applications rises. We’re already seeing Boeing and others test augmented reality on the factory floor.

From a selfish perspective, hopefully, HTC’s success means this also means the end of sitting in a waiting room for what seems like eons until one’s name is called.

 

HTC’s efforts in developing AI technologies and platforms for healthcare and other applications have paid off significantly, with its DeepQ AI platform already utilized by hospitals to support diagnosis and VR-aided surgery and by universities for education and training purposes. The company is also actively developing blockchain-based platforms for healthcare applications, according to Edward Chang, president of HTC’s healthcare division.

He revealed that the platform has been adopted by Taipei Medical University Hospital, Mackay Memorial Hospital and Taipei Municipal Wanfang Hospital for diagnosis instructions, personal medicine, patient registration advices, medication monitoring, disease prevention and vaccination services.

The DeepQ platform can also be applied to accelerate AI training and optimize AI application patterns to lower the time and cost for developing AI applications, Chang indicated, adding that top Taiwan universities have incorporated the platform into their AI education programs.

In terms of healthcare VR applications, HTC has launched Vivepaper, surgical theater and 3D organon services. Among them, Vivepaper is an AR product designed to support immersive augmented reality experiences for education, training and entertainment through media contents including graphics, videos, and music, Chang revealed.

The firm’s surgical theater can combine diverse medical equipment such as magnetic resonance imaging (MRI) and computed tomography (CT) instruments to recompose 3D patterns, and can also go with VR to help surgeons work out optimal surgical training programs.

HTC healthcare division is also developing blockchain-based healthcare application platform, with the first platform, dubbed DeeplinQ, set to be launched in 2019. The platform can also be applied to privacy management at social networks and to smart contracts, according to Chang.

Source: HTC revving up AI, blockchain applications to healthcare sector

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.

 

 

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

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

 

Key Points in This Alert:

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

 

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

As a result of tax reform, the new tax rules allow companies over the next five years to immediately deduct the entire cost of equipment purchases compared to writing off only a portion of the cost in a single year. This earnings season we’ve started to hear from companies, like Boeing (BA) that are boosting capital spending plans and investing in product development as well as its factories. Based on these prospects as well as statistics for private fixed assets that reveal the average age of US factory stock is near 60 years old, the Association For Manufacturing Technology forecast U.S. orders of manufacturing equipment to rise 12% in 2018 up from an annual rate of 9% it forecasted this past November. Given the tax code changes, odds are this upgrade and expansion spending will span more than just 2018.

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

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

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

 

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